Invest Like the Best with Patrick O'Shaughnessy
· Patrick O'Shaughnessy, John Arnold
[00:00:00] S0: In a given day, how much volume and activity would there be? How many key decisions would you make in a given day? [00:00:00] S1: It changed over time. I was, for a long time, the largest market maker in the business. Which I did both because it was profitable, as well as – maybe more importantly – it allowed the ability to put on and off positions with lower slippage and with fewer people knowing what my position was. It also gave me insight into who was doing what in the market, so I could start to build the psychology of the market. I could see certain traders positioning certain ways and try to reverse engineer what their thinking was, which helped me in trying to figure out how I wanted to be positioned. [00:00:00] S0: Maybe for those that are less initiated in the act of market making, just describe what it does, how you’re provisioning liquidity for the market. Also why you were able to sort of cover some of your tracks by being that player in the market.
· John Arnold
[00:00:00] S1: A healthy financial market exists for a reason. And that reason is that there are commercial players – in this case, producers or end users, who have exposure to the commodity, that are willing to pay something to have somebody else reduce their risk to the commodity price. They will pay something to the market for that risk management. And if that exists – so if you think about a producer of natural gas whose revenue is almost entirely based upon what the price of natural gas is for a given month, or even day-by-day. There's these huge boom-busts that can happen, because commodities naturally have this boom-bust cycle. So businesses then, if you're exposed just to the spot price, or today's price – those businesses also go through a boom-bust cycle. So many businesses will choose to hedge out or fix some of their forward revenue and reduce their exposure to short-term swings in the market. That's the demand for hedging. If there's demand, there has to be a supply. There has to be somebody who's willing to take the other side of that trade. Somebody has to warehouse that risk, price the risk, and manage the risk. In aggregate, that's what the traders as a whole have to do. And then there are also speculators that come in. The people who are warehousing that risk often have to price that risk, so they become experts in the pricing and how to hedge it. There's often speculation that happens on top of that. As well as, there can be speculators who are not actively market making, but just have a view on natural gas or oil, or gold, or anything, and come in and want to put on a position. Again, they need liquidity. Somebody gets paid to provide that liquidity.
· Patrick O'Shaughnessy, John Arnold
[00:00:00] S0: It strikes me, as someone that looks at a lot of young companies, that it is exciting. Energy is exciting again. Maybe it's just because of data centers and AI and the new demand that's coming onstream for power. Does it feel that way to you? I mean, I know you've looked at tons of companies. I'm sure you're incredibly on top of energy markets today. Do you feel like it's a good time if you're interested in this field, like you were, to go into it relative to 10 years ago, when it seemed a little bit quieter? [00:00:00] S1: I think it's more on the asset side today. But I think there's an enormous amount of innovation that's happening in energy assets. Whether that is in new technologies like in batteries or geothermal, or advanced nuclear. I think also, all the data center development and the amount of money and capital in those fields, and so the need for innovation – that if you can make things even a little bit more efficient, there's enormous value that is created that a new company or a new individual can take advantage of. One of the characteristics of the energy industry broadly is that it is enormous. If you can have a little edge in a niche of the energy industry, there can be tremendous gains to be had. Certainly, this mad scramble to build data centers and to power those data centers is creating enormous opportunities for new entrants to the market.
· John Arnold, Patrick O'Shaughnessy
[00:00:00] S1: I think it's more on the asset side today. But I think there's an enormous amount of innovation that's happening in energy assets. Whether that is in new technologies like in batteries or geothermal, or advanced nuclear. I think also, all the data center development and the amount of money and capital in those fields, and so the need for innovation – that if you can make things even a little bit more efficient, there's enormous value that is created that a new company or a new individual can take advantage of. One of the characteristics of the energy industry broadly is that it is enormous. If you can have a little edge in a niche of the energy industry, there can be tremendous gains to be had. Certainly, this mad scramble to build data centers and to power those data centers is creating enormous opportunities for new entrants to the market. [00:00:00] S0: If you were describing the industry today to someone that knew nothing about how the U.S. energy system works, what would be the high-level way that you would approach that problem of explaining it to somebody new? "Here's the state of things today."
· John Arnold
[00:00:00] S1: Maybe stepping back about what are the goals of the energy system. I think about systems a lot these days and what the incentives are, what the rules are, what the goals of a system are. In energy, you can think about having a product that's affordable to the consumer, that's reliable, that whenever you want it, you can access it. You can think about times, whether gas lines in the 1970s, or blackouts, when reliability hasn't been there. Having reduced emissions, a cleaner system. And then energy security. Then maybe fifth, I'd say that it creates good jobs for whatever country or whatever locale you're in. If you have those as goals, then how do you meet those? You were saying America's blessed with tremendous energy resources. It has a lot of oil, gas, coal. It has a lot of wind and solar resources. We're a very innovative country – ability to deploy solar and wind, and thinking about both traditional nuclear as well as advanced nuclear. So we have all these inputs and we're trying to get to the system that meets those goals. And then the challenge is in how do you devise policy and the rules of the system to do so. It gets tricky because the priority or the ranking of those goals changes from administration to administration. It's an industry that is slow. It takes a long time to build the infrastructure. You need stable supply chains in order to be able to meet the needs, and you have these changing goals of it. So the industry gets sent, every four or eight years, a different set of priorities or price signals about what we want as a society. Then the industry has to scramble. Then you throw data centers in here, which is just load growth, and being less concerned about price and more concerned about speed than any consumer of energy that we've seen in this country, maybe ever. Put it all in the mixing bowl and try to get a system that works.
· Patrick O'Shaughnessy, John Arnold
[00:00:00] S0: If you could imagine a U.S. energy future? I'd love to paint the poles and have you imagine the best possible scenario you can imagine for us 10 years from now, and what the components of that system would be that are different than how it is today. And maybe the worst possible version of the system that you can imagine in 10 years. Just to get a sense of, having studied the system so carefully, I love your way of thinking about the competing goals and this weird data center variable as well. We’ll start with bad. What would be the worst scenario that you can imagine that would get you concerned about the state of the U.S. energy system in 10 years’ time? [00:00:00] S1: The worst scenario is that the energy system becomes the bottleneck for both U.S. innovation as well as individual flourishing in this country. On U.S. innovation, especially on technology and AI data centers, it's largely around – can we build, can we create the supply that industry is demanding? And on individual flourishment, it's can we do so and maintain the affordability and reliability components that Americans have come to not only desire, but demand? There's this politics around energy and food and housing, because we need all of those. Those aren't optional for people. But there's this politics around it, that if you start to lose affordability of any of those, then there’s real, tremendous political ramifications of it. You can start to see if an energy system goes bad, it will have a huge impact on politics in this country.