Podcast Summary
Principal Asset Management's 360-degree real estate perspective and economic concerns about commodities: Principal Asset Management's unique approach to real estate investment combines local insights and global expertise, while economic concerns about commodities indicate a need for significant investment to grow supply and accommodate demand, but investment is declining.
Principal Asset Management, as a real estate manager, brings a 360-degree perspective to the table, combining local insights and global expertise across various investment sectors. Their approach helps identify compelling opportunities. Meanwhile, in the economic sphere, there's ongoing concern about commodity prices and availability, creating a divide between financial exposure and physical supply. Jeff Curry, Goldman's global head of commodities research, believes we're in the early stages of a commodity super cycle, and ending it requires significant investment to grow supply and accommodate demand. However, investment is declining in an environment where it's needed most. In our daily lives, empathy and awareness can help us better understand the challenges people face, making both individuals and companies healthier.
Commodity market's extreme capital deficit due to ESG policies, banking regulations, and leverage ratios: ESG policies, banking regulations, and leverage ratios are limiting investments in commodities, leading to underinvestment, declining inventories, and commodity price volatility.
The current commodity market may be experiencing a more extreme capital deficit than in previous cycles due to a combination of factors including ESG policies and banking regulations. The leverage ratios in banking, which determine the amount of capital banks must hold relative to their assets, have become particularly binding as commodity prices have risen. These ratios, which are based on bonds and commodities, can be negatively impacted by commodity prices, making them inflation-proof in theory but not in practice. With the need for more capital in the current environment due to higher commodity prices, these constraints are limiting investments in commodities, leading to underinvestment, declining inventories, and volatility. This underinvestment then further scares off investments, creating a vicious cycle. The old economy sectors, including oil and gas, metals and mining, and agriculture, are being shunned due to ESG policies, making the situation even more challenging.
ESG vs Carbon Tax for Energy Transition: ESG may lead to investment distortions and insufficient revenue for decarbonization, while a carbon tax could be more effective in addressing climate change and promoting investment in the energy sector.
The current energy market volatility is a complex issue driven by various factors, including regulatory requirements, ESG initiatives, and a lack of investment due to the industry's poor returns over the past decade. The speaker argues that ESG may not be the most effective tool for addressing climate change, as it can lead to significant distortions in investment and may not generate sufficient revenue for decarbonization efforts. Instead, a carbon tax could be a more effective solution. Additionally, the speaker emphasizes that the energy industry's poor returns and focus on being capital light have contributed to the current capital deficit, and that investment in the sector is critical to easing inflationary pressures and promoting energy stability.
Challenges to Overcoming Energy Supply Issues: Private investment in energy industries like oil and gas is hindered by high inflation rates and historical financial consequences, but long-term contracts can provide stability and incentivize investment.
The current inflation rate and lack of underlying investment in industries like oil and gas are major obstacles to overcoming energy supply issues. The scale and access challenges of these industries make private investment difficult, and the historical financial consequences of past disasters add to the reluctance of investors. However, private investment is currently circumventing institutional players, causing an increase in oil stock prices. To effectively address these issues and promote environmentally friendly investment, a framework of policies and regulations needs to be established, allowing for long-term contracts and minimizing volatility. While some argue for government or central bank intervention to smooth out price volatility, it is essential to remember that long-term contracts are the most effective solution for providing investors with a stable return and incentivizing investment.
Navigating tech industry's volatility through long-term contracts: Long-term contracts and stable environments are vital for tech industry investments. Regulations or creative solutions, like oil-specific policies, can help manage volatility and encourage long-term investments.
The tech industry offers a high-risk, high-reward investment opportunity with a relatively short cycle, but securing long-term contracts and creating a stable environment are crucial for maximizing returns. The seventies saw the creation of long-term contracts and conglomerates to mitigate volatility, but the financial market's involvement in the 2000s led to new types of long-term contracts and increased risk. The current situation calls for a regulatory framework or creative solutions, such as oil-specific policies using the Strategic Petroleum Reserve (SPR), to address the volatility and encourage long-term investment. However, releasing oil from the SPR can crowd out private investment and may not fully solve the long-term investment problem. It's essential to consider policies that incentivize long-term investments while managing volatility.
Temporary Factors Driving Down Oil Prices: Oil prices are currently low due to temporary factors like US SPR release and decreased Chinese demand, but structural issues and demand rationing in Europe for natural gas may cause prices to rise again.
The recent release of oil from the Strategic Petroleum Reserve (SPR) by the US and the decrease in demand due to COVID-19 in China have contributed to the current downtrend in oil prices. However, these factors are considered temporary solutions to a structural problem, and prices are expected to rise again once inventories are depleted and demand rationing is necessary. Natural gas prices, particularly in Europe, are already at a demand rationing phase and are expected to continue rising. The US, with its shale production capabilities, is less affected by these trends but will eventually exhaust its supply cushion as more LNG terminals are built to supply Europe. The question then becomes whether expanding LNG export capacity is in the US national interest, as it could lead to higher prices but also increased export revenue. The permitting process for building new LNG terminals takes around 4 years, but could be expedited.
LNG may not be the best solution for powering a manufacturing economy: LNG is impractical for powering manufacturing economies, while commodities are chosen based on their cost basis for specific uses, and market-based solutions like carbon pricing can help determine the best replacement for high-emission commodities.
While creating a liquefied natural gas (LNG) terminal is a long and drawn-out process, it may not be the most viable solution for powering a manufacturing economy in the long term. The German industrial manufacturing base, for instance, cannot operate off LNG. Instead, it's more practical to move manufactured goods on bulk cargo containers than it is to transport LNG. However, LNG does work well for heating and other purposes. The discussion also touched upon the fungibility of commodities, particularly in the context of geopolitical crises and supply chain disruptions. The speaker emphasized that there are BTU conversions across various commodities, and we have seen this phenomenon in the past. Commodities are chosen based on their cost basis for specific uses, such as transportation, building materials, food, and energy. While we could theoretically use one commodity, like corn, to do all of these things, we don't because it's too expensive. Instead, we should explore market-based solutions, such as carbon pricing, to determine the best way to replace commodities with high emissions.
Price on carbon essential for environmental solutions: A price signal and enforceable policy are necessary to drive investment and innovation in addressing environmental challenges, such as climate change.
The solutions to environmental issues, such as the war on acid rain in the 1970s, were driven by enforceable policies and a functioning market. The same approach is needed to tackle the current issue of climate change. The key is a price on carbon, which would encourage investment and innovation. The lack of such a price and the underinvestment in various sectors due to historical disinvestment in old economy industries is contributing to the current commodity shortages and the slow ramp up of new production. These shortages and tightness in markets are leading to persistent transitory shocks, creating a ripple effect across various sectors. Historically, conservation and environmental policies have gone hand in hand, and it was during the Nixon administration that the Clean Air Act was passed in response to visible damage from acid rain. The key lesson is that a price signal and enforceable policy are essential to driving investment and innovation in solving environmental challenges.
Underinvestment in certain industries led to missed opportunities due to poor returns and decarbonization: Shifts in global savings patterns could impact the correlation between commodity prices and the dollar, potentially leading to increased dollar availability and reduced likelihood of savings gluts.
The underinvestment in certain industries, particularly those with poor returns that were heavily impacted by decarbonization, led to missed opportunities in the past. Regarding the potential demise of the dollar and its impact on commodities, it's important to consider both the demand and supply of dollars. In the past, savings gluts led to a significant transfer of wealth and created a correlation between commodity prices and the dollar. However, today, entities like China and Saudi Arabia have the ability to spend their excess dollars immediately, reducing the likelihood of a savings glut and potentially leading to increased availability of dollars on the global market. This shift could result in a spending spree rather than a savings glut, making it a significant difference from past commodity bull markets.
Localized investment and economic self-sufficiency could lead to increased demand for commodities and higher prices: The trend towards localized investment and economic self-sufficiency could result in higher demand for commodities like oil, gas, and metals, leading to increased prices and inflation, as well as higher funding costs in certain economies.
The trend towards localized investment and economic self-sufficiency, as seen in entities like the Public Investment Fund in Saudi Arabia, could lead to increased demand for commodities like oil, gas, and metals in specific economies. This could result in higher commodity prices and inflation, as well as increased funding costs in places like the US. The production response from OPEC and other oil-producing countries has been limited due to underinvestment and supply constraints. Meanwhile, the shift towards electric vehicles is expected to increase demand for certain non-energy commodities like copper, which could face significant supply shortages. The transition to renewable energy and electric vehicles is a complex process, and it will take time for EVs to overtake traditional internal combustion engine vehicles in terms of market share. The peak of petroleum demand is expected to be reached in the 2030s, but the transition may be disrupted by geopolitical events and environmental concerns. The demand for copper and other metals used in EV batteries is expected to increase significantly, making copper one of the tightest commodities we have ever seen. The upside potential for copper prices is significant, but the transition to renewable energy and electric vehicles will be a long and complex process.
Investing in commodities: Get close to the source: Invest in commodities by getting as close as possible to their production or consumption for better returns and potential entry points during market volatility.
The transition to decarbonize and reduce reliance on fossil fuels may not happen as quickly as some anticipate, as history shows that people often wait until the problem is at their doorstep before taking action. However, when action is taken, it can lead to rapid solutions and significant changes. For investors looking to gain commodity exposure, it's recommended to get as close as possible to the consumer or producer of the commodity, as financial instruments can have disconnects from physical commodity prices. The Bloomberg Commodity Index (BCom) is an excellent product for achieving this, as it rolls the front month of various commodities, bringing investors closer to the consumer and potentially generating better returns. With recent volatility in commodity prices, particularly oil, it may be a good entry point for those believing in a long-term commodity bull market. Copper, for instance, is experiencing tightness that rivals or exceeds what was seen during the oil price cycle in the early 2000s, and its price could potentially reach $15,000 a ton. Ultimately, the key to success is investing in solutions to the problem, as engineers and innovators have the ability to find solutions given enough time and resources.
Significant commodities market deficit, particularly copper, estimated at 15%: The commodities market, especially copper, faces a large deficit of 15%, three times tighter than during the peak oil era. This tightness isn't reflected in the market yet due to Chinese property concerns, but will change by 2023 when the green CapEx story dominates.
The current situation in the commodities market, particularly with copper, is facing a significant deficit much larger than what was seen during the peak oil era. The deficit is estimated to be around 15% of the market, which is three times tighter than the oil market during that time. This tightness is not reflected in the market yet due to investor concerns over the Chinese property market. However, the situation is expected to change by 2023 when the green CapEx story becomes the dominant force. To address this issue, a policy framework around decarbonization and a carbon price is necessary to encourage long-term investment. This policy should be implemented in the US, Europe, and China, which together account for 2/3 of the world's emissions. Additionally, creating a long-term contract system can help reduce volatility for investors. Ultimately, the challenge is to get people to commit to investment in the extraction of commodities, especially as the world moves away from fossil fuels. This requires a clear and enforceable policy around decarbonization and a carbon price.
Underinvestment in commodities and the challenge of transitioning to a sustainable future: Despite the temporary belief that commodity prices will decrease and investment will shift to tech and other emerging industries, the need for commodities in the transition to a sustainable future is increasing. Investment in these industries is crucial for a smooth and successful transition.
The underinvestment in commodities, particularly oil, over the past few years is due to a combination of factors including price volatility, regulatory hurdles, and the allure of tech and other emerging industries. This underinvestment is perpetuated by a belief that these conditions are temporary and that the world will soon normalize, leading to a decrease in commodity prices and an increase in investment in other areas. However, the need for commodities like oil and copper to transition to a more sustainable energy future presents a unique challenge. The demand for these commodities is actually increasing due to the shift towards electrification and renewable energy. Therefore, it is essential to recognize the importance of these "old economy" industries in the transition to a more sustainable future and to invest accordingly. The volatility and uncertainty surrounding commodity prices can make this a challenging proposition, but it is crucial for ensuring a smooth and successful transition.
Odd Lots nominated for a Webby Award: The Odd Lots podcast, produced by Bloomberg, has been nominated for a Webby Award in the business podcast category. Listeners can show their support by voting at vote.webbyawards.com.
The Odd Lots podcast, produced by Bloomberg, has been nominated for a Webby Award in the business podcast category. Francesca Levy, the head of Bloomberg's podcast, expressed her excitement about the nomination and encouraged listeners to show their support by voting for the podcast at vote.webbyawards.com. The voting process only takes two minutes, and the podcast can be found on the Iheart Radio app as well as other popular podcast platforms. While the hosts of the podcast typically don't place a big emphasis on awards, they are eager to win this recognition. The Webby Awards are known for honoring excellence on the internet, and a win would be a significant achievement for the Odd Lots team. Listeners are encouraged to spread the word and help bring home this award for the podcast.
