Published: September 19, 2024
In this TDAM Asset Allocation Spotlight video, Hussein Allidina, Managing Director, Head of Commodities, TD Asset Management (TDAM), chats with Jeff Currie, Chief Strategy Officer of Energy Pathways at Carlyle, to discuss energy transition and the pathways ahead.
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- Hi there. I'm Hussein Allidina, head of commodities at TD Asset Management. And we're super fortunate today to have Jeff Curry joining us from London. Jeff worked at Goldman for nearly 25 years? 27 years. He started in 1996, recently has joined Carlyle as chief strategy officer of energy pathways. Jeff, welcome. And thanks for taking the time.
- Great. It's a pleasure to be here, Hussein. And it's great to see you.
- Can you tell me a little bit, or tell us a little bit about what you're doing at Carlyle, what you're doing for Carlyle Group, please?
- Well, let's talk about what energy pathways really is. When we think about the current approach towards energy transition, the focus has been primarily just on green, and not taking into consideration the whole concept of a transition and the brown side. And I would argue this transition thus far has been nothing short of disorganized and, to lack of a better word, chaotic.
So what we're proposing is to focus both on the brown, as well as the green, but more importantly, on the pathways between the two of them, because that's where we'll end up solving this problem. And I don't think anybody at this point right now can tell you what that pathway looks like. Yes, we're throwing a lot of money at EVs, renewables, hydrogen, but the reality is none of these technologies on their own can solve this problem.
I mean, I'd like to point out in the war and acid rain, we solved it, but did anybody know in the 1970s if we put platinum and palladium in our mufflers that it would take care of all these aerosols? The answer is no. Again, it goes back to the point, the pathways are critical here. We don't know what they look like. And we're going to try a lot of them until we get there. Hence the name, Carlyle's Energy Pathways.
- Yeah, it's interesting. And I'm sure we'll get to this a little bit further on in the discussion. But yesterday, BP came out, and I think are calling, again, in their annual outlook for a peak in oil production in the next three or four years. I think they've done that a handful of times. Maybe I'll go off script a little bit. When you think about the energy space in particular, Jeff, what are some of the biggest challenges you see for this transition?
- The lack of a carbon price. It really is. That's the core problem. Because without a carbon price, the market cannot remain technologically agnostic. And that was the beauty of solving the war on acid rain, is there was a silver price. And I have a chart that shows when the market started trading in sulfur, the number of patents in desulfurization exploded.
And again, I go back to the point, who would have ever thought that by putting platinum and palladium in the tailpipe we would solve the problem? And it was BASF and Englehart who solved the problem. It wasn't an oil company. It wasn't a car company. It was engineering companies, and it was ingenuity that solved it. And so if you ask me, what is lacking from this? Is the market based approach of using a carbon market and carbon price.
And actually, I want to extend that a little bit to the political situation right now. There's a lot of talk about the differences between Trump and Biden. But the reality is, both of them are industrial policy people. We are not even in the debate about market-based approaches anymore.
And that's unfortunate, given the timing of what we're doing in terms of this energy transition. So to answer your question bluntly, was the biggest issue and stumbling block here? It's a lack of a carbon price. I'm pretty sure you would agree with that too.
- Well, we got a price the externality. And one of the reasons I don't speed is because I know that there is a fine associated with that. Today, in most parts of the world, we don't have, and to your point, carbon pricing. Jeff, let's talk a little bit about commodities more broadly.
Last 10, 12, 14 years, some have coined as a lost decade for commodities. Absolute return performance wasn't great. And frankly, even from a portfolio construction point of view, looking back, and it's easy to do this, we didn't need commodities because equities and fixed income provided that diversification.
When you think forward and maybe contrast that with the past-- and I'll mention this as well, I still use the chart that you made 20 odd years ago when I was working with you at Goldman that shows the commodity cycle, exploitation phase, investment phase. What happened in the last 10, 12 years to generate that lack of performance? And how does that look different, in your view, over the course of the next decade?
- By the way, what happened between, let's call it 2014, and at least, 2024, is no different than what happened between, let's say, in the 1990s or in the 1960s. In fact, I think it's more instructive to look at what is common across these commodity supercycle eras and in the in-between periods.
The 1960s, we had the Nifty Fifty, characterized by low and stable inflation that led to very low interest rates, and investors pursuing duration. Duration in the Nifty Fifty or the 1960s was Coca-Cola, Gillette brand names. What about the 1990s? Once again, low and stable inflation, relatively low interest rates, and we had the dot com boom.
And by the way, and Hussein, you were involved with this back in the early 2000 while we were at Goldman Sachs, we came up with this term, "the revenge of the old economy." At the time, we thought it was unique, it was separate, and something we never observed before. But the reality is now we're seeing it once again.
What do we have in the 2010s? Low and stable inflation that led to low interest rates. And we saw the markets chasing duration once again. And this time, it was the FANG boom. But they all have that in common. And the idea of "the revenge of the old economy" is that the investors chase those new economy investments at the expense of the old economy investments that tee you up for the next supercycle.
By the way, this is nothing. All I'm saying is these are big 25-year cycles. Essentially, you came out of the war in the 1950s, produced too much commodities, weighed on global prices, kept it really low, and Central Bank/interest rates. The market went into a equity party, and you had a huge run up in the Nifty Fifty.
What happened in the '70s? Produced-- came out in the '80s, produced way too much commodities, inflation came down, central banks/rates, and you ended up with the dot com boom. It starved the capital. You needed to grow the supply base of the commodities. And what happened in the 2000s? Boom, you're off to the races again with China. And we can say the same setup is occurring again here.
One thing that makes this one, I think, is going to be more extreme, is the inability of investors to grasp this sector because the dislike of the sector this time around is bigger than what it was in the '60s or the '90s because of concerns around decarbonization. But I think the dynamic is identically the same. So I like to point out, the 2010, yes, it was unloved, but it was unloved in the '90s and it was unloved in the 1960s.
- And so really important to appreciate where in that cycle we are when thinking about the outlook for returns. May be different, Jeff, than the supercycle in the 2000s, we had the industrialization of the emerging market, very robust demand from China emanating from their accession to WTO. We don't have a China. I know a lot of people talk about India. Do you see the same magnitude of demand growth tightening balances, or is it more of a CapEX-starved supply constraint, or both?
- Both, but the demand is policy-driven. You think about during the 1960s, when we came out of that, the policy-driven demand was by LBJ's Great Society. In the 2000s, it was the WTO's decision to admit China into the WTO. And the policy here is going to be a combination of decarbonization, deglobalization, and I would argue AI.
And when we think about the decarbonization, not only do we need to grow supply to meet new demand growth that includes AI, but you also need to invest enough to take out the old carbon-producing assets that still represent 82% of primary energy supply. This is a Herculean investment proposal. And then we got defense on top of that with deglobalization. And don't underestimate the commodity demand associated with defense.
This is the same setup in the 1970s. Then it was the war on acid rain, and then you had the Great Society creating demand growth, and then you had the Cold War. The exact same setup that we had then. So when we think about the structural rise in demand, the demand here is going to be substantial.
But I think one thing to keep in mind, though, what is a commodity supercycle? It's nothing other than a CapEx cycle. Because what happened in the '70s? Lots of spending. What happened in the 2000s? Lots of spending. And the best proxy for that is metals prices. And then energy gets a ride along with it because ultimately, that's stimulus.
- So if you refer to the '70s, I clearly would have been better off with an allocation to commodities into the '70s. You spent a lot of time at Goldman working with governments, producers, consumers, but investors as well. Can you talk a little bit about the efficacy of a commodity investment in a portfolio construction context?
- Absolutely, yes. And I think that the diversification aspects of commodities this time around are going to be more important than at any other point in the history of finance. Why do I say that? Is because the decarbonization angle here is going to create enormous volatility in asset prices and goods prices. You've already seen a taste of it over the last year and a half, two years. It's only going to get bigger.
Because again, you're asking to take out 80 some odd percent of the world's primary energy supply. We'll never get the timing right. I look at power prices here in Europe. They're negative right now. Think about how high they were 12, 18 months ago. It shows you that investment is going to go ebb and flow and it's going to create that volatility.
So what I'm thinking about is you're going to have the green inflationary pressures. By the way, the way I think of it, why do I like our structure at Carlyle with the brown and the green? Is because the brown by itself is going to miss out on the demand growth. The green by itself is going to get hit by the lack of investment in the brown stuff that will create inflationary pressures.
And then you have policy uncertainty, like what China did with EVs, exporting too much. And by the way, the dual approach here, look at Ford versus Tesla. Ford had ice and it had EVs. It did OK during the first half of this year. Tesla had a really difficult time because they were just pure EVs.
And then you have technology uncertainty. And I'd like to point out these are transition risks. So yeah, we have always had risks that commodities hedge to you in those types of environments, but these risks today are new, bigger, and more dangerous. And I'd like to say, new transition records come new opportunities.
- Yeah, so you talk about commodities in the context of the portfolio. The diversification benefit is clear, inflation beta as well. But it sounds like commodity exposure is potentially also going to hedge against the risks associated with deglobalization and geopolitics. We haven't talked about geopolitics, and we could probably talk about that till wits end. Maybe just very briefly, what concerns you the most when you look at the world and the geopolitical strife we're seeing, I guess, globally?
- I want to talk about that really in the context of gold. Gold is the best performing asset on your screen this year. That, and Bitcoin. Bitcoin is actually the very best. Why? And when we look at the divergence, people like to show charts of how gold doesn't price off real rates anymore.
And gold goes up as real rates go up. That's a historical disconnect. You look at, when does it start? It starts when the asset freeze on the Russian bank occurred. And the willingness of emerging markets to go out and buy US treasuries has come off.
And instead, they're buying more gold to diversify themselves. And as a geopolitical reasons, a host of reasons, also, they just don't have as much surpluses that they have-- Actually, in China, that's not true. Surpluses are at record levels right now.
But I think the key point is during the 2000s, the Chinese would go take that surplus, just like the Saudis, turn around, buy US treasuries. They knew the purchase of the US treasuries drives down US yields. Lower US yields would lead to a weaker US dollar. Weaker US dollar would reinforce inflation. And it was a virtuous cycle between the dollar and commodity prices.
You would get the reflation that would weaken the dollar. The weaker dollar would in turn reinforce the reinflation. That dynamic is gone. It's not here right now. I don't know if it'll ever come back. But what we are seeing is that instead of buying those US treasuries, they're buying assets like gold. So for diversification reasons.
And so you asked me, can copper really rip to the upside or oil really rip the upside of the dollar? Does it weaken like it used to when it happened? You have to take a step back. It's a lot more difficult for the Indians to go buy oil or copper in an environment in which the dollar is very strong than, let's say, in the 2000s or the 1970s when the dollar weakened.
But I think the key point here, what is missing? What we're missing is dollar recycling. It's not happening anymore. They're not taking those excess dollars and plowing them into US treasuries anymore. In fact, if anything, they've been selling lately.
So you asked me, what leads me up at night? It's really thinking about those dollar dynamics. And right now, the dollar is incredibly strong. Every time copper tries to pop its head above 11,000, boom, boom, it gets smacked back down. So that's really what's on the top of my mind in terms of risks.
- I think it's remarkable. I was looking at some data few weeks ago on EM commodity demand, and to your point, notwithstanding the fact that the dollar has been as strong as it has been over the course of the last couple of years. In the case of India, they're paying, in rupee terms, 147 plus dollar oil, where we were in 2009, 2008, and demand growth continues to increase. But I do appreciate your point on the dollar more broadly. Jeff--
- Yeah, it takes a little bit of the edge off, is probably the way to describe it.
- Yes, yes, absolutely. Maybe quickly here, next two years, next five years, clients always like this, what do you think is the best performing commodity on a two-year view, on a five-year view?
- Oil, near-term. Copper, longer term. Everybody loves copper because they can see the long-term story in copper. And I think that creates an anchor in this market and makes people comfortable with that longer term story. Oil doesn't have it. There's a lot of concern about, is all this investment in green CapEx going to hurt oil demand down the road? Yes, it will eventually. We'll get there. But in the very near-term, not very likely.
And the one thing that baffles me about it, I can't sell oil if my life depended upon it, but we could sell copper all day long. Which one has the better fundamentals today? Who's saying, I know you know the answer to this? It's oil. But oil was net short three or four weeks ago. It shows you how disliked it is. Because it's disliked, the fundamentals seem to get tighter. The demand continues to surprise to the upside. I think there's a lot of upside risk near-term on oil.
Longer term, I think everybody gets the copper story. It's the one all-engrossing commodity that captures everything today, AI, which is chips and copper, defense spending on munitions, decarbonization, electrification of the world. I think you get the point. So you got all this demand in copper, but you really don't have any investment in supply due to "the revenge of the old economy." So longer term, the copper story, I think, it's a superb fundamental story.
- I really appreciate the discussion around terminal value. And I think we're seeing that as well. When we talk to folks on oil, there is this idea that, hey, we're not going to be using oil in two years, three years, five years. I take the over on all of those. But the idea, of course, that terminal value of oil is going to be very different than what it has been, I think, is creating some tension on the investor side when looking at something like oil compared to natural gas or even copper, as you've mentioned. That has implications on the shape of the curve?
- Yeah, it definitely has. And when we think about oil, the one thing about it, it's tight right now. It's backwardated. It's got a very good positive carry. Right now, copper's fundamentals are not that tight. But as they begin to tighten, and we saw it a few weeks ago, as they say tighten, the market moved back into backwardation. So when we think about curve shape, we like oil near-term and we like copper as we look further out.
- Jeff, I really, really appreciate the time you've made for us this morning. Maybe before we part, anything that I haven't asked you that you think is very important for investors to recognize or to appreciate?
- I think, again, let's just go back to the geopolitical risks that exist with the decoupling or deglobalization that is occurring. It's creating new pathways, whether if it's pathways in decarbonization or pathways in deglobalization. And there's a lot of uncertainty how that's going to evolve.
Are we going to end up with two types of markets with a China block in a US bloc? I'm going to leave all of that to you. But I think the world is a far more complicated place than at any point in time. Yet, you and I have been doing this. And it creates new opportunities and new things to be thinking about.
- Jeff, thanks so much for taking the time. I'd love to have you back at some point in the future.
- Absolutely.
- Best of luck at Carlyle. I'm sure you're going to win there like you did at Goldman. Thank you very much for your time.
- Great. Thanks, Hussein.
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