Odd Lots - Jeff Currie on the 'Volatility Trap' Keeping Commodity Prices So High

Episode Date: April 14, 2022

Goldman's top commodity strategist Jeff Currie was one of the earliest to call that we're in a new commodities supercycle, starting early last year. Well, it's not even close to over. Currie estimates that we're just in the second inning of it. The issue is what Currie characterizes as a "volatility trap" that's keeping investment on the sidelines, despite surging prices of spot commodity prices. In this episode, he explains how far commodity prices can go, what the challenges are to inducing further investment, and what policies could help bring things into balance.See omnystudio.com/listener for privacy information.

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in Sauton by Sante Canada. Hello and welcome to another episode of the Odd Lots podcast. I'm Joe Wisenthall. And I'm Tracy Allaway. Tracy, we got the latest inflation data this morning. We're recording this on April 12th.

And it was interesting. I mean, it showed there's some easing perhaps in sort of core goods, core inflation on that side. But the headline, which of course includes energy and food, continuing to move higher, at least as of March. Yeah, that's certainly right. And last month would have captured the worst of the energy spike. So a lot of commodities prices have come down ever so slightly.

But it does feel like there's just generally a lot of angst and concern about what's happening with commodity prices at the moment. And I have to say, I just realized the last time we spoke to our guest, it was also CPI day. And we started out the discussion basically in exactly the same way. Okay, so any year from now, we're going to go, there's some good news here, but oil is a 300. No, but yes, oil and other food-related commodities, energy, natural gas is very expensive. There is, of course, I think two dimensions.

One is like pure price, and then the other is availability. Because as we've been talking about, some recent guests, including Pierre Anduron, like, those have become two separate things. Also, Zolt and Posner, like, there's this fracturing of global commodity supply chains we're seeing. Absolutely right. and even financial exposure to commodities, you might make a lot of money at the moment, but you're not necessarily guaranteed to take delivery. There seems to be a chasm opening up

between financial commodities exposure versus the physical. We saw that very dramatically with nickel and some of the dislocations there. Well, no more intro. I want to get right into our guest because we've had him on twice before, and I would say, of all the people we talked to, he's probably called this commodity cycle.

maybe it's a super cycle as well or better than anyone. We are going to be speaking with Jeff Curry. He's at Goldman. He's the global head of commodities research. We had him last on in middle of October, and he said there was more pain ahead in this commodity super cycle, and that has proven clearly to be true. Jeff, thank you so much for coming back on odd lots.

Great. It's a pleasure to be here. I didn't realize it was CPI week last time. Well, let's just start it off really simple. Like, is there, you know, in the middle of October, you said there is still more pain ahead that clearly proved to be true. They start really general. Is there more pain ahead? It's a different kind of pain.

We like to argue we're entering a volatility trap where higher of all discourages investment, which then reinforces higher of all. And to think about what ends a super cycle, there's only one thing that can end a super cycle. investment. You've got to grow a supply and de-bottleneck the system so that you can accommodate more demand growth on a forward-going basis. And that's how you ended the 70s. It's how you ended the 2000s. And that's how we're going to end this one. But at this point right now, investment, whether it's investment through capital markets, through banking, you know, in the commodity markets themselves, it's all declining right now in an environment in which it needs capital more than ever. So, you know, it's like to say, we're in the early inning still. Maybe it's the second

or third inning of the super cycle, but we're just getting going now. Well, why don't we just jump into that point then? Because this is something that has come up quite a lot on recent episodes, this capital investment point. What is it, in your opinion, that's holding back that investment? And when would we perhaps expect that to change as higher prices start to incentivize more producers. Well, this one is a little bit different than the other cycles, but why don't we start with the other cycles and then talk about how this one is different? And the way this one is different is through ESG in banking regulation following the financial crisis in 0809. So let's go back to the 1960s. You had the nifty 50. That was your new economy, booming along, absorbing much of the

capital from the old economy and starving the old. old economy of the capital it needed to grow the supply base, which set you up for a very tight supply environment when you got the big uptick and demand off the great society in the late 60s and the early 70s. Similar dynamic that happened in the 2000s as well as today. You think about in the 2000s, you had the dot-com boom, and in the 2010s, you had the bang boom. So it was a very similar dynamic, and you saw that, you know, basically. Basically, it was this whole idea, the revenge of the old economy is investors preferred growthy names like Netflix to old economy names like Exxon. That created the capital deficit that led you into this environment.

Now, why is this one so much more extreme than ones that we've seen in the past is when you have ESG policies overlaid on top of that. I'm not going to belabor those points much further because we've talked about them in the past. But it's important to remember that ESG is not a substitute for a carbon tax. It's a blunt instrument that is reducing capital flows into a very critical sector. So if you had a carbon tax, you'd put the carbon price into that energy company model, look at its carbon emissions and think, hey, is this a good investment or a bad investment? What we're seeing is the entire sectors being shunned. And that's made this one much tighter.

And it's not just the oil and gas guys. It's the metals and mining as well as the agriculture sectors. But banking regulation, and that's the one that I really began to focus on over the last, let's say, two to three months. And it really boils down to leverage ratios. And those were put in place back in, you know, Dodd-Frank, back after following 0809. And let's think about what that leverage ratio is. It's tier one capital on the top and the total assets at the bank on the bottom. If you think about what is tier one capital?

It's bonds. What are all the assets that go into the economy, all that lending is based off commodities? So it's things the real world. And so let me ask you if you have, most policymakers are going to tell you it's inflation proof because it's the price level times the bonds and then the price on the numerator and then the price level times the overall assets on the denominator. So the price level drops out. It's inflation proof. The reality, it is not.

And why? Because bond prices are negatively impacted by commodity prices. So essentially, what is that ratio? It is bonds on the top and commodities on the bottom. And what we're seeing is that these leverage ratios are starting to become really binding. And you think about how much more capital of the market needs today than it did, let's say, you know, a year ago. We have oil prices or 2x what they were. year ago, you're going to need two times the amount of working capital out there. And it's in an

environment, you're already bumping up against those constraints in banking. Do you think about banking? Banking's old economy, too. It's, you know, anything that is at, you know, capital heavy. The world was focused on asset light, capital light, everything of that investing, but we've now focused on a need for having capital heavy investments, particularly in commodities at a time it was already underinvested and at a time that you have ESG constraints. So I think, you get the idea that the capital deficit in this market is extreme, and now it's kicking off this volatility trap where the underinvestment leads to declining inventories to raise cash, liquidation of financial positions to raise cash, all of that accentuates the volatility,

and then scares off further investment. So you now are entering this volatility trap, you know, that we've made the point, and I've testified in Congress on this point before, is the only way out of this is you need somebody to stop that vicious cycle and create some type of stability. I say I like to say is spot prices solve surpluses, long-term contracts solve shortages. Can I just ask, because I know we'll have people who listen to this and they'll hear someone from Goldman Sachs, you know, a big bank, a sell side analyst, they'll go, oh, wait, it's someone from Goldman complaining about bank leverage ratios and ESG and regulatory capital requirements.

Can you just, can you flesh that argument out a little bit? Or what would you say to the critics who are immediately going to go, well, this is just, you know, a bank talking its own book. Obviously, a bank would like to lend more to the energy sector. Well, one is the banks, all of them, are very much behind the ESG push. And I want to emphasize, I am very, very much a pro-climate change and really believe it's a problem that needs to be solved. What I'm arguing is ESG is probably not the best way to go at it. You know, as I really believe, a carbon tax is the right way to approach this. And most economists would agree with me on that.

And the way I could think about, ESG is an effective carbon tax on the consumers in places like the United States in Europe and particularly high carbon tax in places like Europe, where the tax revenues do not go to the local governments, is going to places like Russia. You know, in fact, like to point out, you know, the quarter over quarter growth in oil revenues for Russia funded its $62 billion military budget last year. So, you know, the impacts of ESG in the fact that you're not collecting that tax revenue is significant, but more importantly, it creating big distortions and investment. So, you know, I want to really emphasize I'm very much pro-climate change. It's a problem we need to deal with decarbonization.

It's just ESG is not a effective tool in approaching this. Well, there's a more effective tool of doing it. In terms of the question about bank regulation there. You know, the point, I'm just going to point out that the energy companies and the trade houses in Europe, they went to the regulators asking for more funding. So clearly there's not enough funding. And whether it's coming from the likes of banks, there's a point is that you're bumping up at these constraints. The whole industry was focused on being capital light.

And it goes back to this whole revenge of the old economy because banks are, old economy too. In fact, you look at bank price shares and you look at metals prices where you are in the KAPX cycle, they're very much correlated because ultimately the banks are the conduit of that KAPX cycle. So they're all really old economy and pretty much more broadly since 0809, old economy was bad. I could just show you pictures of the equity prices of anything that was capital light, it went straight up. Anything that was capital heavy, you know, like the big oil companies, went down or sideways over the course of the last 10 years. And it's not just, you know, so I'm not going to blame it all on ESG, unless I only be very careful here, so it doesn't sound like I'm so anti-ESG. This industry had really bad returns.

Investors were not interested in it. And if we go back and we look at the previous super cycles, let's say the one in the 2000s, prices started to move up in 03 and it wasn't until 06 that capital came in. they want to see a track record of good returns? That still holds today. So I'm not to blame it all on ESG, all on banking regulations. It's just a combination of many different factors that's created a huge capital deficit. I want to point out it wasn't just all Volcker that solved the 70s. There was a huge amount of investment that went into North Sea, Alaska North Slope, Gulf of Mexico, Mexican production, Brazilian, Norwegian, I can keep on going down the list. That investment that came to fruition did a lot

to ease the inflationary pressures as you went into the 80s. So you just can't, you know, contribute all to the rate hikes by the Fed because there was a lot of that investments. That investment's critical. And we're at a junction right now with eight and a half percent inflation, but we still haven't seen the underlying investment that was already there, let's say, in the 70s that is not here today. We need that investment because the only way out of this is investment in the appropriate ability to grow that supply. You know, you hear from, say, the CEOs of independent oil companies, and they talk about the demand among investors for returning cash. And that's totally understandable because after a decade of the industry having lost half a

trillion or whatever the numbers are, you can understand investors want to optimize for cash flow. And you can also understand, as you've been pointing out, the reluctance of banks to, you know, bump up against their capital requirements by lending further. Why not, though, more opportunities on the private side or why not, you know, why haven't we seen, you know, me and Tracy just start a private oil company and forget about the public markets, forget about borrowing from banks, and, you know, borrow money in the bond market and return money to our investors privately without some of these outside financing considerations. Why aren't more players taking advantage of seeming like, you know, with oil where it is, roughly $100 opportunities around that?

scale. The scale of these industries are unlike anything else on the planet of Earth. You take a Kashagan and Kaspian, its nickname was Cashall gone. Why, you know, it was somewhere around a $60 billion project. I mean, the magnitude in the scale of these investments are unlike anything. And take a company like BP with that horizon spill. It had a right over a check. The fines for something like $38 billion. Tell me another company on the planet Earth who could write over a check for $38 billion. So the first and most important issue is the scale. Then the access issue is really critical. I like to point out things like copper are very narrowly geographically distributed. So you need to have the scale to be able to get into these

places. And you have to have the ability and the know-how to the technological know-how, the political know-how to go in there and do it. So I think that is one of the real key reasons here. But by the way, I want to point out, why are the oil stocks going up? It's because private investors are going around the institutional players in making these investments in these companies. So where it can go around, it is, which is why, you know, ultimately, if you're going to solve climate change, you know, I don't want to, you know, sound dismissive here. But when, you know, the Russian armies coming barreling down, you can't have Germany turning back on the coal plants. You know, historically, when you deal with these problems, you have to have policy-create

rules. These rules need to be enforced. And those rules, if they're violated, there has to be punishments and there has to be a price associated with this is why, you know, trying to go down this ESG-type path to deal with this is going to miss a lot of these really critical points that are going to be required to solve this problem. So, point, you know, looking at this on a, you know, a longer-term basis, we need to have policy put in place that is creating a framework that can be conducive to getting these capital flows coming to the right places. Because even if the private investor tries to do it, he still needs to do this in a way that is environmentally friendly. And I think that, you know, again, you need to have this scale. The policies put in place in such a framework

that it's done and that it addresses the need for investment in a very environmentally friendly way. So you're talking about this volatility trap, and I think you briefly mentioned this earlier, but there has been talk of maybe there is a role for either governments or central banks to play in this space, to make things smoother, maybe smooth out price volatility, or provide financing or funding for energy firms or energy traders that need it. First of all, is that required in your view? And secondly, what is the best way to try to smooth out volatility to give players in the commodity space confidence to actually invest and produce? Well, it goes back to that saying I as made before, you know, spot prices solve surpluses, long-term contracts solve shortages. Why is that the case?

It's because if you can take out that volatility and lock in that return through a long-term contract, that investor feels that he, you know, it's safe to be able to make that investment because there's a minimal rate of return. Because remember, these things are, these things are not like tech. Tech is you have a low chance of getting it, but you get a big return that lasts over maybe 12 to 18 months, you know, like something like an iPhone. It's very short cycle and it's high returning. These are low returning, very long cycle type of investments. So locking in that rate of return throughout that volatility is really critical. And so when we think about, you know, what you need to do to get that, you need to create an environment that's conducive to creating that type of long-term contract structure.

You know, and actually, if you look at what happened in the 70s, that was when we created many of these long-term contracts around LNG and gas, so forth, but there was also conglomerates that were put together to be able to shield the upstream, downstream type of volatility. There was lots of ways, and then we moved in the 2000s to a market base, and this will bring you to the nickel story. Why was this nickel story? Because in the 70s, we did this with like conglomerates in long-term contracts. If somebody failed a long-term contract, this thing would be resolved in a court of law.

So then in the 2000s, the banks got in between these conglomerates, let's say between like a GM and an alcoa could squeeze in there, provide lower cost of capital. And you had the financial market squeeze in there and then create that new kind of long-term contract that was financially based. Now, the problem with that is that when you go through periods like we are right now in that price of that long-term contract goes up because it's traded on the market, you get a huge capital call and a margin call, which is what was happening with that case in nickel. Then you need the cash to fund that margin call. You didn't have that back in the 70s. You have it today. So that's the question is, are we going to gravitate something back closer to the 70s to deal with this problem?

or are we going to try to fix the structure that was created in the 2000s, which means you're going to need different type of lending agreements, and people have to be more comfortable in that risk in how much capital these sectors need. Obviously, I think the easiest way to solve with this is create a regulatory framework. You know, Tracy, as you talk about, that would be able to address these issues, take out that volatility, make banks, investors, and so forth comfortable with that kind of risk. Otherwise, we will go back to the period of the 70s, which is vertical integration, conglomerates,

and these longer-term contracts that end up in courted laws, not in financial institutions. Is there more, so one proposal that's floating out there would be to be more creative with, this would be oil-specific, of course, with the SPR. And so we know that the administration has authorized daily sale of oil.

Could it solve the long-term contracts problem or the challenge by pairing that with more, more robust commitments to buy back at a certain price. We have seen this sort of, it's flattened a little bit, but this heavy backwardated oil futures curve, essentially putting a floor underneath the longer term prices. And could it use the SPR to sort of create more domestic supply and investment right now? You can do that.

What you're describing of the farm subsidy programs that the U.S. has with, you know, it's farm bill with the farmers in terms of giving that kind of basically buying the farmer a put on soybeans in case some bad weather shock or something like that occurs. You don't need the SPR to create that type of dynamic. But what you're talking about is a physical version. You know, the farm bill really is one that the farm subsidies are ones that are more like a financial put, but what you're describing is more like an in-kind physical put. Both are ways to think about solid it.

But the one thing I will say about dealing with higher oil prices with an SPR release, like what we're seeing right now, that's cross. out private investment, which doesn't help solve that longer-term problem of getting investment into the right place. So these policies need to be thought through in such a way that they're conducive to creating incentives in place to make these longer-term investments. I wondered if I can ask something I've been wondering about when it comes to the SPR release, and I'm sure a lot of people have been asking this as well. But it's a pretty big release, and we saw a very immediate impact on prices. And I think Goldman also cut its prices.

target on oil because of the release. What happens after this? How does that actually get topped up in the future? And how does the U.S. source that oil and at what pace would you expect it to replenish that stockpile? I mean, the details on the replenishment rates are not that clear at this point, but it would be at least a year or two before you expect them to come back and buy it. I think the plan right now is that they would go back and buy it. But let's talk about the impact that it has had on prices. There's two factors that have created the recent downdraft in oil prices and commodities more broadly is the SPR announcement, which was a million barrel per day, throw in the Europeans, it gets up to around 1.2 million barrels per day release for about six months. And then, you know,

it's meant to be a bridge the gap until you get the investment that brings on new supply that can be used to refill the SPR. So you can see it's a temporary patch. And then you have the COVID situation in China, which is another 2 million barrel per day demand hits. You've had a big hit to the situation more near term. Now, I want to emphasize, though, that, you know, these are all transient events. A loss in demand, once you normalize China, you get the problems come back again. Once you have to buy back those barrels of oil that go into the SPR, the problems come back again. So we're in a down draft right now, which is part of this whole idea of higher volatility, but it doesn't mean that any of this is signaling into the longer term problem. I'd like to point out,

Policy right now is a temporal solution to a structural problem that needs to be readdressed. I wanted to pivot actually, you know, so much of our conversations, and I think like over the last several years, most commodity conversations, including this one so far, there's obviously a high emphasis on oil. But natural gas is also really at the forefront of mind. We see prices. They were already surging in Europe even prior to the invasion. Obviously, the politics of Germany and other countries cutting such a big check to Russia every month is incredibly uncomfortable. And we've seen prices rising here in the U.S. I think it's like a multi-decade high at the Henry Hub prices for natural gas. What is the, where is the how much further? Let's start just simply,

does that, do prices there have a lot further to run in the U.S. and Europe? In the U.S., yes, in Europe. You're at the demand. rationing phase. You're going to have periods. We're going to have more severe shortage. You need more upper price bikes and maybe you have periods that less tightness. But you're at that, you're at that. You can think about a commodity cycle that is going, you know, from you draw your inventories down and the price begins to trend up. Once you've exhausted your inventories and have to go into a demand rationing phase because you don't have enough supply, that's when, you know, you get the high volatility. Europe is at that phase right now. The U.S. on the other hand is not. One, it has

the shale production that can be brought online. You can't continuously export it because there's constraints around LNG liquid liquidation capacity in the U.S., which means the U.S. is much more immune to this than the rest of the world. I like to say it's East Iraqi U.S. California has a problem similar to the rest of the world, but East of Rocky's U.S. is a relatively well-supplied market, But it won't be forever, particularly as you continue to build more LNG terminals and the policy more recently in response to the situation in Russia, Ukraine, is, you know, to build more LNG terminals to supply Europe, which will ultimately exhaust that cushion and then push you up into a much more higher-bawal regime. But I don't think we're going to get there any time in the next year.

So this is something that I'm curious about, is expanding LNG export capacity? Like, how should we think about it from the perspective of U.S. national, because it does seem like a more globalized LNG market would cause prices to go up. On the other hand, we would have more export revenue. So how should we think about it from the policymakers? Is it an unallied good to continue to build out LNG export terminals and so forth? If you do it with all the permitting, some are around four years. You take out the permitting, you could get it down to 23 months.

You do a Defense Act, Production Act type. Maybe you can squeeze it down to 12 to 18 months. I don't know what you could get it down to. But you get the idea. It's a pretty long, drawn out process to create one of these liquefaction terminals. And that's definitely one of the goals in terms of dealing with this geopolitical situation. But I want to emphasize the following. And I've talked to many German industrials that have made this point.

The German industrial manufacturing base can't operate off LNG. move the BMW plant to the U.S. and build the BMWs on top of the gas plant and then export the BMWs or build the BMWs in Qatar. Don't move the gas. You know, move the gas to heat people, but you can't run an industrial base off of, you know, liquefied gas. You know, I've never been a fan of that. You know, think about what this thing is a $300 million floating thermos that is frozen and you pump a bunch of gas into it, and you move it around the world. It's a lot easier to move manufactured goods

on bolt chip containers than it is in LNG tankers. So I'm not a fan of using LNG to run a manufacturing economy, but it does work for heating and things like that. But, you know, the question is, you know, is this the most viable solution to this thinking about it on a longer term basis? It's probably not. So this actually leads into my next question quite well, which is how should we think about the fungibility of commodities in this situation? Because it seems like one thing we are learning over the past couple of years is that if there's a crunch on coal in China, it's not that easy to source alternates. If Russian gas is suddenly taken out of Europe, it's difficult to source replacement supplies as well. So how are you thinking about that? And how does that inform your overall? super cycle commodities thesis.

It's critical here. And as I like to say, there's BTU conversions across all these commodities. We saw it in the 70s. We saw it in the 2000s and we're beginning to see it happening again, meaning that if you think about commodities and you rank order them, we chose all these commodities to do what they do for us by their cost bases. Actually, I come to the point. There's four things we use commodities.

Obviously, transportation, and we figured out oil is the lowest cost way to create that transportation. You can do it with electricity, you know, with, let's say, nuclear, but it's got a different cost basis. Actually, it's higher. If you just look at the density of oil and you put it into the car, it's pretty much the lowest cost way to do that. In fact, Ford and Edison had this debate well over 100 years ago about which one was better, and we determined at that point in time that the oil was. Then the other one is we need to build things. And, you know, copper is best for things like plumbing, electricity, conducting electricity.

Then you have, we got to feed ourselves. We figured out using corn, wheat, soybean, which are your workhorse grains that were the cheapest to do that. And then you have to cool yourself, heat yourself, which then, you know, you look at natural gas and nuclear and those other types of combines. So we chose all these things for that reason. Let me point this out. and this is fairly obvious, we could do all of that with corn. We can drive our cars on corn. We all know that.

You can make plastics out of corn. You can build your house out of corn. You obviously can feed yourself with corn, and you can use corn to generate electricity, heating, cooling, and all those things. So we would only need one commodity to do that, which is corn, but we don't do it because it's too expensive. And so what you're asking now is, okay, we look at some of these other commodities like oil and gas. They have these emissions that we don't like. let's figure out how to replace them.

And the best way to do it, I'm going to go back to my carbon price, carbon price, put the carbon price out there, this is how much it's going to cost to do it? Then let's figure out, is nuclear the best way to do it? Is hydrogen the best way to do it? That would be the appropriate way to do is create a market-based solution to find the answer to this. I want to go back and talk about the 70s because it was very similar to today about the war on acid rain and how we solve the war on acid rain. In fact, the same three big themes we talk about the super cycle,

about redistribution of policies, environmental policies, and de-globalization, they're all the same ones. You had redistribution was the great society or the war on poverty. The environmental was the war on acid rains. And let's talk about how that war on acid rain was solved in the 70s. is there was the Soviets and the Americans wrapped up in a nuclear treaty that was enforceable the rules around desulfurization. And in doing that, you had an enforceable rules that then was imposed on NATO countries

and Warsaw-Pact countries, which is why they were able to enforce them. But you got a functioning sulfur market out. Once you have the functioning sulfur market, you were able to let venture capitalists come in there and create the solutions to it. And by the way, it ended up solving the sulfur problem was much cheaper than what we'd ever envisioned. We're now focused with a very similar part. By the way, the other lesson to learn from the acid rain, when did the Americans get serious about dealing with the acid rain when places like Lake Erie were on fire? They had to see it.

And once they saw it, they passed. The other thing to do it was Nixon who passed the Clean Air Act. And, you know, a fact, actually somebody pointed this out to me that, you know, conservation, conservatives and conservations historically had a gone hand. in hand. But I think the key point here, it was a sulfur market with a price signal, and it was enforceable policy that led to that solution. And we need something similar to that around carbon to deal with this current problem that we're dealing with, call it the war on climate change. So just to put it all together, you know, ESG, in your view, discourages investment. What we need is a price on carbon, some sort of tax, but then that would, in theory, create the

encouragement of investment because, okay, you know the rules, you know the cost that any given entity is going to bear, and then the challenge is out there to do better, to find a way to make it profit. Absolutely. And then you would look at some oil companies and you would put their total emissions, you know what that number is, you put a cost on it. And then the equity analysts would go, hey, this is a good company, this is a bad company. And I did it. You were looking at the economics that they're imposing on society. And then we wouldn't have this blanket under investment that's creating many of the problems we're witnessing today. Can I ask, you know, how do you see like these various shortages and tightnesses in markets affecting all the other ones? Because it's interesting,

you know, one of the reasons cited for the slow ramp up of U.S. production is shortages in metal pipes and shortages, well, shortages in labor as well, and other commodities sand as well that are needed to expand domestic production. How much is essentially the shortage and the tightness of every commodity at the same time contributing to slowness in the ramp up of a of a of a of new production and new investment. It's a revenge of the old economy. At my point, banks are old economy too. It's why they're not providing the capital. They don't have the capacity. We didn't invest in everything you just mentioned plus old economy banking. I can just give you a list of all the things that were underinvested. You know, warehouses in the U.S. port facilities. You know, it's a trucking chassis.

The list goes on and on. And then all of a sudden, we got a pull in demand that stress the system and then we find out where all these shortages are. You know, part of the reason why, you know, you go back to, you know, the 70s and the 2000s. What made it very similar was you had that same dynamic of that, you know, revenge of the old economy, being the new economy, the nifty 50 sucked all the capital away. It was the dot-com boom did it again in the 2000s, the fangs again this time. That's why you have this, you know, it's a very broad space. But once you brought base shortages, you get this persistency in transitory shocks, meaning that one shock in one market then leads to another shock in another market,

which then makes it feel like, you know, the transitory becomes much more persistent. That's what we're seeing. But the core reason is everything you just listed were poor returning industries that also were very much impacted by decarbonization, which as a result, we under the investment. Can I ask another question on a topic that has been coming up quite a lot recently, which is this idea of the demise of the dollar or the long-term decline of the dollar. And maybe that starts with certain commodities producers asking to be paid in something other than U.S. currency. So we've seen Russia talk about getting net gas payments and roubles, for instance. And there have long been rumors and speculation about China taking U.N. payments and things like that. How do you see that playing out in the commodities space? One, to make one of these reserve currencies work, you need to have a current account deficit in a very large bond market, of which China does not have.

But I think, you know, let's go to another point about, you know, all this, you know, talking about the demise of the dollar is, you know, everybody's focused on the demand of the dollar. Let's talk about the supply of the dollars. And you look at the commodity bull markets in the 70s and the other in the 2000s, what was associated with both of those was a savings glut. And the reason why everybody thinks that higher commodity prices and oil prices is bad to the economy, it's because could you think about it? If you just took a closed economy, raised oil prices, let's say the U.S., let's take the U.S.,

produce enough oil, you raise the oil price, all it is is a transfer from Chicago to Houston. it should have no impact on the broader U.S. environment. Maybe they'll spend, you know, through the wage increases in Houston may take time. I don't want to get it. You get the exercise that went through. If everybody had the same consumption and savings, it had no impact. The reason why the 70s and the 2000s had such an impact and we saw it was that savings glut.

You had a transfer from groups in the U.S. that would consume something, you know, like 92%, to groups that were consuming somewhere around 50 to 60%. And then so that you created that savings glut. You know what? This time around, they're going to spend it. You're not going to get that savings glut off the higher commodity prices, which is going to reduce the availability of dollars on the global market. In fact, the reason why you had that sharp oil dollar correlation in the 70s as well as in the 2000s is, let's think about this.

And this was, you know, Ben Bernanke was the one who coined the term, you know, savings glut is as oil prices went up, the dollars would go to Saudi Arabia, Saudi Arabia take those excess dollars and then buy U.S. treasuries. In fact, when they were hiking rates between June of 04 and June of 06, the front of that curve was going up and the back end was going down because you had such higher commodity prices going in and buying U.S. treasuries on the back end. That was the recycling. You know why they had to do that?

They didn't have anything else to do with those dollars. I remember one time I was in China in 05. I was talking to save. They were spending $100 billion. They needed to place $100 billion per month. That's a huge amount of, one of the key reasons, you couldn't spend $100 billion inside China in 2005. Guess what?

Today, you could. You could easily. Same thing with Saudi Arabia. So you have these entities that are developing in places like Saudi Arabia, take PIF. The only market that had enough liquidity to absorb that kind of, potential investment were U.S. Treasuries, which is why we saw that savings glut and saw the capital move into places like, you know, U.S. treasuries. And you can think about that period between

June of 2004 and June of 06 when the Fed was hiking rate, the back in was coming down. Why was the back end coming down? It's because you had all of that capital going into those emerging market that was being recycled back into U.S. treasuries, hence the term, the savings glut. Now, the difference between today in the 2000s or the 1970s is you can place $100 billion into someplace like China immediately. You can place $100 billion into someplace like Saudi Arabia immediately. So you can think about if we had a savings glut in the 1970s and in the 2000s, today, what we're teeing ourselves up for is the Spanish.

ending spree. And I'm going to say T enough. You look at an entity like PIF in Saudi Arabia. It was the intention of that investment vehicle is to go out and invest in Saudi Arabia. There's similar entities in places like Abu Dhabi. They're going to invest in power, gas, logistics, transportation, health care, all of these things in their own economy. And this is part of this whole idea, de-globalization, is that you're going to get a lot of this investment locally. So if the savings glut was able to create a slowdown and growth from higher oil prices, a spending spree is going to do the exact opposite. And if anything, it's going to reduce the available supply of dollars that was being recycled back into the U.S.,

run up funding costs in places like the U.S., but also create more commodity inflation out of spending in places like Saudi Arabia, it was a Neon city or in China like one belt, one road. Can I just ask, where is the production response from OPEC? Because again, you know, traditionally in a situation like this, you would expect OPEC to start ramping up production, but it hasn't really happened or at least not to the scale that people have anticipated. And one of the things that comes up is that some of the smaller OPEC members actually have trouble increasing production. They have underinvestment in their own oil sectors. And so they can't, you know, immediately press a button and satisfy the world's energy needs. So you've got to ask yourself, who's going to put money into a $15, $20 billion deep water offshore project? We're going to be producing oil 20 years from now. The answer is not very many people, hence why you don't have capital going to places like Nigeria and Angola and why production is starting to decline. I want to, you know, speaking of oil, obviously the surge in gasoline prices has talked people about

upping EV production. And so, you know, that does seem to be happening. demand for electric vehicles seems to be growing pretty rapidly in the U.S. and elsewhere. I guess I have two questions. Like, when, in your view, do we see the peak of petroleum demand as a result of this shift? But then related to that, what kind of deficit do you think we're facing for the other commodities that go into EVs, such as all the different metals and chemicals that go into batteries? How are you thinking about that?

Yeah, you can think about the hydrocarbon commodities like oil and gas, and coal, they face underinvestment and supply constraints that you're referring to while most of the other non-energy and metal commodities in copper and aluminum in particular are going to see significant increases in the demand. In fact, I would argue copper is likely

to be the tightest commodity we'll have ever seen. It's much tighter than what oil was did during the 2000. Let me remind you, oil went up 7X in the 2000. Our forecast is 15,000 a ton on copper, but no matter what technology,

you use, you're going to be using electricity. And the only thing that can conduct electricity, given the rules around the periodic table and the rules of chemistry, is copper at the rate we need to conduct it, which means that the demand for copper is going to be there. So, you know, I think the upside around our 15,000 target, which, by the way, if you started this cycle at $5,000 copper, 15 is a 3x. If oil was 7x over that time period,

the upside potential in copper, I think, is significant. But I think there's a big disconnect here that I think is why people are going, how is this happening? Can't we just invest in green EVs more to solve this problem? It is the scale of EVs. There's maybe 10 million of them on the road today. There's 1.25 billion internal combustion engine cars on the road today. You're going to have to grow those EVs a very rapid rate to overtake the combustion.

Russian engines to get to that point, you're asking, when is the peak oil demand? I'll take our base case, which has been generated off of, our base case has generated off of, you know, announcements and investments and everything would say that, you know, we start to slow demand growth, and this was pre-Russia, Ukraine, invasion. You start to slow demand growth somewhere around 2025, 2026, you hit a peak in the early 2030s, and then you begin to roll over. That's probably optimistic thinking. You're probably going to overshoot to the upside near-term. Let's not forget, there's also the constraint about the damage we're doing to the environment. Eventually, it's going to be a point. Remember the 70s? I said it was we started dealing with

the war on acid rain when people started to see, you know, fires in on Lake Erie. Are we going to see a similar dynamic where people start to see enough of, the damage is being done by carbon emissions, they go, hey, enough enough, and we're going to do an about phase and start to deal with this thing in a much more efficient way to try to get results. More likely, just watching things historically, you don't deal with the problem until it's knocking on your back door. Think about what do we learn from COVID. If that's the case, oil demand probably goes well above those projections near term. Then we hit a wall and we go, hey, time to deal with this, and then it starts to drop precipitously. We showed during COVID that, you know,

ingenuity was able to come up with the vaccine in six months. Now, if you have to remove this stuff from the sky and figure out how to, you know, store it and do, you know, removal or capture or something like this to do it on a very rapid basis, that could potentially be a solution here. But I think the key point here is you need investment, technology, people, everything directed at solving this problem. Like I say, don't ever bet against an engineer. You give them enough time and money. They will solve the problem. The problem with decarbonization, we just. haven't given them enough time and money to solve the problem. So if you're an investor and you're

bullish on the commodities cycle, how do you actually go out and play that at the moment? Because, you know, I feel like we talk conceptually about, for instance, the copper price going up, but as we've seen over the past six weeks or so, there can be a difference between financial exposure to commodities and the physical. So had you, you know, just bought a wheat ETF, for instance, you might have experienced problems in the past couple of weeks or so. So how would you recommend people actually get commodities exposure at the moment? By the way, you know the thing that I've really learned in the last six months is nobody has to buy a financial product, but somebody has to buy a commodity.

Somebody has to buy oil and somebody has to buy wheat. I could say commodities have a captive consumer and a captive producer who can do nothing about their position in the very near term, In contrast, as you know, nobody has to buy an oil equity. We've now learned that. Oil prices can keep going up. The fundamentals of the company can get better and better, but nobody has to buy it. And that's why you have that huge disconnect between commodity prices and the commodity-related financial instrument. So to answer you that question, what do you want to own?

You want to get as closest to that person who actually have to buy this thing as possible. And these things like the B-Com, you know, the Bloomberg Commodity Index, that rolling front month and I'm not pitching Bloomberg here, but the B-Com Index is an excellent product that does it. It's rolling the front month of these commodities. It gets you right up as close as you can to that consumer who actually has to buy this commodity because that's where the returns are going to be generated.

And given this pullback that we've seen more recently, with oil down below $100 a barrel yesterday, you're in an environment in which that entry point, I'd argue, is relatively good, particularly if you're going to have volatility going forward. Because the other thing, too, that rolling front month strategy, it's just another way to say your long commodity ball. And if you believe our view that commodity ball is going to be rising over time,

being long of that kind of product is going to be your best bet here. So, you know, if you don't even really have to think about trying to choose which sector to own, just go out the overall decomm index gives you a nice weighting across energy, metals, agriculture, and the rest of the commodity complex. If you want to be more weighted towards energy, the old Goldman FAC commodity index, which is now the S&P one, the GSCI is more energy weighted. The BCOM is a more broad-based weighted commodity index. And then you can pick the sub-index. But the thing that you're capturing here is you're as close to that consumer who has to buy it as possible.

I just want to ask a quick question about copper again real quickly. And you talked about $15,000 a ton being plausible, where it's, I think, roughly, 10,000. But you also said the tightness that we're seeing in copper rivals or perhaps exceeds, even what we saw with oil in the sort of earlier 2000s during that cycle. What are the numbers? Like how much, what's the potential deficit we're looking at given where demand is going and how much new production needs to come online? Like quantify the tightness beyond just the sort of where the dollar, where the price is. Okay, good question. So if you go back to 2000 to 2003, when we first started getting really bullish on oil.

And you looked out, you would say peak oil, you know, somewhere around on 05, 06. By the way, it rolled over on conventional oil, late 04. And then demand what China was going, you know, you would get a deficit of somewhere around 5% of the market. The numbers were coming up with copper are like 15% of the market, three times as tighter than what you would have seen of oil in the 2000s. And, you know, part of it, you know, at this point, right, Now, oil is not, or copper is not responding this because the inventories are going down, but investor interest is very concerned about China. So, you know, the fight the fact that fundamentals are getting tighter and tighter, you don't have investors and consumers worried about copper because they're focused on the China property market. But this is the big gear, which you see the passing of the baton from Chinese property market to the green cap X story.

And by 2023, it's all green cap X becomes the dominant force there. You talked about we need to create sort of a regulatory structure that encourages long-term investment. And that's really the only thing that's going to solve this. So the White House calls you up and says, Jeff, we need to craft a plan. And anything you say will get implemented. What are the basic ideas of what the ideal policy response, at least just let's just say in the U.S., what is the ideal policy response? look like to induce that increase in investment?

What are the components of it? First and foremost, you need a policy around how we're going to do decarbonization. Right now, there's a focus on the demand side, but it's a very asymmetric response in terms. There's no policy around how you're going to wind down the supply side. So first and foremost is create a policy framework around how we're going to actually decarbonation. and then create it in such a way that it can be rolled out in U.S., Europe, and China, because that's two-thirds of the world emissions right there. The second thing is then create, once you have the rules in place that are enforceable by punishment,

and that's the key. They got to be punished. You know, we saw with Volkswagen with the catalytic converters, they got punished for cheating. If you cheat on this, you got to get punished. Once you have that, then you can now create a cap and trade model, a tax, a carbon price, And once you have that carbon price put in place, then solving a lot of these problems and getting the investment to flow becomes much more easy. The other thing that, you know, Advocate is creating, you know, Tracy came up with a few ideas or something around the SPR or whatever it might be to create that idea of a long-term contract to take out the volatility that investors would potentially be focused on. So, I mean, those are the two ways.

I think first and foremost is we need a policy around decarbonization. And if you go back to the 70s, the example, it didn't happen until you saw Lake Erie on fire. I don't know what's going to take in the 2020 to get that. But that's first and foremost. We need that policy around decarbonization and a carbon price. Well, Jeff, always fantastic to talk to you, this question of how we're going to finance, increase, of extraction of commodities, which is the question and fantastic perspective. So thank you for coming back on Auburn.

Great. Thanks for having me. Jeff. Thanks so much. Yeah, that was really good. Tracy, I obviously, I love talking to Jeff. I mean, that really does seem to be the fundamental challenge that we face right now. It really does seem to be on the investment side, however you want to slice it, like whether you want to talk about moving away from fossil fuels and the copper deficit, whether you're talking about just what do we need to bring balance to the oil market right now, solving this sort of like long term. It's kind of like a game theory problem. How do you get people to commit to investment seems like a huge is the huge challenge

at the moment? It is weird to think. I mean, if you think about what human beings need on a day-to-day basis, it's basically food and energy. And you could argue that the entire role of the state is basically to ensure those two things maybe as well as social order and security and things like that. But clearly, two vital things. And yet, it seems like structurally there have been years and years of underinvestment now. And this is something that's come up, both from Jeff, as we just heard, but also Zoltan Pozar's idea that, A, you have previous underinvestment, but now you have the cycle of volatility, increased transport costs, things like that, that just means you need even more capital to support commodities trading and production. I love Jeff's use that the volatility

trap. Yeah. That's a really good one. And I think, you know, it speaks to, obviously, look, the job, I guess, of the capitalists of capitalists is to take risks and including price volatility. But if you have this sort of like volatility that feeds volatility, overall, you can create this situation in which you have this dearth of investment. And it's interesting, too, because so Jeff talked about, obviously, bank capital requirements and the discouragement there. And then the ESG overlay on top of that. And then also this extraordinary tech boom that we saw. And so the rise of like the net. flickses in our life and the rise of the iPhone and the rise of Facebook and social media,

you just like in an environment like that, you could just see like, who wants to invest in digging up, you know, fossils, you know, dead animals that turned to liquid out of the ground. It's just in that, in that period, you can just see why there had been such a dearth of interest in this. Right. Well, this is also just, I guess, the sort of headspace that a lot of investors tend to be in, which is you're always looking for the next big thing. And oil has never been, or, you know, for a very, very long time, it has not been considered the next big thing.

And so it just doesn't have a good story behind it. Well, and I think there's another thing, you know, we talk about normalization all the time, right? And so normalization, I think, of the very sort of crude senses, all the restrictions from COVID, slowly getting lifted, and we go back to services. But I think that like implied is just the idea that like, yeah, and then oil prices are going to go back down and then everyone's going to invest in tech and Web 3 and crypto, et cetera. But I feel like as long as we have that mentality or as long as everyone sort of has this feeling like, well, yeah, we're having this like temporary surge because it's weird. Like you're not going to actually get there. It's almost like in order to get, you know, in order to get prices down, people have to believe the prices will never come down. Yeah, which is very tricky.

from a narrative perspective. I mean, I think like if you, you know, you think back to like 2004 or 2005, we thought that prices were, that was the exact opposite. I think people thought there was this big oil boom that's happening. China's usually got an infinite amount of oil

will never catch up. And then you get the investment response. Well, you had the peak oil narrative as well. The whole peak oil narrative. Exactly right. And so now it's like, well, we are still in the opposite where these sort of conditions seem temporary

and we're going to move to EVs and we're going to normalize and everything we'll bring back into balance. And that's not a sort of a great headspace for actually bringing stuff into balance. We need to think of a good story for like wheat. Right. What is? But in all seriousness, though, like the copper thing I think is like really interesting. And I hadn't thought about that that people maybe associate copper as largely a Chinese construction, Chinese real estate story. but if we're going to electrify everything in the world, that creates a lot of copper demand.

And so then it's just a matter of like, well, what's the cycle for building that out? Well, this is another thing that we are discovering on these episodes, which is that you actually need a lot of these old economy metals or dirty fuels or whatever in order to get off the other dirty fuels. Yeah, exactly. Well, yeah, exactly. All right. Shall we leave it there? Let's leave it there. Okay.

This has been another episode of the Oddlots podcast. I'm Tracy Alloway. You can follow me on Twitter at Tracy Alloway. And I'm Joe Wisenthall. You can follow me on Twitter at The Stallwork. Follow our producer, Carmen Rodriguez, on Twitter at Carmen Armin. Follow the Bloomberg head of podcast, Francesca Levy, at Francesca Today. And check out all of our podcasts at Bloomberg under the handle at podcasts. Thanks for listening. Hey there, Odd Lots listeners. We are very happy to let you know that we've been nominated for a Webby Award.

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