Blue Horseshoe Loves Energy

Damon GonzalezInvesting Leave a Comment

Before getting started, I have two announcements:

  1.  If you have an IRA managed by Domestique Capital, there is a good chance that you will receive a K1 tax form from USCF for your investment in the US Brent Oil Fund, BNO.  There is a little-known IRS rule that says if you have unrelated business taxable income UBTI of greater than $1,000 you have to pay taxes even though the investment is growing inside of your IRA.  None of our clients will have UBTI and you do not need to do anything with the KI you receive on your 2022 1040 tax return.
  2. Our latest ADV Part 2 disclosure form has been added to our website.

This month’s blog is all about energy and why we added an energy tilt to portfolios we manage in 2022.  For those who don’t understand the title, please watch the classic scene below from the 1987 classic movie, Wall Street.

As I have mentioned a million times, beating the stock market over decades is possible, but extremely difficult to do.  You are competing against the smartest and most well funded people in the world.   Even with their Ivy League MBAs, CFAs, satellite data, and Bloomberg Terminals, most funds don’t beat passive investments over time.  In 2007 Warren Buffet famously bet $1 million that a selection of hedge funds couldn’t beat the S&P 500 from 2008 to 2018.  The index fund returned 7.1% and the hedge funds averaged 2.2%.  This is why Domestique Capital has the bulk of client assets in low-cost, passively managed funds.

Even though U.S. stocks dropped a lot in 2022, as a whole, they are still expensive.  The 2010s were a wild time where the Federal Reserve was able to get away with expanding the money supply significantly without causing the consumer price index to rise substantially.  The world is a totally different place than it was just four years ago.  One of my biggest concerns is the world’s misguided energy policies.  Investing in energy at today’s prices seems to me as the best risk-reward investment on the board right now.

Brent Crude and Oil Service Companies

In June of 2022, I wrote about why I believe we are in a true energy crisis.  The bulk of the thesis is that there are a lot of young people building wealth in the Global South that want to live like you and I do.  The oil business lost billions of dollars between 2014 and 2021 and a variety of factors have caused energy companies to reduce exploration and new drilling.  Europe got really lucky with its warm winter this year.  Their troubles are far from over.  China has finally abandoned their inhumane, Zero Covid Policy, and the United States’ Strategic Petroleum Reserves are close to empty and will eventually be filled.

If I am right and the cost of energy rises significantly, this is terrible news for the world economy.  As a growing amount of people compete for these resources, the prices will go higher until supply rises to meet demand.  You can see in the chart below how energy CEOs went wild from 2000 to 2014 drilling holes in the ground.  This incinerated shareholder value and many of those firms are no longer with us or have new names after their bankruptcies.  It pushed oil prices low and the invention of fracking furthered our standard of living.  Drill Baby Drill ended in 2014 and I don’t think the oil companies will keep up with demand over the next few years.

Despite their recent outperformance, Energy companies remain cheap!  Look how Microsoft is valued higher than all 23 energy stocks in the S&P 500.

Timing when oil prices are set to take off is difficult.  I thought China reopening would be the trigger.  I also think the U.S. Government took a big risk depleting the Strategic Petroleum Reserve in 2022 and am surprised they haven’t started to fill it up now that oil is under $70.  We have had a lot of inflation since 2006 and Brent Crude is still the same price.  When you buy quality assets for low prices, things tend to work out over the long run.  Perhaps that is why some guy in Nebraska keeps buying up every share of Occidental Petroleum he can get his hands on.

 

 

Brent Crude. Source: Stock Charts

Last week was a crazy week for stocks and energy stocks along with most everything else were sold off as big funds began deleveraging.  I read about markets for hours everyday and I can say that virtually nobody saw the regional bank crisis coming.  I think the markets are missing the shortages of energy supply to.  This is an older blog post, but it does a good job of explaining how the author doesn’t think OPEC+ will be able to increase capacity.  You also have trillions of dollars that have ESG mandates and aren’t allowed to invest in energy products or lend money to these companies so they can expand.  NIMBY (Not in my back yard) and excess profit taxes aren’t encouraging companies to risk millions hoping for a new discovery.  Harbour Energy, the biggest oil and gas producer in the UK North Sea, has announced their new investments will be in countries that don’t have the U.K.’s windfall profits tax.  Brent crude spiked to about $140 when Russia invaded Ukraine and is down almost 50% in a year.  What “windfall” are the Brits even taxing?  Unfortunately bad people who don’t understand energy and the economy run our world.  We have found the easy to get to oil and gas if fracking has peaked, the world is in for an energy shock.

 

For further learning on oil, I recommend:

Yet Another Value Podcast: Judd Arnold on Offshore Rigs

Rigzone: Offshore is Back

Decouple Podcast: Have We Reached Peak Shale?

Follow @Josh_Young_1 and @ericnuttall on Twitter

 

Uranium

Commodities work in boom-bust cycles and uranium saw a major bust after the Fukashima Daichi disaster in 2011.  Many reactors were shut down and started to sell their nuclear fuel along with the supply that was coming to the market from the US and Russia’s Megatons to Megawatts Program.  With supply exceeding demand, the price of uranium dropped for a decade and this caused many mines to stop producing uranium.  Who would pay $70 a pound to dig up something they could only sell for $50?

In the Summer of 2021, the giant Canadian Asset Manager, Sprott, bought the Uranium Participation Corporation and re branded it the Sprott Physical Uranium Trust.  This trust can trade above and below the net asset value of the uranium stored in its warehouses.  When the trust’s share prices trade at a premium, it sells shares and uses the proceeds to buy more uranium.  You can see in the chart below that in less than two years, they have gone from owning 18 million pounds to 61 million pounds.

Uranium Stored in Sprott Physical Uranium Trust. Source: Sprott Asset Mana

Nobody knows exactly how much available supply there is sitting at nuclear power plants.  According to the World Nuclear Association, the World’s 440 nuclear reactors consume about 74,000 tons of uranium oxide per year and the mines supplied about 57,000 tons in 2021.  This deficit can’t last forever.  At some point, the price of uranium will have to rise and give a signal to the market to increase supply.  I think it might take one to two years to sufficiently supply the market.  After all, it is hard to find someone to work at McDonald’s in Houston.  Imagine how hard it is going to be to recruit people to go move to Where-am-i, Wyoming and learn how to mine uranium.  Below is a chart showing the amazing bull market of 2005-2007 for uranium that was followed by a long and painful bust.

The Bull and Bear Markets of Uranium. Source: Sprott Asset Management

The mines are not supplying the existing reactors sufficiently, but what about the demand side?  You can see in the chart below that much of the world has made some commitment towards net zero emissions.  I am not sure if it will ever happen, but I am sure that it can’t happen without a lot more nuclear power.  The world grids need base load power.  Solar doesn’t work at night and produces significantly less power during the winter months.  Sometimes the wind doesn’t blow much.  Intermittent power is making the grid less stable and require peaking natural gas plants to balance out the supply and demand of the grid.  When the wind stops blowing in West Texas these turbines have to quickly speed up to make up for the lost power.  The slowing and peaking of these turbines costs more than running them at a steady rate.

Source: https://www.climatewatchdata.org/net-zero-tracker

World governments are going to come to the conclusion that nuclear power is the best source of renewable, carbon-free, energy.  The IEA World Energy Outlook predicts a 52% increase in electricity demand from 2020 to 2040, with a 75% increase predicted from 2020 to 2050.  There are currently 439 reactors and 52 under construction.  We will see some older reactors retired, but I am seeing many reactors get a life extension.  There is even subsidies in the Inflation Reduction Act to keep these valuable assets producing more safe, green energy.  A current generation plant can last 80 or maybe 100 years.  Wind turbines are only effective for about 20 years and the resin and fiberglass blades can’t be recycled in a cost effective manner.  Solar panels only have a useful life of about 25 years.  If the world was able to install all the wind and solar it needed for Net Zero 2050 today, the “renewable” turbines and photovoltaic cells would all need to be replaced again before 2050 got here.  The more I learn about energy, the more I realize that nuclear energy is the only sensible path forward.  One day soon, even the politicians will figure it out.

For further learning on Uranium, I suggest the following:

Hedge Fund Manager, Harris Kupperman, on why he is invested in uranium.

Thestreet.com: Why Uranium is a Great Investment Right Now

Commodity Culture Podcast: Wild Expectations for Uranium Bull Run Won’t Play Out Like People Think: Warren Irwin

Wealthion: Doomberg on Why to Invest in Nuclear Power

Macrovoices Podcast 355: Mark Nelson Understanding All Things Nuclear

 

 

The opinions in this article are not investment advice.  Commodities and commodity producers are extremely volatile and can and do lose money (See oil and gas from 2014 to 2020 and the entire Uranium complex since 2012).

 

 

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