February 28, 2023 | Podcast
Revenge of the Old Economy

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Low interest rates and a focus on being green led to significant underinvestment in the old economy. Netflix rose and Exxon fell. But we’re now beginning a rotation away from the new economy back to the old, says Jeff Currie, global head of commodities research at Goldman Sachs. In this episode of The Active Share, Jeff tells Hugo how he sees the future of energy, from green tech to oil, from the east to the west—who will win, who will lose, and how investors can prepare.

Comments are edited excerpts from our podcast, which you can listen to in full below.

You’ve been saying we’re experiencing the revenge of the old economy. What do you mean by that?

Jeff: The term was coined in February 2002, and was meant to capture the fact that over the previous decade, the dot-com boom had stolen so much capital from the old economy, it had prevented the growth of the supply base.

At the time, we thought it was something totally new. Then we saw it resurface.

Take the 2010s. Exact same setup. The new economy was the FAANG stocks boom—Facebook (now Meta), Amazon, Apple, Netflix, and Google (now Alphabet). But it was doing the same thing—syphoning capital away from the old economy.

Investors made the right decision in buying Netflix over Exxon because the returns on Netflix (and Microsoft and the rest of them) were far superior. But ultimately, that underinvestment choked off the supply base such that returns in the old economy are now substantially greater. Last quarter, Exxon printed $20 billion of free cash flow versus Microsoft at $17 billion. So how is the valuation of Microsoft still four times that of Exxon? We’re just beginning a rotation away from the new economy and toward the old economy. Another way to say it is, the old economy is taking its revenge.

We’re just beginning a rotation away from the new economy and toward the old economy.

You’ve said you’re beginning to realize that what we’re really experiencing is an inflation-duration trade-off.

Jeff: Yes, and to understand that, let’s go back to 1960, when we had excess commodity supply coming off all investments in the post-war era. This led to low and stable inflation, which led to very low interest rates. Investors in that environment want duration, and duration in the 1960s was the “Nifty 50”—brand names like Coca-Cola and Gillette. And this did the exact same thing it did over the past decade: it choked off capital to the Exxons of the world.

Go to the 1990s. Exact same setup. There was excess commodity supply coming off the boom in the 1980s, and we had the collapse of the Soviet Union. This led to low and stable inflation and low interest rates. Remember Greenspan talking about irrational exuberance? Investors chased the dot-com, which was then duration.

All of those environments represent the transition point where you began to price higher inflation and higher interest rates.

So, are these environments inherently inflationary? The answer’s no. But what occurred in 1968? LBJ’s great society. What occurred in 2002? China’s admission to the World Trade Organization (WTO). What occurred in 2020? COVID stimulus. All of those represent the transition point where you began to price higher inflation and higher interest rates. And what do investors then do? They chase shorter duration.

And here’s the final point. What do the 1970s have in common with the 2000s, and could have in common with the next decade? Huge capex booms. And ultimately, what people miss is that you need the higher rates to actually create those capex investment booms. They don’t kill it off. They actually create it. Why? They discourage the duration trade. Where do you put your money? Into today.

Have you attempted to try to quantify the level of underinvestment? And do attitude and beliefs, which you could also describe as environmental, social, and governance (ESG), create a different equation from previous supply shocks, because the period for payback is much more uncertain?

Jeff: If you had asked me this question six months ago, I would have separated the ESG story from the duration story. I’m beginning to realize that ESG and green tech, all of that’s duration. Is it any different than crypto, big tech, or anything that has been hit really hard? The sell-off in green tech is similar to other tech sectors.

We have a lot of technology available that could reduce emissions. But we’re not reducing emissions. In a 0%-interest-rate environment, being green has no cost; it’s just part of that duration play, whether it’s net-zero 2050 or whatever these lofty ideals might be. They make a lot of sense in a low-interest-rate environment.

In a 0%-interest-rate environment, being green has no cost.

So, because of the underinvestment in oil and gas, which are relatively clean-burning fuels, the world (particularly low-income countries and groups) is substituting into the lowest-cost, fastest-cycle energy source, which happens to be wood and coal. Wood emits five times coal, and coal emits two times gas. So, we’re making emissions worse.

Instead of being focused on net-zero 2050, we need to be focused on today. And higher interest rates are going to force duration so we use the technologies that are available today to get emissions down in 2023.

When do you think there will be a sufficient supply-side response to keep energy prices within a range?

Jeff: It’s still old economy; it just has to be green. And it’s going to be the largest capex initiative the world has ever seen. That will make it far more difficult.

But let me answer based on what we learned from the 1970s and the 2000s. The first three years of a commodities supercycle create a track record to convince investors it’s investable. Then, in years four through six, you see capital rotate into the sector.

We’ll see if we get the rotation like we did in 2005. In the case of the 2000s, it took oil from 50 all the way up to 100. I have no idea what it’s gonna do this time around, but I’m pretty sure you’re gonna see it. This time, it’s gonna be competing with the green capex.

I want to talk about what it takes to build a new green energy system—the skills, capital, materials, laws, regulations. What is in shorter supply?

Jeff: Metals are going be the biggest bottleneck. Copper inventory is extraordinarily low. The big copper supply increase that everybody expected for 2023 has been ratcheted down from 8% growth down to around 4% to 4.5% growth. And we haven’t even gotten into the issues around rare earth metals, or aluminum.

Metals are going be the biggest bottleneck.

When we create fossil fuels, it’s basically plants (carbohydrates) that rot over thousands of years. If you’re driving an internal combustion engine car, and you have an 80-kilo person and 20 liters of petrol on board, that’s not a whole lot of weight.

Now think about a Tesla. Depending on the quality and the speed, the battery weight is anywhere from 1,500 to 3,000 pounds. It’s enormous, because you’re using inorganic energy to replicate organic energy. You’re replicating a thousand years of the deterioration of oxygen off that carbohydrate.

Now let’s move the 10 million electric vehicles (EVs) on the road today to 1.3 billion, which is how many internal combustion engines we have. It’s going to put an enormous amount of stress on the availability of green metals. 

I want to talk about geopolitics—some countries having access to materials. Does that lead to a shift in power?

Jeff: Absolutely. And who has access? People like to point out that China has all of the world’s rare earth metals. But guess where all the reserves sit? The Sierra Nevadas in the United States and the Andes in Latin America. The western hemisphere has everything the world needs—oil, gas, metals, chemicals, fertilizers, food baskets.

Another point about where the resources are: If we know we need to decarbonize, and you don’t want to invest in long-cycle oil production like these deep-water projects off the coast of West Africa, that only exists in three places: the United States for shale, the Arab Gulf, and Russia. Russia’s out, leaving you two options.

Europe, India, China, and northeast Asia are not endowed with the type of commodities that the world’s going to need.

So, when we think about where the power goes, the other place that has a lot of the resources the world needs is the Middle East. Their solar and wind capabilities are absolutely massive. They can create things like blue hydrogen, green hydrogen. They can put industrial activities on top of gas fuels and produce goods without emitting anything.

And they’re the only true Switzerland left in the world. Switzerland lost its secrecy banking and voted in the United Nations against Russia. So, if you really think about where neutrality exists, I’d argue that Dubai is going to attract a lot of the world’s capital, particularly from places like Russia, more recently.

Europe, India, China, and northeast Asia are not endowed with the type of commodities that the world’s going to need.

It looks like Europe has shifted from energy dependency on Russia to energy dependency on the United States. Maybe that’s what the United States wants?

Jeff: On that point, liquefied natural gas (LNG) reduced dependency on coal to get rid of the London fog problem in the 1950s. But it’s not a fuel that you run your industrial economy on. It’s too expensive, because you’re liquifying it, putting it on a $300 million ship, then re-gasifying it at the destination. Moving the BMW plant on top of the gas field and shipping the BMWs makes much more sense.

So what is Germany going to do? Move all of their industrial activity to the rest of the world, or realign themselves with Russia? They may talk a tough game right now, but will likely come to an agreement with Russia. Because pipe gas is just far more economical and environmentally friendly than any other energy sources available to them.

I don’t understand the simplistic idea that Russia can just shift its energy east. Some of the U.S. companies that are no longer in Russia enabled extraction. And it takes a long time to build pipes.

Jeff: Foreign technology and capital was critical to the growth of the Russian energy sector. But in the near term they’re still going to be able to extract it. When we think about the longer-term prognosis for the Russian energy sector, however, it becomes a significant headwind on supply growth.

But to the broader point about redirecting everything to China, do you think the Chinese want to be 100% dependent on Russia after everything they’ve seen with Germany? Highly unlikely. So you’re not going to rotate everything east overnight.

Can we talk about moonshots? Things like nuclear fission. Do you get excited about that? Do you think it could be a genuine source of energy?

Jeff: I think we need a shift in policy around climate change to create carbon markets and carbon prices to get a real moonshot. You need the venture capitalist to start throwing money at all these different technologies, and one of these moonshots will probably pay off. In the current environment, we’re not incentivizing that kind of investment.

Remember the war on acid rain in the 1960s? Acid rain came from aerosols and sulfur in fuels that created smog. We solved acid rain by creating rules and regulations and fines around not meeting targets. Volkswagen paid $20 billion for violating the catalytic converter rules that came out of the war on acid rain.

Would anybody be turning on coal plants in Germany this last year if they were going to be fined $20 billion? Absolutely not. But that’s how you’re going to clean up the world.

I’m not trying to say that getting rid of carbon is going to be as easy as getting rid of sulfur, but the political frameworks that were put in place were instructive. And once we got a functioning sulfur market, venture capitalists could go to work.

Ironically, they were all in Germany. They weren’t any of the usual suspects: They weren’t oil companies. They weren’t car companies. They weren’t utilities. They were engineers, BSF and Englehart. But you had to incentivize them and let them work their magic.

That’s the kind of moonshot we’re talking about, but we don’t have the political arrangements put in place to get a carbon price to harness the kind of ingenuity and investment that could ultimately create a solution.

Give engineers enough time and money, and they’ll solve the problem.

By the way, if somebody created a carbon capture technology that’s scalable, everything else is moot. It’s winner take all, which involves a lot of risk.

And by the way, why am I not a big fan of renewables? Energy waste is directly proportional to energy density, meaning wood creates far more waste than nuclear. Wood, like coal, has carbon emissions, ashes—both of them are pretty nasty. A nuclear power plant’s waste is the size of your fist. You bury it in a safe place.

Let’s think about the waste associated with renewables. It’s going in the wrong direction. We’re going backwards from the wood age because of how much damage you’re doing to the environment with all the windmills and the waste. And the other problem with renewables is that we still don’t know how to deal with the storage. The question is, will technology get there?

By the way, did you know EVs are recreating the aerosol problem? We’re going backward on solving acid rain with the hybrid EVs because when they burn, they release noxious toxins because the battery keeps the temperatures too low.

I think the key point about very dense energy types like nuclear is that you don’t have those kinds of problems.

I try to be optimistic, but you talked me down.

Jeff: Give engineers enough time and money, and they’ll solve the problem. We will solve climate change. And I think there are going to be good returns for investing in the commodity space. So, there’s your optimistic answer.

That’s a much better note to finish on.

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