1st Qtr 2024 West of the Hudson™

Dear Clients:

As described in Ed Conway’s Material World: The Six Raw Materials That Shape Modern Civilization (Penguin, 2023), there are six elements that have enabled the world to evolve — salt, sand, iron, copper, oil, and lithium. These fundamental materials have, at various times over the millennia, created empires, razed civilizations, fed our ingenuity, and were the center of the technologies and trade of the time. Without them, our world would not exist as we know it. Reading this book happened to coincide with our in-house analysis of a mineral business critical to current alternative energy production. The expiration of tax incentives and other adoption carrots, combined with mounting supply constraints in green alternative energies, has led to a deceleration in output which caused critical mineral prices embedded in these technologies to collapse. We thought it practical to identify potential targets before any snap-back.

As is usually the case, there is always another side to an investment thesis and while we are coming to understand the last of these materials — lithium — we ended up drilling down into the material that came to define progress in the 20th century — oil. What follows is not well advertised and, in this politically fractured environment, is inconvenient for the prattling media class. As one analyst, whose daily note arrives in our morning in-box noted, “it is the greatest energy boom you’ve never heard of”.

Among other things, oil production is a political cudgel, and his comment was aimed at the state of U.S. political discourse, as one side claims that the current administration is waging a debilitating war on America’s energy sector and, by extension, the American consumer. Claims that “we are begging countries to give us gasoline”; and “we have destroyed our energy independence”; and “we are waging an unprecedented war on American energy producers” — are demonstrably false. But America’s energy boom is an inconvenient truth for anti-regulatory pundits because it contradicts their key accusation: that naïve environmentalist-minded politicians have blithely sacrificed U.S. energy independence and security. This narrative is clearly negated by the fact that the U.S. is more energy independent today than it has been in decades. But the political absurdity extends across the political spectrum to the party currently occupying the White House, which doesn’t want to take much credit for the energy boom they stimulated because record-high fossil-fuel production is an awkward fit with internationally agreed-to climate goals.

After having to import massive amounts of foreign oil in the latter half of last century, and motivated by the 1973 mid-East oil embargo, the U.S. innovated and drilled its way to becoming became fully energy independent five years ago as a result of the shale revolution. Today, the U.S. is the largest oil producer in the world, and accounts for ~20% of total daily global oil production. A similar story can be told for U.S. natural gas production, which has recently overtaken Australia and Qatar as the world’s largest exporter of liquified natural gas. The fact is, global energy needs are growing rapidly, alternative energy feedstocks at scale are years away, and energy companies are going to fill the gaps regardless of policy.

It is believed that, if the U.S. were to scale back on production, prices would rise, enticing producers in other countries to step in. According to U.N. data, the U.S. has the least emissions-intensive oil industries, and shifting production to countries with looser standards will result in higher overall global emissions. So, while drilling for oil and gas does exacerbate climate change in the near term by increasing carbon and methane emissions, the alternative to more American oil and gas isn’t clean energy — it’s more foreign oil and gas. We may wish it away, but demand for fossil fuels isn’t going anywhere in the near future. So, we thought we would shed some light on both the production of oil, the cost (in oil) to transition, and the proverbial wall green energies have run into. And it is here that we jump off for this, our first letter West of the HudsonTM in 2024.

• The Greatest Energy Boom You’ve Never Heard Of

Accounting for one-fifth of the world’s total oil production, the U.S. has never extracted more black gold than now, producing millions more barrels/day than either Russia or Saudi Arabia. Raising America’s fossil-fuel output was not part of this administration’s original plan. In its first week in office, they killed the Keystone pipeline (which had nothing to do with U.S. production but was a means to transport Canada’s “dirty” tar sands oil across the width of America’s heartland to Gulf Coast export terminals!) and placed a moratorium on new leases on federal lands. But a year in, Russia’s invasion of Ukraine sent global oil prices soaring so that, from January to June 2022, the price of gasoline rose ~50% to a national average of more than $5/gallon — the highest price in more than a decade. Spiking energy prices pushed already-high inflation even higher, igniting fears of a 1970s-style price spiral.

Understandably, the administration backtracked on its campaign promise to cut domestic fossil-fuel production, including lifting its moratorium on oil/gas drilling on public lands. Considering the lack of reporting on this, it might come as a surprise that this pro-green administration has now issued more of these permits than the preceding, anti-green administration. One cannot overstate the importance of gasoline prices to the consumer (and the associative impact on over all consumption). The White House readily began to deploy every tool at its disposal to bring prices down at the pump, including the release of 180 million barrels from the nation’s strategic petroleum reserve (SPR), and easing sanctions enforcement against Venezuela and other ‘hostile’ regimes.

But oil, in its refined parts, fuels ~95% of our economy and, while consumers are acutely sensitive to the price of gasoline, we are less aware of other modes of transportation. For example, the airline industry reports that every $0.10/gallon increase in the price of jet fuel adds $2B in annual operating costs. Politicians hold limited, and tenuous, control over gas prices, but the administration’s moves did have a positive impact on production. Today, the U.S. is producing peak oil — 13.3/MBD in December 2023, up from 10.9/MBD the week President Biden took office (+22%). For context, the U.S. produced 4.0/MBD in September 2008. The amazing thing about the surge of production is that it has occurred using far fewer drilling rigs: 500 today compared to 877 in January 2019, as consistent advances in horizontal drilling techniques (simul-frac and now trimul-frac) have greatly improved efficiency and productivity.

The other side of this production coin is that America is drowning oil cartel OPEC in its own oil. Led by Saudi Arabia, OPEC has been cutting supplies to prop up prices, with Saudi Arabia alone extracting one million fewer barrels per day. In the context of U.S. production, all those barrels are coming at OPEC’s expense. Combined with escalating production in places like Brazil and Guyana, the global market share of OPEC has fallen to ~48%. America’s large and growing market share also deprives Russia, Iran, and other petrostates of both pricing power and leverage. This has led to speculation that, as further production cuts eat into state revenues, OPEC members will need to flood the market in a revenue grab, which is a positive for consumer consumption.

But that time is not now: with the U.S. economy humming along, the European and Chinese economies stable and even beginning to turn up, and the drumbeat of geopolitical risk ever-present in Russia and the Middle East, the prevailing market sentiment has reversed sharply with the price of oil +25% YTD ($85)/BBL. Of course, the run-up in oil prices has not taken place in isolation. The prices of gold, copper and even cocoa are also up sharply. But the price of oil is uniquely important, accounting for a disproportionate share of the world’s primary energy mix. Ironically this is a positive for U.S. production, as higher prices typically encourages increased production.

Naysayers argue that the administration has abandoned its principles at the first sign of political trouble. After all, the only way to reduce emissions is by burning less fossil fuel. By boosting domestic oil supply, the administration was seen by some as to be contributing to the very problem it claims to want to solve. But the short-term solution to global events ignores the longer-term roadmap codified in law: the climate provisions of the Inflation Reduction Act. They are, quite literally, designed to do one thing — destroy future demand for fossil fuels. By funneling hundreds of billions of dollars into solar, wind, and EVs, the

law will (if all goes according to plan) make clean energy so cheap that people will switch over voluntarily. EVs are expected to be cheaper than gas-powered cars in the coming decade and, by 2030, projected to make up ~65% of global car sales. Solar is already the cheapest energy source and, along with wind, expected to provide 35% of global power in the coming decades. Such growth is in large part predicated to the exponential decline in the cost of these technologies, further boosting adoption and competitiveness.

But to get there from here will, paradoxically, require producing more fossil fuels. Concrete for example is the 3rd largest global CO2 emitter, accounting for ~8% of the world’s CO2 emissions. A typical wind turbine uses ~567 tons of concrete, requiring an astounding 2,775 megajoules of energy (771 kWh) to produce. Most of this energy comes from oil — 89 barrels per turbine base. All this plus the CO2 emissions from the prodigious production of the steel rebar! A lasting factoid from The Material World, is that for every ton of fossil fuels, we extract six tons of other materials, from sand to stone to wood to metal.

Fossil fuel demand is projected to peak, but the outlook remains uncertain. Total demand for fossil fuels is projected to peak around 2030 but remains at the core of the world’s energy mix for decades to come. Total natural gas demand is projected to increase through the 2040s, driven in large part by the balancing role that gas is expected to play for renewables-based power generation, and until batteries are deployed at scale. According to a deep-dive from McKinsey, the outlook for gas demand differs widely, from a steady increase under slower transition scenarios to a steep decline under scenarios in which renewables and electrification advance faster. Worst case scenarios we have uncovered puts the demand in oil demand to decline by just 3% over the same period; this reflects much slower auto electrification of and lower penetration of alternative fuels in aviation, maritime, and chemicals sectors as bottlenecks of materials and infrastructure limit their growth. The energy transition has gathered pace, but the path ahead is full of uncertainty in everything from technology trends to geopolitical risk; consumer behavior makes it difficult to shape an investment strategy that reflects these multiple scenarios.

• The Path to Alternatives

While unlikely, history may well designate 2023 as the year America’s clean-energy revolution took off as hundreds of billions of dollars in climate-related spending flowed into ~300 clean-energy projects and electric vehicle (EV) sales hit a new record. It is estimated that renewable energy sources are expected to provide ~50% of global generation by 2030, and 65-85% by 2050. Solar will be the biggest contributor, followed by wind. However, the renewables build-out faces challenges, from snarled supply- chains, slow permitting, and grid build-out implications.

As noted, however, getting there is fraught with uncertainty, beginning with the current surge in power use. In an ironic twist, the swelling appetite for more electricity, driven not only by electric cars but also by battery and solar factories and other aspects of the clean-energy transition, are taking a toll on power grids.

Driven by the unexpected explosion in data centers, the growth in advanced manufacturing, and millions of EVs being plugged in, demand for electricity, which has stayed largely flat for two decades, has experienced a surge, causing utilities to nearly double their forecasts of how much additional power they’ll need by 2028. Many power companies were already struggling to keep the lights on, especially during extreme weather, and the strain on grids will only increase. Peak demand is projected to grow by 38,000 megawatts nationally in the next five years, which is like adding another California to the grid.

The U.S. especially is experiencing unprecedented imbalance between supply and demand for transformers — the crucial devices used on the power grid. Almost every kilowatt of electricity flows through a distribution transformer, which manages the flow of electricity along the power grid by changing high- voltage electricity from interstate transmission lines into low-voltage electricity before it reaches our homes. Distribution transformers are a bedrock component of our energy infrastructure, but utilities needing to add (or replace) them are currently facing high prices and long wait times due to supply chains which extend to China. This has the potential to affect energy accessibility, reliability, and most of all, affordability.

Based on the transformer data collected by the National Renewable Energy Laboratory (NREL), distribution transformer capacity may need to increase ~260% by 2050 to meet all of our energy demands (residential, commercial, industrial, transportation).

A composite of corporate conference calls confirms that big tech’s latest obsession: finding enough energy to fuel artificial intelligence (AI) insatiable appetite for electricity. Amazon Web Services noted that the world adds a new data center every three days. And that electricity is the key input for deciding whether a data center will be profitable. Currently, a typical datacenter from Microsoft, Apple, Amazon, or Meta consumes 100-megawatts (MW) of power/day. That’s a lot — enough to power a medium- sized town of 25,000 homes. In the future, a 100MW solar power plant is expected to power 60,000 homes/day, while a 100MW wind power plant will power 30,000 homes.

As a result of the tax policies contained in the 2021 Inflation Reduction Act (IRA), this demand surge comes just as a wave of advanced manufacturing plants come online. Stimulated by the growth of remote work, video streaming and online shopping, the expansion of data center capacity has suddenly turned into a frenzy. By 2030, electricity demand is expected to triple, using as much power as 40 million homes, equivalent to an additional ~1,600 100MW datacenters to be built.

This of course has utilities stumped as to how they are going to bring enough generation capacity online at a time when wind and solar farms are becoming more challenging to build. Utilities will have to lean more heavily on natural gas, coal and nuclear plants to help meet spikes in demand that are clearly coming. Datacenters can be built in about one year — faster than power generation can be added — and construction timelines have already been extended by years because of mounting permitting delays. It can take five years or longer to connect renewable energy projects to the grid and a decade to build some of the long- distance interstate power lines they require. Utilities also note that data centers and factories need continuous 24/7 power, something wind and solar can’t provide.

According to local utility Dominion Energy, northern Virginia — already home to 75 massive data centers — is expected to see capacity double in the next five years. In Georgia, where dozens of EV manufacturers and suppliers are setting up shop, local utility Southern Company now expects 16 times as much growth in electricity demand largely driven by the build-out of data centers and other industrial activity this decade as it did just two years ago. In California, 20% of new cars sold are EVs, and officials estimate that EVs could account for 10% of power use during peak hours by 2035. The lack of foresight is in part due to the forceful impact of the IRA: after decades of offshore investment, IRA tax breaks have fueled investment in American manufacturing. Since 2021, companies have announced plans to spend in excess of $525B on factories for semiconductors, batteries, solar panels and many more.

While many projects won’t ultimately come online or stay online due to lack of profitability, clearly the energy infrastructure isn’t ready to absorb the spike in demand, and more (traditional fossil fuel) capacity will result..

While much of the above requires a committed political landscape and supportive legislation, the continued growth in EVs is mostly consumer driven. Tesla, the electric car pioneer, grew rapidly. Seeing its success, traditional internal-combustion-engine (ICE) manufacturers the U.S. and Europe concluded that large numbers of consumers were poised to switch to battery-powered cars and trucks and began investing many billions to catch up. But a host of emerging headwinds have halted volume growth. Costs and expired tax credits are the two most cited, but the discomfort with running out of a charge — range anxiety — has emerged as a concern (the result has been the growth in hybrid ICE/EV vehicles that pair a gasoline engine with batteries and electric motors).

This is not a localized phenomenon. China’s auto industry has become an economic powerhouse on the back of EVs, churning out highly competitive, low-cost cars that find favor with consumers throughout south Asia. But after years of booming sales, demand has slowed substantially thanks to the removal of local tax breaks, and leading to the fall in the price of minerals that launched this analysis.

Unlike the U.S., where households are the main source of demand, China’s power use is mainly industrial, accounting for ~65% of electricity consumption. The main industry consumers are in focus here — semiconductors, datacenters, green tech, and EV manufacturing — but also in industries the U.S. has essentially ceded, like metals processing (steel, aluminum, copper) whose smelting demands a lot of electricity and polysilicon processing (the basic raw material for solar panels). Producing one ton of polysilicon requires ~60,000 kWh of electricity, more than 4x the requirement for a ton of aluminum, and 150x that for a ton of steel.

When it comes to the growth in green technologies and the minerals that enable their properties, we see the same bottlenecks that we saw in the re-shoring initiative: land availability, energy and transportation infrastructure, material availability, investment incentives, and consumer affordability. The world needs over 2x the current annual supply of several key minerals to meet global climate pledges, and China dominates the production of these minerals, including 80% of the global refined market for lithium.

• Conclusion

With the current and emerging headwinds, it is clear governments and industry overestimated the ability to transition away from oil as an energy source. Still, as the world accelerates towards its zero-emissions goals, the transition will ultimately change the trajectory of energy feedstock demand. A couple of years ago, investing in green metals like lithium (and nickel and cobalt) seemed a no-brainer, yet prices have tanked to spectacular lows. Some of the responsibility lies with weaker-than-expected demand, and myriad bottlenecks, but also oversupply (especially in Chinese EVs), adding to the long and familiar pattern of overinvestment breeding overcapacity in advance of actual widespread demand.

As the froth comes off the recent boom, overcapacity and falling prices have become more evident, exposing some of the costs of the industry’s rapid expansion. Even so, the calculus for energy grids worldwide will continue to strain under the yoke of technologies transformation and the path we take to achieve anything resembling carbon-light remains a long way off.

In order to back-stop the security of supply and demand — particularly in end-use sectors with no current energy alternatives (chemicals, aviation, trucking) — investment in oil and gas will remain more or less as is. The headwind to this transition is, of course, politics, with the current opposition party promising to scrap current green transition initiatives, pivot back to the exploitation of extracted resources, canceling subsidies, and tax credits, tearing up energy efficiency rules, and dropping emission standards. Whether this would put downward pressure on fossil fuel isn’t obvious. It might play well with voters but, with the natural gas market oversupplied and prices at multi-decade lows, producers have little incentive to invest in new capacity. Oil production has climbed to record levels and, with capital costs up and shareholders clamoring for better ROIs, it’s not obvious that the anti-green movement would lead to higher production growth or lower prices at the pump when share buybacks and dividends are what investors demand.

The clean energy transition is gaining momentum, but it will take longer than initially expected because of the necessary infrastructure investment. Oil and gas will remain a key component of the energy mix, which actually puts the U.S. in a good position, as we are energy independent just as we begin the long slog of implementing the clean energy transition. This provides us with interesting secular investment ideas not currently in mainstream focus. From our families to yours, we wish you a peaceful, safe, and profitable 2Q.

Yours truly,



Hirschel B. Abelson

Chairman, LCES



Adam S. Abelson

Chief Investment Officer, LCES

This information is intended for the recipient’s information only. It may not be reproduced or redistributed without the prior written consent of Fischer Stralem Advisors & HighTower Advisors LLC, an SEC-registered investment advisor. Securities offered through HighTower Securities, LLC, member FINRA/SIPC. This information is intended for the recipient’s information only. It may not be reproduced or redistributed without the prior written consent of Fischer Stralem Advisors. This commentary reflects our current views and opinions. These views are subject to change at any time based upon market or other conditions. Past performance is not indicative of future results. Sources: Eurasia Group (i, 3/20/24), The Atlantic (ii, vi, vii, xiv, xvi, xviii,12/20/23), U.S. Energy Information Administration (iii, v, ix, x, xvii, 2/29/24), United Nations (iv, 9/30/23), American Airlines (viii, 1/25/24), Bloomberg (xi, xxii, xxxvii, 3/28/24), Quartz (xii, 1//18/24), Gavekal (xiii, 1/11/24, xxxv 3/11/24, xxxvi, xxxvii, 4/5/24), McKinsey & Co. (xv, xix, xx, xxi, 10/18/23), New York Times, (xxiii, 3/14/24), National Renewable Energy Laboratory (xxiv, xxvii, xviii, 3/4/24), Amazon.com (xxv, 2/1/24), Wall Street Journal (xxvi, xxxiv, 3/24/24), Boston Consulting Group (xxix, 2/28/24), CBRE Group (xxx, 9/14/23), Dominion Energy (xxxi, 2/22/24), Southern Company (xxxii, 2/15/24), PG&E Corp (xxxiii, 2/22/24)