Invest Like the Best with Patrick O'Shaughnessy
· 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?
· Matthew Smith
[00:00:00] S1: Make sure when your assets are deployed that you understand exactly what the source of your natural gas will be. Make sure you have physical supply locked up and that you understand your counterparties and what will likely be very meaningful counterparty risk in two or three years. And counterparty risk isn't something we've really talked about during the last couple of years in the AI boom. But when it comes to parties being long and short something that is moving a lot, imagine being short memory a year ago or 18 months ago and finding out all of a sudden you're short memory. That is what this natural gas market looks like to us, not two years out, but six-plus months out. And making sure you understand the physical provisioning of gas for your assets is important for the hyperscalers and for the buyers of simple cycle and CCGT large-scale plants, but especially for fuel cells. We are very cynical whether you can deploy fuel cells at scale. Because there isn't the gas in the system to power those 24/7, 365. And so therefore, we treat them in our base case that I described as backup gen. To the extent you were to deploy fuel cells as baseload gen, that only pulls forward and is additive to the convexity that I described. CEOs and partners on projects, whether you are the E&C company trading at 25 times cash flow, which is a historically high multiple for an engineering construction firm, and your main business is building natural gas plants, and we may not be able to build or deploy more gas plants at a certain point in 2029, 2030 because gas is much more expensive and you may have regulators asking questions. The focus for you should be on how do you do accretive M&A to backfill your and diversify your business so that you're not entirely beholden to natural gas generating asset build. For hyperscalers, I know memory has been a pain point. Natural gas could be 20, 30, or 40% of their cost of doing business, at a time when they're supposed to be reaching escape velocity with profitability.
· Patrick O'Shaughnessy, Matthew Smith
[00:00:00] S0: Performance per watt is probably a compute metric that we're going to care more and more about. [00:00:00] S1: I would say that the questions or the challenges for each industry of companies is a little bit different, but it's all focused on making sure you're managing risk and you understand exactly when your plans play out, how it can go wrong — which in this case means what if gas is not $3.50, but $10 or more? What happens if physical gas is questioned? What happens when consumers and therefore regulators start to ask questions? [00:00:00] S0: Matt, I love talking about the energy system with you. This was an especially fun one on the back of so much of your work. So fascinating and interesting. I hope, as the US has been very good at doing historically, that lots of people listen and start to imagine solutions and also create the right amount of urgency to get those solutions in place, and that we emerge from this more resilient, more capable, more efficient, all these things. Thanks so much for your time.