Invest Like the Best with Patrick O'Shaughnessy
· Matthew Smith
[00:00:00] S1: Currently there are ten to 20 nuclear reactors envisioned by the US government through different groups, but no one wants to be first. I think we're close to a few stepping forward. But if the US said, hey, we have $260 billion to spend at the Loan Program Office — now, the EDF. It's $260 billion, I think, to spend by the end of '28. We need to build four nukes with this. That would de-risk this materially. And I think you would see it jumpstart the nuclear equation. Energy and resource availability, egress and knowledge, we think, are the biggest bottlenecks to productivity and deploying all this incredible technology that America has really been the leader of developing. When we set up our firm and started building a team, things are happening pretty quickly in AI, and especially with regard to power. So we didn't set out to understand the now. It's important to understand now, but we set out to understand where the puck is going, and where it's going looks like it will meaningfully diminish growth if not dealt with. And so that's why it brings me to the nuclear solution, as maybe the most viable long-term. My comments on solar are probably the most important thing that I would do. I think everybody should get a solar system on their houses. It won't be perfect. It will deliver electricity when there's sun out, may not deliver electricity when it's cloudy, but it's a way to protect yourself from very high peak power prices from 10:00 AM until 6:00 PM, which is the biggest part of your bill. I would incentivize people to study your state's rules and try to put incentives in place to really, really start to grow residential solar faster than what's been a stagnating industry the last year after some incentives were removed. That would be one place to be reinvigorating solar incentives because they're going to be needed in a few years.
· Patrick O'Shaughnessy, Matthew Smith
[00:00:00] S0: Could we build a giant pipeline from Canada or so, try to tap our neighbors to help us solve this problem? [00:00:00] S1: Canada's an interesting partner of ours. They have the capability of delivering about 11 or 12 BCF — usually in January — periodically. And there are meaningful pipelines from Canada to the US, but largely it's seasonal and it helps us solve winter, but otherwise they're net imports most of the year. But we're not really set up to take from Canada year round. There are a few reasons for that. One is Canada has limited storage. It's about just over a TCF, about a fourth of the US storage. If I think about this on a three to five year plus basis, Canada by far has the deepest and richest resource of economic gas in the ground, but it's been trapped behind pipe. I would build a 1 to 2 Bcf a day, at least, pipe into the US Midwest, the MISO power market, and then wheel it around MISO, PJM, SPP, ERCOT, and try to satisfy this demand because I really don't want to see demand slow. I really don't want to see consumers' bills go up. [00:00:00] S0: What are the implications of this for the rest of the world?
· Patrick O'Shaughnessy, Matthew Smith
[00:00:00] S0: What are the implications of this for the rest of the world? [00:00:00] S1: The US has become the leading provider of natural gas with, our exports going from virtually zero to starting in the mid-teens. And now we're at 15 Bcf a day. That'll be 35. Many countries in the world are building gas-generating assets that are dependent on our delivery of that gas to them. And so lots of political conflict-related tensions or bottlenecks today or Russia-Ukraine. Russia used to be one of the biggest deliverers of gas to Europe, for instance, and then we filled the gap. To the extent we cannot deliver our 30 to 35 or more Bcf a day of gas to the global consumer, rebalancing will be required. You probably impact Europe meaningfully, and they're left with a trade-off of taking Russian gas or much, much higher cost US gas because they can't produce it there domestically themselves enough to satisfy their need. Asia is a large consumer — the largest consumer, until Russia-Ukraine — of US natural gas, and they probably will be at some point the largest consumer again with some of the outages in the Middle East. We potentially hurt important allies at a time where we really want them to be allies if we can't send them the gas they need. And so it is pretty important that we don't curtail LNG, although that will certainly be one of the levers as we go out to the late decade that we will be forced to think about to deal with rising electricity prices in the country.
· Patrick O'Shaughnessy
[00:00:00] S0: Anything that we haven't talked about that has surprised you in this year-and-a-half-long analysis of trying to understand the state of things and where we're going? Obviously, we've covered the big conclusion, which is scary and hard to deal with even if we start acting now. Anything else that's surprised you either in your work or in people's reaction to it as you've started to share it?
· Matthew Smith
[00:00:00] S1: Really for the last two or three years, the phenomenon where CEOs, CFOs of companies — all of whom have really been asked by their investors or their products lend themselves well to deploying products to capture AI compute rent. What CEOs have said versus what is possible from the system, I think is an interesting study that will happen over time. The amount of capital made available to companies to make investments that are really shortsighted in the context of our work, like the incremental distributed natural gas genset. It's an inefficient, high heat rate or high cost, inefficient asset that really should only serve as backup generation in any context outside of this fast time to power setting where AI compute needs the power now. Over four or five years, those assets may not even run. And so you've had tens of billions flow into these distributed power assets, all of which are short and will consume natural gas. And we really haven't seen anybody, including firms we really respect, question at any point whether there will be enough gas and what the cost will be when the time comes. It's been surprising that enough folks haven't put pen to paper to then start contracting gas to make sure they have supply certainty. We haven't seen more financial contracting. '28 is somewhat illiquid, which is why we really haven't seen the forward curve move. And we think that's where the action starts. As soon as utilities turn the page and start to really hedge or buy gas in '28, and we start to see all these natural gas generating companies start to think about securing supply, you're going to start to see a knife fight to secure natural gas physical in '28 like we really haven't seen before. And it's been surprising we haven't really seen any of this yet because '28, '29, the physical market tightens materially depending on where you are. And the amount of money that's gone into unproven, untested, and the amount of capital being raised for things that really may not happen until 2035, maybe. That's been surprising, especially as it relates to — you've got Expand trading at four times EBITDA, low to mid-teens free cash flow yield on a gas forward curve that is complacent to all of the objective things that we already know are likely to get plugged in.
· Matthew Smith, Patrick O'Shaughnessy
People are not really willing to look past summer heat or a slight outage in an LNG facility right now, but in six months, we start to see these companies roll forward to look at '28. You can start to see the forward curve really move up materially. And investors are not willing to look past near-term appropriately supplied gas market, but they're willing to pay for something in 2035 that is totally untested or unproven. It's been surprising, the assumptions and the inconsistency across sectors and industries, even among the four sectors we follow. [00:00:00] S0: So maybe in closing, what would be the healthy challenge to pose to anyone out there whose business has as an input, directly or indirectly, energy prices? How would you encourage those CEOs? What questions should they ask of themselves or their business?