Charts of the Month - July '23

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If we actually wanted to solve the problem…

Some quick, back of the envelope math on what it would take to cut global carbon emissions from electricity generation by ~20%.

• Since 2014, the world has spent ~$4 trillion on renewables.

• That’s increased renewable’s contribution to global energy production by ~6%, from 23% in 2014 to 29% in 2022. This includes hydropower.

• In 2014, global carbon emissions were ~36 billion metric tons. In 2022, they were ~38 billion. So $4 trillion bought us 2 billion metric tons MORE carbon emissions… (Yes, carbon emissions have gone up even while adding all that renewable energy because energy production, in absolute terms, has continued to increase with ever-increasing demand.)

• Coal power plants represent ~35% of global electricity generation.

• Coal emits ~200 pounds of CO2 per million British thermal units (MMBtu). Depending on the type of coal, that number can get close to 300 pounds per MMBtu.

• Natural Gas plants represent ~23% of global electricity generation.

• Natural Gas emits ~117 pounds of CO2 per MMBtu. 42% less than coal. 50%+ less than some types of coal.

• There are ~2,400 coal power plants around the world today.

In 2021, Canada completed a coal-to-natural gas retrofit on one of their Edmonton based units. The total cost to convert the coal plant to burn natural gas was $32 million. With this retrofit, Rob Dutton, CEO of Heartland (the utility that runs the plant) said, “At full fire, it’s a reduction of about half [50%] of the CO2, same with nitrous oxides and the like.”

Here’s the quick math: convert all 2,400 coal plants to burn natural gas at $32 million each, for a total cost of $77 billion, or to be conservative, let’s say every conversion costs 2x what it cost Heartland to convert, so each conversion costs $64 million. The total cost for converting the entire globe’s coal plants to natural gas, effectively wiping out 20% of global carbon emissions from electricity generation (35% coal power x ~50% reduction), is $154 billion. And that’s on the high end.

Think that’s a lot of money?

Remember, we’ve spent $4 trillion in the last decade on renewables, and still saw carbon emissions INCREASE by 6% (2 billion metric tons).

Still think it’s too much?

Here’s a fun look at how we decide to prioritize our spending, even in the face of “the greatest threat the world has ever faced”. (Note: those are the UN’s words, not mine. Hopefully you pick up on the satire throughout this piece)

If leaders were actually interested in ‘reducing carbon emissions’ instead of setting ‘renewables targets’, (which, as Doomberg has taught us all, are NOT the same thing) then this “greatest threat the world has ever faced” could be mostly solved in a few years with less money than we spent on the Football World Cup last year.

I haven’t even gone down the nuclear path and I won’t for once.

As Carl Sagan once said, “extraordinary claims require extraordinary evidence”.

The extraordinary claim, that the greatest threat to ever face humankind is at our doorstep, is woefully short on the extraordinary evidence required to support our path forward of continuing to spend lavishly on renewable energy projects that have proven less than impotent against their stated goals.

Not all fossil fuels are created equal, and hopefully people begin to wake up to the power of natural gas.

As Anas Alhajji says often, “Natural gas is not a bridge to the future. It is the future”.

A History of Stimulus

“The greatest trick the devil ever pulled was convincing the world he didn’t exist” – Verbal Kint

It’s been a wild ride since the early days of 2020.

The pandemic produced and is still producing, a seemingly never-ending chain of events that will likely reverberate through global markets and our social fabric for most of our lifetimes. The recent banking crisis, the 2022 Gilt market crisis, meme stocks, the rise and fall of SPACs, Cathie Wood, the Inverse Cramer Index, the fastest rate hiking cycle in history… all compliments of that pesky little pathogen.

The crisis also produced the most acute and long-lasting period of fiscal and monetary stimulus we’ve ever seen in modern history.

In the U.S. alone, the CARES Act, the American Rescue Plan Act, and the Consolidated Appropriations Act, in aggregate sent $814 billion direct to American bank accounts. Monetary stimulus was in the +$4 trillion range, but the mechanics of monetary stimulus are much more nuanced and not as relevant to this discussion (they are, nonetheless, crucially important to understand how we got here, but we’ll leave that for another day).

Like most complex systems however, the devil is in the details, and there’s an oft-forgotten stimulative monster that’s been around since the first programs of early 2020, and this one is larger than the three Acts combined – the pause in student loan payments.

There are 47 million student loans outstanding with an average $500 payment per month, and the freeze has been in effect for 39 months.

That’s $917 billion that consumers, 47 million of them, have added to their discretionary income over the last 3+ years. That’s $23.5 billion per month for 39 months. That’s $100 billion more than the combined three direct stimulus Acts.

Below, you can see how in the early days of the pandemic, the student loan pause plus CARES plus the Fed Funds Rate dropping to zero, jointly had a dramatic effect on Personal Consumption Expenditures (PCE), which had started to plummet with the world shutting down. At the time, the fear was a deflationary spiral, so getting inflation was actually a good thing. How times have changed…

PCE (the Fed’s preferred gauge of inflation) has grown ~25% since the end of 2019, that’s a CAGR of a little over 6% - way above the 2% preferred rate of inflation growth. Which is why so many within the investment community have spoken openly and vehemently about the U.S. overstimulating.

Mike Wilson, Chief U.S. Equity Strategist and CIO at Morgan Stanley, has a grim view of the back half of this year, and he echoed this sentiment in a recent interview:

• “In 2020, when we were out of consensus and bullish on earnings, we made the call in April 2020 that we’re going to have massive inflation because they’ve overstimulated and it’s going to be really bullish for earnings because it’s going to go right to the bottom line because companies have laid everyone off and it’s just going to accrue to the bottom line. It’s operating leverage.

• We’re expecting the back half of this year to be really bad because of sales growth, and the inflection point will be the third quarter.

• Earnings have actually been really lousy this year. The projections just keep getting marked down and then they jump over the lowered bar. The market will give a pass on that usually until sales growth goes negative. Once sales growth goes negative, that’s when the market multiple figures it out, says “these numbers are way too high” and that’s when you get the repricing in the market [down].

• One thing I underestimated was how much fiscal stimulus was still in the system. Over the last twelve months, the fiscal deficit has gone up by $1 trillion. That’s 4% of GDP. At a time when the Federal Reserve is supposed to be fighting inflation. That’s a real boost to the economy that has made things look and feel better.

• We’re already feeling the effects, but because of the fiscal spending, things have held up a little better, but we’re rolling into the second half of this year where these effects are going to wear off and that’s where the risks are much greater.

• I think we’re at a very important point right now because so many things are lined up. The positioning sentiment is bad, the valuations are out of bounds, and now, you have all these things that are going to work against you. You not only have the fiscal move going the wrong way,you have consumer savings running out, you have a liquidity change which was another big benefit in the first half which we didn’t really predict (the TGA, the Treasury General Account was drained to zero which means there was no treasury issuance), we also had $500 billion injected into the banking system which isn’t QE but it is a form of liquidity.”

Mike’s bearish outlook for the back half of this year stems from his forecast for revenues to contract with inflation falling (price of goods sold going down) and stimulus wearing off (quantity of goods sold going down), both hitting earnings simultaneously.

Mike is 100x the market mind I am, so I’m sure he’s thought about this, but the devil he didn’t talk about is the student loan pause coming to an end. When those payments begin again on October 1st, $23.5 billion per month of discretionary consumption will come out of the market.

And, as Mike mentioned, consumer savings is running out, and not mentioned, consumer loans (including credit card debt) are skyrocketing:

Yes, wages are up across most of the country, which has strengthened consumers’ debt servicing ratio (i.e. they’re able to pay their debts more easily with their cash flow). However, the safety net of savings has been stripped away and replaced by more debt, and 47 million consumers’ cash flow is about to be stretched further when the loan payments kick back in.

I’m not a big ‘earnings season’ guy, but I’ll be watching like a hawk in Q3 & Q4 to see how this all plays out.

And since my student loan will be kicking back in and since I’m currently travelling through Norway where a cup of coffee requires a HELOC, I’ll probably be watching all of that from a friend’s couch in their basement.

Runaway Interest

And here’s where all the fiscal and monetary stimulus and inflation fighting narratives get put into eloquent perspective as only Lyn Alden can do.

I’ll let Lyn do the heavy lifting but for context, remember that even though inflation has been coming down, core inflation (which excludes the volatile energy and food prices) is still sitting at 4.83%.

“During the 2020s, we have a different problem. Most of the inflation was caused by large 1940s-style fiscal deficits, and yet the Federal Reserve has primarily used a 1970s-style playbook of raising interest rates to deal with it, even though that’s primarily a tool to constrain lending. However, raising interest rates when federal debt is over 100% of GDP substantially increases those deficits at an equal or larger pace than it reduces loan creation in the private sector.

An issue here is that the Federal Reserve doesn’t really know what else to do, because their tools don’t really address deficit-driven inflation; their tools are meant to deal with lending-driven inflation. It’s a fiscal matter, and so the best the Federal Reserve can do is try to suppress the private sector to offset some of what’s happening in the public sector, even though that’s not addressing the core problem.

So as the Federal Reserve raises rates, federal interest expense increases, and the federal deficit widens ironically at a time when deficits were the primary cause of inflation in the first place. It risks being akin to trying to put out a kitchen grease fire with water, which makes intuitive sense but doesn’t work as expected.

The effective federal interest rate increases with a lag, since it consists of many different durations. Their short-term debt gets refinanced to higher rates within a few months or years, while their longer-term debt remains locked in until it matures and needs to be refinanced at the new higher rates. If all of the federal debt was yielding what T-bills currently yield, the annual interest expense would already be over $1.6 trillion, and the total fiscal deficit would be about 10% of GDP.

To quantify it another way, every 1% increase in the weighted average interest rate of the $32 trillion federal debt results in $320 billion worth of additional annual interest expense. That’s equivalent to the government hiring 2 million people at $160,000 per worker per year. Or, it’s equivalent to adding ten NASA’s worth of annual expenditure.”

Said differently, every 1% increase in the weighted average interest rate on the $32 trillion federal debt could pay for the entire planet's coal power plants to be converted to natural gas… 4 times over.

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Last week we covered:

1. Our outlook for oil in 2H this year.

2. A deeper look at our interview with Cem Karsan on options hedging strategies.

3. Why we think natural gas looks cheap here.

4. What Turkey's about-face on Sweden's NATO membership means.

5. China's export controls are a lose-lose.

6. What the end of the Black Sea Grain Deal means for commodities going forward.

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