When Russia turned the nat gas taps off things got ugly.

• Europeans saw their energy bills go from €250/month to more than €2,500/month.

• Energy costs skyrocketed from under €100 / MWh to +€1,000 / MWh in some EU countries.

• Liquid Natural Gas (LNG) import prices shot up from €7 in 2021 to €70. 

Corporations, individuals, and utilities felt the pain.

To ensure that there would be enough natural gas to keep the lights on, many fertilizer companies were forced to cut production by 50%. The effect on crop yields are still to be seen. 

Then, there was relief.

It’s better to be lucky than smart… 

Europe got lucky, and had the second mildest winter on record – which brought energy prices down to pre-invasion levels. 

A blessing for European energy bills and an opportunity for savvy investors.

This wasn’t a stay of execution… just a delay. However, it has given the West more time to come up with solutions – one of which is U.S. LNG imports.

The Freeport LNG terminal, which was shut down due to a fire and explosion in June of 2022, is ready to come back online. This will be a major source of LNG exports heading to Europe. 

Added EU demand will put price pressure on U.S. natural gas. 

There is a high probability that a significant price move could occur in the North American natural gas markets over the next 12 months.

Last summer we saw U.S. natural gas prices break $7.00 / mcf for the first time in 14 years.

State of the (natural gas) Union.

We have been convinced that U.S. oil and gas production growth would stall and eventually turn negative, delivering a major hit to US energy supply. This thesis has been largely driven by the research of our friend Scott Lapierre – a world class petrophysicist that we had on the Ri Podcast 3 years ago. 

So far, things are playing out as we expected. 

Peak Oil

Today many analysts refer to peak oil demand, but originally peak oil referred to supply. 

The idea of a basin’s peak oil supply is associated with a controversial Royal Dutch Shell geologist from the 1950s named M. King Hubbert. He believed that an oil or gas field’s production resembles a bell-shaped curve.

Hubbert expected a field’s production to increase at an accelerating rate, level off / plateau, and then decline at a rate similar to its growth phase. 

In 1956 he predicted that U.S. crude oil production would peak in the 1970s at around 10 mm b/d. In 1970 when U.S. production did peak at 10 mm b/d, his work gained widespread attention. 

From 1970 until 2008 U.S. oil production declined, until a new type of basin came into the limelight…

U.S. Shale Oil & Gas

When hydraulic fracturing (aka: fracking) came on the scene, shale oil and gas became huge. In return, the U.S. became the largest producer of oil and gas in the world.

But, we believe the theory of a bell shaped production curve still holds true for fracked wells, just like it did for conventional oil and gas.

If we’re right… We’re running out of O&G. 

Our own controversial geologist, Scott Lapierre, has been pounding the table warning investors of declining shale production. 

Scott came to this conclusion independently of Hubbert’s ideas. Scott’s ideas arose from first principle calculations using the physical properties of oil, gas, and the rocks that trap it.

If both Scott’s science and Hubbert’s theories are correct, it could mean U.S. oil and gas production could fall as fast as it rose since the onset of fracking. 

The proof is in the pudding.

The two earliest shale basins, the Barnett and Fayetteville, saw peak production between 2011 and 2014. Since, they have each declined by 70%. 

Both of these early shale basins were gas fields. 

What does this mean?

The days of cheap natural gas in the U.S. are over. 

The next largest natural gas fields are the Marcellus and the Haynesville. 

The Marcellus is following Hubbert’s bell curve model, having reached its plateau in 2020. Over the last twelve months, the Marcellus declined by 300 mcf/d. Hubbert models suggest that the Haynesville could plateau as soon as next year. 

Exploration is dead.

Natural gas drilling in the U.S. is near all-time lows. 

The number of active natural gas rigs in the United States has declined by more than 75% since 2014, resulting in U.S. gas production declining by more than 10% in the same period. 

Because of low energy prices, and a move towards clean energy, the appetite for hydrocarbon exploration has been dead. 

This leaves the U.S. in a precarious position… And natural gas prices are vulnerable to a surge.

We’ve been watching the U.S. energy sector for 3-years, searching for the right deals to get energy exposure through natural gas.

On a trip to Texas earlier this year, we finalized one of our next deals…

Project Patriot

This is a natural gas development opportunity in East Texas with an all-star team. 

The company is led by a gentleman that was groomed at a multi-billion dollar oil and gas company before he left to run his own deals. After a string of success stories, he is putting together his forth deal. 

On the technical side, this company is led by the geologist that literally wrote the discovery paper for the Haynesville-Bossier shale basin, where this deal is located. With her protege, she’s successfully drilled over 100 wells in the basin. 

Now, they’re at it again.

If I had to choose one metal to own it would be copper. It’s essential to nearly everything, but more importantly we’re running out…

There are two trends driving copper demand:

• The energy revolution (AKA the electrification of energy)

• The urbanization of underdeveloped countries (primarily Asia and Africa)

To meet demand we’re going to need to mine more copper over the next 27 years then we’ve mined in ALL of human history to date.

That would be a challenging task even IF we had the copper reserves… the problem is, we don’t.

Copper production is falling at the world’s biggest mines. 

Codelco, the Chilean government-owned copper miner, is the world’s largest copper producer. And, Chile is where most of the copper comes from. 

Things are not going well. 

Production is at its lowest in a quarter century, costs have surged, and profits have slumped – all at a time when the world’s need for copper is greater than ever. 

Codelco’s production fell more than 10% in 2022 and is set to fall another 7% this year, to 1.35 million metric tons. 

This is more than a 20% drop from six years ago.

But, it is not only Codelco, ore grade is deteriorating around the world as existing deposits are mined and new ones are more difficult and costly to develop. 

Codelco’s CEO said “There’s no easy mining left—not in Chile nor the rest of the world.”

Global production issues confirmed.

I came across an interesting Twitter thread looking at Q1 2023 financial statements from the biggest copper producers. 

Copper production from Q1 2023 to Q1 2022, production was down ~200kt. 

The biggest contributor to falling numbers is the fact that there is consistently less copper in every tonne of rock that comes out of the ground (Note: Percentage of copper per tonne of rock is known as grade.)

It is becoming more expensive to mine a pound of copper. Add to that the fact that energy and labor prices are skyrocketing. 

4 of the 8 copper companies that reported cash costs saw increases of more than 20% from last quarter…

Let that sink in.  20% increase in costs in 3-months. That is insane! 

All of this is to say one thing: the world’s future copper supply is seriously in trouble.

We need much higher copper prices to incentivize exploration and development. And remember, we can’t just turn on the taps and produce more Cu – It takes +10-years to bring a new copper mine online. 

Oh, BTW Inventories are running dry…

Below is a chart of global copper inventories over the past 10 years. The gray area is the high, and low range, the white line is the average, and the orange is the 2023 inventory level. 

This chart should scare you because it says one thing: the world has no copper inventories. 

In summary:

1. Copper demand is stronger than ever.

2. The world’s biggest copper miner is having major production issues. 

3. Costs are up and production is down for the world’s top 10 biggest copper producers.

4. Current copper inventories are lower than they have been in the past 10 years.

My takeaway is simple: Own copper or be poor.

I don’t want to be poor, and neither do Ri Members. That’s why we’re about to launch our next Ri Deal: 

Project Patriot

We have one objective with this deal: BIG GAIN HUNTING.

Kazakhstan’s Chu-Sarysu is the world’s 3rd largest sediment-hosted copper basin. Yet, the region has been largely unexplored since the 1970s, but that is changing as we speak. 

In 2018, the government overhauled the mining code, unlocking exploration in Kazakhstan for the first time since the collapse of the Soviet Union.

The team locked down some of the most interesting assets in the region and are applying a fresh, modern approach to discovery. 

• Big Data – compiled and digitized the largest privately-held exploration dataset for Central Asia.

• Machine Learning – applying predictive machine learning to datasets, optimizing for the most prospective geology.

• Major Partners – They have signed a joint venture agreement with one of the largest copper companies on the planet.

They are ready to drill multiple porphyry copper targets. These are the type of geological formations that have the potential to become monster deposits. 

These are the types of deposits that took Filo Mining (FIL.TO) from a $200 million market cap to a $2 billion market cap. 

I recently invested into American Oil and Gas royalties. 

Here’s why:

• Exposure to energy;

• Exposure to the USA;  

• Exposure to cash flow;

• Exposure to assets NOT listed on capital markets;

Let’s dig in… 

The Case for Higher Oil

The investment case for oil and gas is pretty straight forward. It boils down to the this: 

Oil is cheap, but is about to get expensive.

We believe oil prices, compared to equity markets, will revert to the mean due to significant under investment in the sector.

We are now going to walk through the market conditions that got us to this conclusion.

FACT: Oil is Cheaper than ever.

We compare oil and natural gas prices to the S&P 500 because the ratio helps give us an understanding of the true cost of energy. 

When energy is “cheap” compared to the value of the S&P we can anticipate that over time this will correct. It will do so but either energy prices going up, or company valuations going down – either way you want to own energy in this environment as a means of protecting and/or growing your capital. The inverse is true when energy prices are “expensive” as we saw in the 80’s during the oil embargo. 

Theoretically energy should be priced so that investors and producers make enough money to justify operating and investing in new production. But, cheap enough that consumers are not gouged at the pump and can maintain a comfortable life. 

But markets do not exist in a state of equilibrium. The pendulum swings back and forth. 

Right now energy is objectively cheap. 

Nothing in life is certain but based on historic data we expect the pendulum is about to swing the other way. 

The chart below shows the price of oil compared to the S&P 500 since 1900. 

Today the price of oil is ~$75/bbl and natural gas is ~$3/mcf while the S&P 500 is trading at 4,000. 

Before 2020/the pandemic, oil and gas prices were the cheapest in recorded history when compared to the S&P 500. 

If the ratio swings back to 2008 levels at today’s S&P 500 levels then oil will be ~$240/bbl and gas ~$30/mcf.

If the ratio reaches 1918 or 1980 levels… then the world is in for a world of hurt. Oil prices will be ~$660/bbl and natural gas will be $84/mcf. 

Now, I think it is unlikely that oil prices will spike without a simultaneous pull back in the S&P – but even still I wouldn’t be surprised if we see oil prices above $150/barrel.

Even if oil prices don’t move at all (unlikely in my opinion), in the event of a major pull back in listed equities energy should act as a safe haven for capital. 

Why is Oil so Cheap?

Horizontal fracturing (AKA fracking) came on the scene in a big way in the mid 2000s. 

Between 2005 and 2010 the shale-gas industry in the United States grew by 45% a year. In 2005 shale gas production made up just 4% of the USAs overall gas production, by 2012 it accounted for 24%.

Meanwhile, oil prices were high. In 2008 oil price shot up to more than $140/bbl. Prices briefly crashed later that year, but quickly recovered and consistently traded around $100/bbl until 2014. 

From 2005-2014 the frackers were printing money – the likes of Harrold Hamm of Continental Resources (CLR) developed the Bakken, Tom Ward and Aubrey McClendon of Chesapeake Energy (CHK) built the 2nd largest natural gas producer through a levered land grab, Charif Souki of Cheniere Energy (NYSE: LNG) built the first U.S. LNG export terminal, and Scott Sheffield at Pioneer Natural Resources led the development of the world renowned Permian Basin. 

Horizontal wells came online with huge volumes of oil, but were expensive to drill.

Then the problems started.

Banks allowed the frackers to borrow against their estimated oil reserves, and so they did.

Frackers would drill, hitting oil nearly every time, but unknowingly (to most) they were significantly overestimating their reserves. 

The result?

Wells would “run dry” sooner than expected… There was a lot less accessible oil than anticipated. 

The above charts demonstrate well decline rates occurring far faster than anticipated. 

Which is not good when borrowing based on expected production. 

So what did they do?

Naturally, they drilled more wells to keep production high and meet debt payments. Inadvertently creating a pyramid scheme, with the revenue generated by new wells was required to pay off the debts on the old wells. 

They drilled to borrow, and borrowed to drill. 

Companies relied on rising oil prices to bail them out. But inevitably the sheer volume of oil that was being produced ensured that maintaining high prices was impossible. 

More Supply = Lower Prices.  

By 2018 the U.S. had grown to be the biggest oil and gas producer in the world. 

A Change of Heart

Executive bonuses were tied to production, not profitability. Which brings to mind one of Charlie Munger’s favorite sayings “show me the incentive and I will show you the outcome.”

During the Covid Crash, when oil prices went negative,this all changed and executive compensation was restructured. Today, compensation is driven by profitability. 

This means more disciplined balance sheets with less debt (aka less drilling). In turn, capital discipline will lead to less production, higher oil prices, and more profitable companies.

The Rusky Bailout

Then Russia invaded Ukraine and oil prices skyrocketed, saving many companies. 

They took this opportunity to pay down debt, hedge production at higher prices, and start telling a different narrative (closer to the truth) to the market. 

The truth is that they had  “high-graded” all of the U.S. shale plays. This means that they have drilled the best and most profitable shale locations trying to make ends meet. What’s left is lower quality acreage. 

This means that the U.S. shale production outlook is in bad shape. 

Speaking at a Goldman Sachs energy conference in Miami, Scott Sheffield, CEO U.S. shale giant Pioneer Natural Resources, said that the company has lowered its 2030 total Permian Basin oil production forecast from +8 million b/d to ~7 million b/d.

This indicates a significant slowdown in annual U.S. oil production.

Lower production means higher prices. 

Will drilling come back?

It is going to take time for drilling to come back in a big way. The world at large has mismanaged invested in the energy space for two main reasons:

1. The Green Energy Transition

A willful blindness has infected the western world, with the claim that oil demand is somehow going to disappear in 5 or 10 years. 

This is highly unlikely. 

Two decades of aspirational policies and trillions of dollars in subsidies, most of it on solar, wind, and battery technologies, have yet to produce anything close to an energy transition that eliminates hydrocarbons.

Over the last 10 years $3.8 trillion has been poured into renewables, yet fossil fuel dependence has only been reduced by 1% (82% to 81% of the overall energy consumption).

The IEA (International Energy Agency) noted that an energy transition is “a shift from a fuel-intensive to a material-intensive energy system.” 

They estimate the world will need to increase the supply of minerals such as lithium, graphite, nickel, and rare earths by 4,200%, 2,500%, 1,900%, and 700%, respectively, by 2040. 

The world will need dozens of new world-class mines for all of these minerals, requiring tens of billions of dollars of investment to develop. 

On average, it takes 16 years to bring a mine from exploration to production. So, even if we had the technology (which we don’t) and the mineral reserves (which we don’t), it is nearly impossible to provide the materials required to replace hydrocarbons for energy demand in the next 10 years.

In the interest of time I’m not going to touch on the inefficiency and the intermittency issues of  renewable energies here… Instead just ask your German friends how it’s going. 

2. Poor Returns

The frackers were so far off on production estimates that many investors watched their money get torched by aggressive  drill programs. 

Once upon a time any semi competent wildcatter with a half-baked idea could call up an energy PE fund and walk out with a $100m cheque. Today it is nearly impossible to find private equity money willing to drill new wells. Their mandates have been changed to buy production (where they can accurately calculate reserve estimates). 

To give you an idea of how far off historic reserve estimates were, today banks discount all future annual production by 10% then discount reserve estimates by 50% before calculating how much they are willing to lend. 

To incentivize this sort of investing again, oil prices are going to have to move MUCH higher. 

What about today?

The lost energy production resulting from the Russia/Ukraine war  is just the start. China’s reopening is about to shock the oil markets once again. 

Since China reopened, the International Energy Agency (IEA) increased its 2023 forecast for oil demand growth by nearly 200,000 bbls/day to 1.9m bbls/day. 

The IEA now expects 2023 total oil demand to average 101.7m barrels/day – setting new record highs.

We have already talked about that OPEC+ has been cutting production. But that’s just the tip of the iceberg…. 

Saudi Arabia is saying that they are maxed out on production – meaning, they don’t have the capacity to produce any more oil than they are currently producing. 

Why Now?

The Russians are off the board, the Arab world is tightening production, the Chinese are ramping up the economy all whilst oil demand is peaking and USA energy reserves are dwindling. 

This confluence of events has made me want to get long U.S. energy production. 

BUT I want to minimize risk so I’ll be using an investment instrument you’re all familiar with: royalties. 

In 1872 William Knox D’Arcy had the good sense to marry Elena Birkbeck of Rockhampton, the daughter of a successful mining engineer. After a decent legal career D’Arcy was launched into the world of  gold speculating.

In this, it turned out, he had a special talent.     

By 1889 he was worth £711,000,000 (in today’s money). Most decent Englishmen would retire to their country estate to drink gin and smoke cigars when they achieved filthy rich status… 

Turns out this was only D’Arcy’s opening act. 

Black Gold

In 1900 with the help of a few associates and the grand sum of £20,000 (worth ~US$2.9 million today) D’Arcy and crew locked down the oil rights to nearly the entirety of Iran (1,200,000 km2). In exchange D’Arcy promised Iran 50% equity ownership, including 16% of any future net profits.

 In 1908 he struck oil and the money started rolling in.

But, as Europe descended into World War oil became a strategic resource, prompting the British government to buy a controlling stake in D’Arcy’s venture, effectively nationalizing British oil production in Iran. In 1935 the company was renamed the “Anglo-Iranian Oil Company” (AIOC).

But…  All was not well.  

Throughout Iran discontent was brewing over the management of AIOC, seen as a tool of British imperialism.

The Brits didn’t do themselves any favors; refusing to allow the AIOC’s books to be audited they left the Iranian government with no way of knowing whether they were being paid what they were promised.

But that was about to change…

In 1951, Mohammad Mosaddegh was elected as the 35th Prime Minister of Iran. 

Mosaddegh wouldn’t take no for an answer. When the Brits refused to cooperate, the Iranian parliament voted to nationalize Iran’s oil industry, including the British-built Abadan oil refinery – the world’s largest refinery at the time.

The nationalization of AIOC meant the Iranian government took total control and ownership over the company and its assets.

Calling in the Kermit

Energy markets are the talk of the town right now, and for good reason.

Here are some headlines:

• Nord Stream 1 and 2 are down
• US petroleum stocks are below the 5yr range
• OPEC+ cuts production by 2million bbl/d

Nord Stream

The Nord Stream pipelines connect Russia to Germany via the Baltic Sea. Nord Stream 1 historically supplied the EU with ~35% of the total gas imported from Russia; Nord Stream 2 (which was on track to be operational in the first half of 2022) is equally as large.

We’re in the midst of stagflation with a recession looming and the Fed has been unrelenting in raising interest rates. 

Big Problems are Ahead for Real Estate Investors.

If you locked in a 30-year fixed mortgage rate on a $600,000 house at 2.6% interest rate in 2021 you have the same monthly mortgage payment as someone that just bought a $380,000 home at today’s 6.5% mortgage rate.

That’s ~37% reduction in home value based on monthly mortgage payment affordability, but that’s not the only problem lurking in the real estate market…

Bonds are back baby! 

US Treasury rates are now trading at 3.97% (6-month), 4.27% (2-year), and 3.83% (10-year).

Friendly Fire

Have you ever wondered why we no longer invade middle eastern countries?

I’ll give you a hint. It has nothing to do with Trump, Obama, or Biden spontaneously growing a conscience. 

It has nothing to do with a love for the troops. 

There  is one simple reason: ENERGY SECURITY

We don’t invade middle eastern countries because we don’t have to. The US shale revolution accomplished what pouring trillions of dollars and thousands of life into desert countries never could. It turned the USA into a net exporter of energy from a net importer. 

The ability to economically recover shale gas is perhaps one of greatest technological achievements of this generation and, although few know it, initiated the biggest shift in geopolitics of the last 30-years. Allowing US isolationism to thrive and giving Presidents the ability to turn the other cheek when their line in the sand is crossed. 

Because here is the reality: If your country does not have energy security it’s not really your country… You’re merely renting it from someone else. 

Just ask our friends in the EU…

Despite ample warnings from Trump and others they’ve managed to snatch defeat from the jaws of victory and leave an entire continent exposed to the imperial ambitions of a lunatic despot. 

But Jamie, that’s not fair you say? Europe can’t contend with North America’s vast geological resources. Just the luck of the draw!

Wrong!

Even though they don’t want you to know it, there is vast shale potential in Europe too. According to a 2011 study, Europe has 18 trillion cubic meters (tcm) of natural gas.

Europe has a long history of oil and gas production dating back to the mid 19th century, just like the US. The Polish Bobrka field was discovered in 1853, gas in Britain’s Weald Basin was discovered in 1875, and deep gas was discovered in Italy’s Po Valley in 1945. 

There is oil and gas in Europe.

But to put this fact into context first we must explore how shale revolutionized O&G estimates for US recoverable reserves. 

In the image below you’ll notice two things:

1. Shale extraction exploded the US’s recoverable natural gas reserves
2. When exploration starts reserves consistently increase (i.e. there is no short term lack of supply, only investment)

Democrats passed the Inflation Reduction Act and it magically made inflation vanish, even before the bill was signed into law. This is how good the bill is, it retroactively reduced inflation.

Rates & the Market

Recently we discussed how, as the Fed raises rates, we expect the dollar to continue its move higher, and a subsequent rally in broader equity markets. 

We are currently seeing this trade in full swing as the Fed raised the fed funds rate last week by 0.75% to 2.25% and the S&P 500 is trading at about 4,125 (up from 3,700 a few weeks ago!). Stocks are still following the playbook from the past decade, acting as though the Fed will soon ease interest rate policy. 

This rally will be short lived. 

Things are different in a post pandemic world – inflation, not deflation, is now public enemy number 1. Under the current economic conditions, the Fed will likely continue hiking rates into the fall  until inflation is under control. 

The only way inflation is going to slow is through a true recession, the kind where we see mass layoffs and real economic hardship. Only then will the Fed finally start slowing hikes or cutting rates.

This recession is coming faster than most believe.

It’s going to be painful BUT it will kick off the next bull market in precious metals. In the meantime, it is important to understand why markets are behaving the way they are.

Last week we saw another MASSIVE inflation print as headline CPI reached a four-decade high: 9.1%

This puts the Fed and markets in an interesting position. As inflation has yet to peak there remains pressure to raise rates even faster to slow the economy, meanwhile GDP is likely contracting for the second straight quarter. This means the Fed is in the unusual position of trying to slow the economy while GDP is contracting. 

This comes as no surprise to Ri Members, as we’ve been hammering on this theme for months. We also know these conditions are setting up a trade in precious metals. 

However, precious metals miners have been under significant selling pressure all year. This downward pressure is unlikely to let up before the fall, when I expect silver and gold to enter their next bull run. 

Let’s dig into why. 

The USD &  Rates

Fact: precious metals perform well when the dollar is weakened. 

Today this is largely tied to the fed funds rate. As the fed funds rate increases, overall interest rates such as treasury and credit rates rise. Higher rates typically result in a stronger economy and better returns. As global capital flows into US dollar-denominated assets, chasing higher returns, the dollar strengthens.

The important takeaway here is that the dollar won’t weaken until the Fed is forced to capitulate on their current stance by cutting interest rates. 

The question is when will that happen?

The Fed will only capitulate when a recession is imminent.

Globally many central banks have been far slower than the Fed to raise rates, especially the European Central Bank (ECB) and Bank of Japan (BoJ). Because of this, we are seeing capital flee those regions and pour into US equities and bonds. 

This has resulted in the USD surging higher. We’re seeing the Euro and USD hit parity for the first time.