Invest Like the Best with Patrick O'Shaughnessy
· Patrick O'Shaughnessy
[00:00:00] S0: Before we keep going through this sequence here, can you just say what you think the state will be? Let's assume that there's roughly inertia in the system and nobody listens to this, nobody does anything. A lot of people will listen to this and have ideas, but what is going to happen in the world? What will the state of the world be like in 2030 if none of this starts getting addressed sooner than later? What's your best guess as to what it looks like?
· Matthew Smith, Patrick O'Shaughnessy
[00:00:00] S1: There is tremendous inertia around natural gas being the primary fuel to power AI. SemiAnalysis, for instance, leader in many respects — they've done excellent work on everything up to the power source and their behind-the-meter, BTM, load forecasts, generation and load forecasts where they match. They do everything up to the point where they don't assess where the gas would come from. And so the market has been focused on understanding the power shortage and trying to solve that. Generally, power generation, which could be solar and batteries, wind, nuclear — whether large-scale or small modular reactors, SMRs — or natural gas. Natural gas is well-supplied today, '26 and '27. And the result is that nobody is investing in gas. In fact, EQT is shutting in natural gas right now because they think it'll be more valuable later. The rig count, the things that we can see real time to figure out if the market is onto this tightness in 2030 — it's not apparent today. And so it's perpetuating this view that most Americans have, which is there's plenty of natural gas. Because for 15 years, it's all we've been told. [00:00:00] S0: It's been abundant, yeah.
· Matthew Smith
[00:00:00] S1: And so there's a complacency that's developed, and we think that complacency is going to take us right up to the point where it's too late. So we do think the die has been cast. Where gas, which is currently at $3.50, $3.60 going out to '26, '27 — in '28, the curve is flat. '29, 2030, the curve is flat because people believe that gas is abundant. That's despite all of these AI compute announcements, despite what all of the companies are doing for their investments. Gas has lulled everybody to sleep. But what happens is these structural things start to fall in place in '27, '28, and we start to draw meaningfully in the middle of '28, early '28, on the gas system like we've never drawn before. And as we look at '28, '29, 2030, we start to cut into the US working gas storage, which is about 4 TCF, total gas storage. There's kind of a range of high and low for that storage seasonally as we draw in summer and winter and then build in the shorter months, in the spring and fall. When you get to the middle of 2028, we start to break very materially below in a historical way where gas available in storage has ever been before. And by 2029, we drop below all known historical storage evidence. And by 2030, we get pretty close to where we think — ceteris paribus — gas storage looks very, very low. And at that point in time, because it's not happened before, we're forced to look at where has gas price gone during shortages? We can look at Russia-Ukraine, and gas went to $8, $9, $10 an MCF, because we sent a lot more externally, to Europe. We've seen various weather anomalies, polar vortex in '14, December of '22, and those prices have gone to $6 or $8 or $10, but those have been transitory. And what we're talking about are structural drivers of demand against a known possible production of gas, and they don't match up. You pull in a very historic way starting in '28, to the point where the deficit gets really convex and unbounded, as I said.
· Patrick O'Shaughnessy, Matthew Smith
[00:00:00] S0: Meaning that gas prices could be $20 or something like this? [00:00:00] S1: I would hesitate to even put a price target on it, but at $8 or $10, we think you potentially shut off some of the US exports — their spot cargoes. And they are leaving the border to capture uplift in Europe or elsewhere. Those spot cargoes may not be lifted and that gas is left in the system. And we've tried to account for that in our model, but the spot cargoes alone can't solve this. You would have to get into shutting off contracted cargoes leaving our border via LNG to really start to mitigate some of this. And it's hard for us to count on the choice to shut off contracted cargoes that are — where there's some Japanese utility counterparty who has counted on it for its provision of electricity. [00:00:00] S0: In crazy convex outcomes like this, can you tick through who you think the biggest winners and losers are?
· Matthew Smith
[00:00:00] S1: There are some clear natural gas producer winners. Expand Energy is probably at the top of that list. They probably control 70% of the remaining core Haynesville wells, the very closely known parameters of rock where we know it to be very productive. And so Expand, we think, is far and away the biggest winner. Uniquely, Expand is CEO-less right now. There was some turnover early in the year, they're going through a search. The stock has plummeted over the last six months as a part of that search, and it's trading at four times EBITDA on a forward curve where no one believes what I'm telling you to be the case, even though we think modeling the facts gets you to a much higher gas price. The stock has dropped. The assets have not changed. It has some of the highest quality rock in the country. Highest quality upstream company in Appalachia is probably Range. Range has significant room to grow production and materially grow returns to investors. So those would be the upstream companies. It's not going to be obvious in the first pass through this equation for most, but natural gas sits as the marginal fuel for the next-in-line power-generating asset in each power market. As natural gas goes, power prices go in the country. And so if you think about the dispatch curve of different generating assets in the country, there are some where the fuel is free. Maybe solar, to a lesser extent wind, hydro. Solar assets, which are growing meaningfully, they've been 90% of the interconnect queue with batteries in the last ten years in terms of new assets coming on other than gas. Solar assets stand to benefit from a windfall where electricity prices are going up because the margin of plant taking fuel where the price is increasing is rising while sun costs the same. We think there are some companies positioned very well for margin expansion, for no incremental capital costs. XPLR, ticker XIFR, formerly NextEra Yield Co., which is an interesting set of assets. They have a windfall coming in the latter part of the decade because they mark their PPAs to market at much higher values without any CapEx. Clearway Energy would be another one, similar circumstance. And so solar assets at the utility scale especially stand to win.
· Matthew Smith, Patrick O'Shaughnessy
Maybe more interestingly, as it relates to some of our discussions in the past, residential solar, which has been suffering from really the first removal of tax incentives to install residential solar since the late '70s. Residential solar assets are really one of the only ways to protect yourself from what's going to happen during the time of 10:00 AM to 6:00 PM once gas gets really tight in the electricity markets, what you pay for electricity at your house. So we think residential solar grows exponentially from here, even without tax incentives. For the first time, it's very economic with where electricity prices are likely to go — to install solar, especially when it accompanies batteries, which make the electricity much more available around the clock. [00:00:00] S0: I think it's important to say you're an investor — you have money behind this work. Beyond those two categories, are there any other surprising winners, do you think, in all of this? What about nuclear? What about Westinghouse or places like this?