Chuck Yates Needs A Job

0:20 Hey everybody, welcome to Chuck Yates needs a job. The podcast, my guest today is Brad Olson and quick disclaimer, Brad. Sequels always suck. Yeah, just, just. But the actors get paid more on

0:32 the second movie, even though they're much worse films. Yeah, there we go. The writing suspects, the directors, but the actors get paid more. So appreciate you coming back on. Cause I think

0:43 the text I sent you was like, holy crap, what happened over the last month Yeah. So let me do this. Let me start in just for the audience. Give the quick elevator pitch for recurrent. Yeah. So

0:58 recurrence affirmed that my partner, Mark Laskin and Oliver Doolin, the three of us started it about six years ago. And the thought process was we were coming out of or coming through a huge energy

1:10 dislocation. There were going to be opportunities on the long side going forward You could say that COVID deferred, but did not. cancel our view that there is an inflationary cycle coming and

1:24 that's what we're investing around. The name of the firm's recurrent because everything we do is driven by long-term historical research where we try to figure out what does today's market look like

1:35 and which markets of the past that people aren't paying attention to does today's market most closely resemble. We'll get into that, but just real quick to start with, I'm going to throw some

1:47 numbers at you Last month, near term, WTI down 22, large caps down 27, the Dow is only down about 1 over the last month, believe it or not. Then here's kind of the disconnect I want to touch on

2:04 a little bit. If you look at the three-year strip WTI, it's down 10, the four-year strip's down 6

2:12 One of my two questions are, one, just what happened? Let's touch on that a little bit. And then why do stocks trade with the near month on WTI when their cash flow durations are more like three

2:26 and four years and that didn't get hit as hard? Yeah. You know, obviously my superpower, but also my fatal flaw is lengthy answers. So I'm going to try my best to keep it punchy Primary fears,

2:34 specifically fears around what the higher price of energy is doing to the global economy has, you know, kind of ripped everything's face off for the non-energy sectors starting in January. But

2:55 energy has finally kind of caught up with this recessionary narrative in the last month or two. And why has energy reacted without any real resilience despite the fact that valuations are cheap and

3:09 cash flows are strong and you've got buyback programs in place? You know, that kind of comes down to at any given time. who's buying and who's selling energy. And when we look at the fund flow

3:21 data, as much as it pains me to say this, the broad fund flow data, your average American investor, despite all of the positive things that you just talked about for the oil price, the strip,

3:34 the average American investor is buying tech every time it sells off, and they're selling the little bit of energy they did own every time energy is strong. And so, at the end of the day, there's

3:46 fundamentals, which obviously go back to the oil price and how many years of cash flow we're talking about. But then there's also, what is the actual supply and demand for the equities themselves?

3:57 And right now, I would say your average investor is not convinced that the energy recovery trade is a three or a four year story. The average investor says, this little energy recovery we've seen

4:11 since COVID probably dies with the recession and coming out of the recession. I probably want to take a shot on tech instead of energy. We disagree with that for a lot of reasons that we can talk

4:22 about, but that's kind of the overall view as we have right now. And that's where I want to spend the most of the time talking, but real quick before we get there, is that sentiment on energy

4:35 driven by we sucked over the last 15 years and lost people a lot of money? Is it the green problem and we're polluting the planet, both of them, something else? What's driving that? Because what

4:50 I've said on the podcast is I think it's both of them. And I think what changes the world is when a CIO becomes a former CIO because they didn't have energy exposure. And at 2 of the SP 500, that's

5:06 not going to happen But we checked up a month or two ago above 5 on the SP 500 and we're starting to feel relevant again. Maybe that was in our own minds. Yeah, no, look, I think the kind of

5:19 obviously you're, you know, we both know that there's a energy finance community specifically on Twitter that, you know, was in a heated debate about has energy run too far? Are things too good?

5:32 And I laughed a lot about this debate because I spent some time in Europe talking to investors as recently as May And in Europe, here there's a war kind of going on a few hundred miles to the east of

5:47 offices that I was meeting in in Germany or Switzerland or France. And the average allocator kind of said like, when can I stop caring about energy? You know, like when can I, like I would love

5:58 for it to stop outperforming because I don't really have an allocation to it. I have to answer questions about energy and inflation for my clients even here in Europe. And I'd love to not have to

6:08 talk about it at all So for a lot of guys, it's a little bit of like hitting the snooze button hoping it goes And what's also kind of funny, right, is you read, obviously it's much more kind of

6:19 trading oriented community, but you read social media, EFT, and there's this like heated battle about where energy is, is it overbought, is it oversold, is it an opportunity, or is it a bull

6:32 market trap, or whatever you wanna call it. And I think folks like that have to remember that in the 100 trillion global capital markets, like that battle is like a tiny red ant hill, where there

6:47 are ants in like the battle of their lives in a pitched argument over 80 or 120 oil. And the average allocator in Switzerland who's got 600 billion in a pension system is like looking down with a

7:00 magnifying glass and saying, I've never, I haven't touched this in the last 10 years. I don't know why they're so fired up down there, but it's completely irrelevant to a lot of these global scale

7:13 investors. I hear you that on a tick by tick basis, I think we got to 45 or 5 of

7:21 the SP, but for your average active allocator who is making a decision, or even individuals who are making decisions about buying an ETF or selling an ETF, this has clearly remained a highly

7:34 skeptical market. And of course, as we've moved into this more recessionary environment where we're starting to see some economic slowdown indicators, you've had a lot of people who have been

7:46 hitting that snooze button and they've almost kind of said, Sweet, I've gone from not owning the one thing that's going up and now I can just say, well, I don't own it but it's going down the same

7:56 as everything else. So for a lot of allocators, this sell-off and energy has been kind of a relief because it allows them to not think about energy the same way that they weren't thinking about

8:06 energy before about January of this year So kind of given that. What are you telling clients these days? What's kind of the pitch? What's the outlook? What are you guys thinking - Yeah, it's a

8:22 great question. It sounds corny, but when we started recurrent, one of the hardest things about starting a company is coming up with a name, right? Like you're kind of sitting there rubbing your

8:33 forehead, like let's call it

8:37 stone ridge partners. Everyone's coming up with a stone or some rock formation and we came up with this idea that a lot of the work we did internally really was focused on trying to go through

8:48 history because today, right, everybody points at the energy market and whether it's like an algorithmic shop that programs, it's trading algos based on what the market has looked like over the

9:01 last two, three, five years, or it's just people's memory. Most guys who have traded energy remember that energy was the worst thing in the COVID recession. Right. So recession equals terrible

9:15 for energy. There aren't many guys who even go back to 08 and 09 and say, wait, why did energy outperform everything during a really nasty financial credit crisis recession in 0809? Why did oil

9:30 run back up to a hundred bucks while the Eurozone was on the verge of breaking up? Um, okay. Well, let's go back to like the 90s and the 2000s during the tech bubble When GDP was roaring, you

9:42 were in that kind of Clinton dot com economy with the strongest GDP that really we've seen it even, even today, that's the last strongest bit of GDP growth. And oil price was, was in the tank that

9:55 whole time. And when you had, you know, the recession of the early 2000s, energy was a relative outperformer. And so as you go further and further back and you say, well, wait, now in the 80s

10:06 and the 70s, energy was actually an outperformer in almost

10:12 non-COVID recession, why do we talk about recession being a kiss of death for energy? The reality is, right? Half the guys who invest in energy today get fired on a 5 drawdown with apologies to

10:27 all my buddies at Citadel and Millennium, but you know, you have a bunch of guys - And Kane Anderson -

10:34 Right. And so everybody operates in energy because it's not a long-term capital investment today There aren't long-term allocators in it. It's a hedge fund, it's a trading vehicle. You know,

10:46 there's a lot of, and I love EFT, and I learn a lot from it, but when I read it, there's a huge culture of like, remember when you said oil was a goodbye 20 ago, moron, you know, like there's

10:56 a lot of that kind of, you've been wrong for 20, you know, hang your head in shame and leave. And unfortunately, as a guy who's built a long-only firm over the last six years, I don't have the

11:07 option to quit and find a new job that time energy pulls back, even if it feels like it's every other month. And so I kind of have to look back at a longer, 50, 60, 70 year data set and say,

11:20 Wait, the bad news is in a recession, stock markets don't do well. But the good news is, energy actually tends to be pretty defensive in a recession and outperform coming out of a recession,

11:31 because guess what? All of the problems that created inflation before the recession are gonna be there on the back end of a recession And so I think that is a conversation, I'll say we're trying to

11:43 have with allocators, but most allocators are like, Dude, right now, you know what I'm not trying to do? Defend a new idea to a client who's watching everything down 30 year to date. And then

11:57 when I tell them my new idea is the most volatile and underperforming sector from the COVID recession, now it's a longer, more annoying conversation I don't really want to invite into my office.

12:11 Look, obviously there's a contrarian element to any kind of energy investment today, but what I will say is like we do go back and look at history and say, and I'd love to talk about this some more,

12:24 you know, I would argue that the Fed has historically had almost no impact on inflation for 50 or 60 years and that recessions do very little to the structural rate of inflation They take a little

12:38 bit of short term kind of fizz out of the economy, but if you didn't fix the inflationary problem, it's still going to be there when the recession's over. And I think that people investing in this

12:49 economy don't appreciate that this inflationary cycle is going to return as soon as the economy comes back after whatever choppy period we're going through right now. Is the,

13:02 I think what's underappreciated about this and somebody tweeted this out I need to give credit. I think it was Blake Street. bomber that tweeted this out. So I'll give credit there. But I've also

13:14 agreed with this is I do think historically the Ron Paul, 10 foil wearing hat, gold bugs have been right that the feds just printed too much money over the last call it 50, 60 years, you know,

13:30 we're saying that damn Nixon took us off gold standard I've believed in that. I think it's been totally hidden though by the fact of just the technological innovations we've gone through the computer

13:41 and all that that have been deflationary. Yeah. And so it's kind of hidden it. And if you're sitting here in 2022.

13:50 And the Fed just went, you know, last 50, 60 years we kind of gotten away with it. Let's see if we really print some money, which they did kind of through COVID I don't know that we're sitting

14:00 here staring at technological innovations that are going to be deflationary. Yeah, you know, so I always hated when a management team would walk into the office. Hey, Chuck, this time it's

14:10 different. It's never different, but it feels different. Yeah. You know, it's a lot to get your head around because the Fed, I feel like people have such strong opinions about the Fed that, you

14:25 know, we kind of, like, there are times when you're in an allocator meeting and we kind of joke that when you go and you pitch an investment, you are literally the world's lamest rock band, right?

14:35 Like, you're going into every meeting and you're like, I think we should hit him with inflation now Like, no, man, this concert will get out of control if we go inflation this early. You know,

14:45 it's like, can't do Enter Sandman as the opening song of the Metallica concert. Like the police will be called in halfway through. Now, of course, in real life, there's a bunch of like sleepy

14:54 people sitting around a table and kind of, you know, but there is something about like, hey, the Fed is an emotional debate. And you know, it's funny what I spent during the last, you know,

15:07 couple months as there's been this kind of energy beat down.

15:12 There's obviously, my model's, okay, let's say company X has a 40 or 50 crude kind of cost structure break even. So everything from 50 to 120 is, let's say, their economic profit in the current

15:25 environment. Oil goes from 120 to 90. Okay, well, I can come up with a reason why as a operationally levered entity, ENP X or ENP Y is down 40 on the pullback. Like I can back-solve for that in

15:40 a model, but what I find to be a little bit more interesting and for the way I like to think about the market, I actually went through kind of microfilms of different newspapers and I'm not

15:50 microfilms. Like

15:53 I'm not in a library with a magnifying glass, but you go through different archives on the internet and you go through the late '60s and the early '70s, what you mentioned, obviously Nixon took the

16:07 economy off the gold standard. And of course, at the time, people were like, He freed us of all of these unnecessary constraints. He's given us a lot of flexibility. The Fed has more policy

16:19 flexibility to manage the economy now. And that was obviously a big headline grabber. But what was really fascinating is that in the late '60s and the early '70s, you had this rip roaring economy.

16:32 Every headline in the business section was, economists agree, 1970 is going to be the best decade yet Because so many things are going right for the American economy. Once we end the Vietnam War,

16:46 there's going to be even more investment coming back home. And '71 by then, '72, you see these inflationary pressures bubbling up for the first time in 30 years. And just like today, nobody is

16:57 used to inflation. So in the early '70s, people are like, Well, we're going to have to hike rates a couple of times. That'll settle everything down, and then it's going to be back to business as

17:06 usual And by the time you had real inflation, oil price tripled. What happened? The Fed said, inflation's up, oil price tripled. We need to hike the heck out of the Fed funds rate and get a hold

17:20 on inflation. The issue is as many people have made this comment, but I know I've read it a bunch of different places. You can't hike your way to more oil in the economy, right? And so the Fed

17:33 created a recession. Oil went from three bucks to 10 bucks, but oil stayed at 10 during the recession And so these are kind of the things that, as we kind of think through the, like it's easy to

17:46 blame on the Fed, but the reality that when we look back at the real kind of long-term multi-decade trends, in the 60s, you had a belief that you didn't need to drill more wells, you could hike

17:59 your way out of an inflationary problem. In the 70s, the government ingeniously put a cap on the price of oil and said, that'll show them. And of course, the industry said, well, we're

18:10 definitely not drilling now. And of all people, Jimmy Carter, cardigan wearing, Democrat, took off price controls in '78, CapEx went through the roof, and shocker three years later, inflation

18:24 was secularly falling, even as the economy was making kind of new highs and growing much faster than it had in the previous decade. And so for us, like, there are so many explanatory variables,

18:35 like Fed policy, GDP, all these other, like how efficient cars were, the only variable over a 60 or 70 year time period that has any correlation, and I truly mean any correlation greater than

18:49 zero, is are you spending money investing in new wells? And when we talked on your policy debate, you know, one of the things I said was giving the energy industry free money to drill wells, is

19:03 the only way to actually fix inflation, but everyone always hates that. So they just end up saying, let's hike rates and guess what hiking rates does? It makes guys drill fewer wells and it

19:15 prolongs the inflationary problem. So I know that's a lot, but that's kind of, we've been focused on this idea that inflation's actually gonna be more prolonged because the focus right now is what

19:26 can the Fed do for us? And I think the answer is the Fed can't really do anything for you if you're not increasing the supply of commodities in the economy So the Milton Friedman and me just rolled

19:39 over in my grave hearing all that. But so did oil as a percent of GDP or whatever metric you wanna use, ie. the point being, was oil way more important to the economy 60 and 70 years ago versus

19:60 today just with our energy efficiency and does that still hold?

20:05 Yeah, is that a decent question to ask - No, it is a decent question to ask. I think the things that, so if you look at the 70s, oil is a much bigger percentage, but how much plastic, how much

20:19 rubber, how much different energy inputs crept into other parts of our lives, you might have your metal cup or your glass cup, and today we're just going through 10 of these a day at our other desk,

20:35 right? So yes, energy as a percentage of GDP has definitely gone down, and the amount of services, the amount of financial services, consulting, all that other stuff has obviously grown

20:48 dramatically as a portion of GDP, but when you look at the actual share of GDP, that is non-services, energy still goes into a huge percentage of the things that we do and use every day. And I

21:02 think what's really important too, right, obviously airline tickets, but also Amazon Prime, right? I'm not the only one getting suggestions of, if you delay this package delivery by two days,

21:16 we're gonna give you two Amazon points credit to your account, like there's different ways that costs and inflation are kind of working their way through the economy. And I think that the key thing

21:27 is, right? You've got complete Fed policy flexibility when oil prices are restrained and historically we've kind of seen in the 80s, the oil industry did what we're now because it's our recent past.

21:42 In the early 80s, the oil industry did exactly what we think of when we think of the shale boom.

21:49 Oil price caps were removed, CapEx tripled in the next three years and the amount of drilling on long dated 10 year projects in Alaska, places like that went through the roof when oil went up to the

22:03 30 and then crash back to 10. A lot of these projects were too long in the tooth to be canceled. And so there was an outspend even as oil price fell. And it's funny because everyone kind of

22:15 naturally is a buyer of energy, not a producer. So the newspapers always write from, energy is always a headache. It's never presented as a good thing. And that was the same in the 80s. There

22:25 was an article I was reading the other day that kind of said, Here we are, GDP is 6 growth The most it's been since the 60s. And in 1983 or 4, 6 growth and no inflation. Who to thunk? And that

22:41 was the end of the debate, right? There was no discussion of why does oil price keep falling as the GDP keeps growing? Is it because we're drilling too much in an already crashing oil market? And

22:52 so I think one of the things, you're absolutely right, the oil intensity, the economy consistently drops. The energy intensity of the economy doesn't drop as fast as the oil intensity of the

23:03 economy does. And as we're finding out in this kind of post Russia world, the prices of global coal and global gas are obviously heavily influenced by the fact that you don't have the same

23:15 exportable barrels floating around the world as you did a year or two ago. Gotcha. Gotcha. The, uh, we're back. Yeah. Maybe we would actually matter. I almost believed you I was like, I was

23:28 like sitting there. So, so in terms of, let's get back to talking to clients. So let me summarize to see if I've got it. Uh, let's see if I can play salesman for recurrent. If I walk into a

23:40 meeting, it's, Hey, probably our heading into recession. If we're not already there, actually believe it or not, oil has performed better in historical recessionary periods. Here's why Oh, by

23:54 the way, until we change policy. And it's got to come from the US because at the end of the day, I honestly don't believe there's any excess capacity out in the world. I don't think the Saudis

24:05 have it. Yeah. You know, Russia with all their mess. They don't have it. Venezuela is not going to get its act together. Iran's Iran, whatever. I mean, it really has to come from the United

24:16 States. And as long as we have the policies we do, I was talking to a CFO of one of the big multi-billion dollar oil and gas companies and said, How's it going? He goes, Man, I haven't gotten a

24:27 nasty call in a year. He's like, I'm just going to keep sending checks out. I don't want to pick up rigs. I have to deal with all that mess. He's just like, I just want to keep sending checks

24:39 out because people are happy when I do that. So it does have to come from the US. And so until we see kind of policy shift on supercharging drilling in the United States, we're saying the

24:52 inflationary pressure is going to be there and that ultimately oil is going to outperform. somewhat right - You got it right. I mean, I am a big believer philosophically, we are at recurrent,

25:05 like get rid of the variables that make people emotional and stick with an explanation that is time tested makes sense. And it was really actually kind of uplifting for me to go back to the articles

25:17 from the 70s and read these headlines where Exxon is pleading, like please allow me to sell oil for more than 5 a barrel I promise you, I will go find some oil. And the government was like, best

25:32 profitability in 10 years. And they're asking for more. Can you believe these guys? And I thought like you can't blame it on ESG 'cause ESG wasn't a thing. This is just a human, like you're

25:44 profiting on broad misery in the economy and you're asking me for a better deal? Like the nuts on you, it's incredible. And you look and you say, energy did great in 73. In '74, we went into a

25:57 recession, energy outperformed, but nobody writes you a thank you note for losing only 20 in energy. Kind of how I feel after the last couple months. And then as we kind of ground through the rest

26:09 of the kind of economically crappy 1970s, energy compounded a forebagger and the broad equity market was basically 100 return. And you kind of say, that felt bad. The economy was bad Energy was

26:26 always getting threatened by DC. It felt crummy the whole way through and you quietly outperformed by 300. And so that is, I think the outcome, certainly that we think of as kind of a bull,

26:40 that's a bull case outcome, right? It's like, it's not gonna feel good even in the bull case because unfortunately in energy, you tend to really make money when the rest of the economy is kind of

26:51 in the tank. And so you're never gonna get like a, man. Thank you so much. Everything's so awesome. It's going to be like we experienced in the last 12 months, like everything else is down 20.

27:02 I have a 3 allocation of your fund and it's up. Thanks. You know, and you're kind of like, great. But, but yeah, I think your sales pitch is right that until, and look, Jimmy Carter of all

27:15 the presidents, you know, Tom Cambodia, Nixon, you know, Gerald Ford kind of coming in whip inflation now, Republican, and then Jimmy Carter, please readjust your thermostat. Like which one

27:30 of these guys is the most likely to give incentives to allow more drilling? Not Carter, but Carter was the guy who did it because Carter was the guy who said, guys, we've tried 10 years of yelling

27:43 at them to reduce inflation. We've taxed them. We've capped their prices. We've created EPA the

27:51 to basically police them. It's time to let them make money. and see if they can get us out of inflation. And a few years later, you know, Paul Volker's chomping on a cigar saying, I did it -

28:01 Right - You know, and look, history is written by the

28:05 winners and Volker definitely got to write his own history as he lasted into the 80s much longer than any of these guys, but it is fascinating as you go back and you look through and you say, People

28:17 angry about oil prices demanding that Exxon get taxed and not be allowed to drill more is makes me feel better knowing we're just as dumb as people 50 and 60 years ago. And it's not, you know, a

28:31 lot of the adiocracy jokes you hear around like we're the dumbest generation, you know, people just get dumber, you're like, makes me feel better to go back and find a fairly consistent level of

28:41 intelligence, not a high level of intelligence, but a consistent level of intelligence through time So that's the beta. What are you telling clients? on the alpha level. Do you guys have a theme

28:59 of, we wanna play Permian, we wanna play oil sands in Canada. Do you have any color there - You know, it's funny. I made a joke when we were about to start recording that. I feel a little bit

29:10 like as on the last pod, we talked about philosophy major from Rice, I'm a total accidental energy investor. And whenever people talk about type curves, it's kind of like, I'm gonna go grab a

29:23 drink you guys need anything You know, like no geology. And look, as I've worked in kind of places like Tudor Pickering or Millennium, where the focus is intense on those geological kind of,

29:35 which play is the best, I've been exposed to it and I've kind of grown in my conviction that that, it may be some guys deliver alpha that way, but for me, the economy is a mess. Inflation in the

29:50 oil field from everything I hear is 50 and 60. And I'll give you an anecdote. My wife is in insurance. She puts together complicated insurance packages for energy and non-energy companies. And

30:05 last year, one of her OFS clients was like, Look, I do not want to pay your fee this year. 2021 is still very much like growing pains. We're still recovering. It feels still very COVID here in

30:19 terms of our economics Next year, when we do our insurance policy next year, charge us whatever you want next year. And obviously, she was

30:29 fair and she did a very good job if she's watching this, but her clients like, When did we say that? It's horrible right now. Like, I'm paying guys who fail drug tests 200K. Like, I can't pay

30:42 you that. And she's looking at me like, Honey, oil price is over 100 like are these guys trying to like, you know, are these guys trying to scam me? No, their life actually still sucks. In the

30:55 actual operating field level, all my buddies in OFS, all my buddies work at EP's, like my EP buddies are like, we're trying to put ourselves up for sale and it turns out none of our PUDs are worth

31:06 anything. You know, all my OFS buddies are, well, they fired three guys I used to work with and bumped my pay 10, 20 and they're like, well, you've got to do all four guys jobs for 12 times the

31:18 money. So you're - And I'll get the stat wrong, but you know, you wear the green hat when you're the rookie out in the field, so everybody does stay away from you. And when the alarms go off,

31:32 they know to grab you. Run! But I heard that on some projects, as many as half of the people running around in the oil field are wearing a green hat. I believe it. I mean, look, this is an

31:45 industry level and I don't want anyone coming up to - my wife and asking her who her clients are. But like an industry stat, she's like, the craziest thing is profitability is not jumping up higher

31:57 for a lot of these companies in the field. And insurance bills are going through the roof because the insurance companies that sit over in London who don't know anything about our industry, you know,

32:06 a guy's sitting over a Guinness like, my fatalities, injuries, like, you know, it's like, it's a 200 increase to your premium. And all these guys are like, dude, I haven't started making

32:17 money yet. And so it's funny, like going back to that little EFT, Ant Hill, like EFT is like, RSI is overbought, you're moron. And you're kind of sitting there like, guys, if you're really

32:28 trying to think about this as a multi year cycle, the guys who make this cycle possible still hate life, you know, like, so you're talking about calling time on the cycle. And when I was in, you

32:39 know, France, Ireland, England, or London, you know, like, well, guys, how much longer can oil really run? I'm like, well, I'm not talking about WTI or Brent Price running. But the idea

32:50 that we're calling time on an inflationary cycle 14 months in, we're refusing to call time on a 14 year tech cycle. We're still buying the dips on a 14 year tech cycle. We're calling the end of a

33:03 14 month energy cycle we never even invested in. And the companies in that industry haven't even noticed that the cycle is necessarily happening beyond the like EMP guys who are the first to benefit

33:16 It does bring up a lot of really fascinating kind of philosophical debates like namely,

33:23 what do we need to see change before we can feel like, hey, maybe this cycle is getting long in the tooth. And to me, the tightness in the field and again, just going back to the what theme,

33:35 what investable theme,

33:37 when you talk to the companies themselves, they're like, dude, diesel is a hundred and eighty bucks a barrel. Like like steel is up is up. Diesel's almost double. So everything that I buy out in

33:49 the field is up 50 to 150. So our big theme is can you build an energy portfolio where you're anti or blind or whatever you wanna say at the poker table? Where are the companies that can voluntarily

34:06 ratchet down CAPX during these ugly inflationary kind of turbulent times that we're seeing without their production collapsing? Like, so we're not really, you know, small cap, like shale guys

34:20 necessarily because we are looking for assets where the actual, where the reserve life is longer gonna you're, months 12 next the be in decline in 3 a the experience and rig another hire to refuse

34:25 can you, if hey, like, us to Because. declines type asset conventional more,

34:36 CAPBORD seat versus a company that says, dude, I've gotta pay whatever the incremental rig costs 'cause otherwise I'm gonna decline 20

34:45 crush my cash flow at a time when I should really be reinvesting into the cycle or I should be trying to grow or maintain production. So that's kind of the big micro theme is the economies of mess,

34:56 overall inflation and oil prices are going to stay strong. But how can you participate in those oil prices and commodity prices without constantly having to go out and hire an incremental rig staffed

35:09 by rookies that costs three times more than the rig you already have running in wherever it is that you're drilling? I got you. And then does the current theme, du jour of the EMP companies, let's

35:24 buy back stock, let's pay out dividends, does that play into the theme any or? You know, look, there's no doubt that structurally all the companies across energy are in a return of capital mode

35:40 And so part of the reason that we like guys who's let's just say the lower your decline rate, the longer your asset life, the less you have to spend on CapEx to maintain your assets every year, the

35:51 more cash hypothetically you should have to buy back stock and pay dividends. And I think when we talk to folks, we get a lot of questions, particularly, I wanna be gentle here, but like, a

36:04 generalist who don't spend any time in this space, the last update they got was, Oh, the biggest we've ever allocated to energy was in 2016. And so we're just generally grumpy anytime somebody

36:18 brings up energy in our office. And you talk to guys and they're like, Isn't it great that all these terrible CEOs are doing the right thing for shareholders now? And the thing that I think you

36:29 find when you go into a lot of pitch meetings is,

36:34 there are times when you kind of say, I've been thinking about this a lot, and I have some thoughts. No, I just wanted to say that. You know, like, and we had a meeting recently where someone

36:44 said like, well, isn't it great that all these terrible energy CEOs are now really focused on returning capital? And I kind of said like, all right, well, you know, before we move on, could I

36:53 just ask like, were they the worst CEOs in the world during shale? And are they really good CEOs now? And like, were they visited by three spirits at some point during COVID? You know, like when

37:08 did this transformation, how real is the transformation? Because, you know, the same way I don't like to think of the Fed as the reason for anything good, anything bad, because a lot of times I

37:18 think there's not a lot of explanatory power. And similarly, it's like the CEOs are responding to a world where the CEO says, all right, you know, let's just kind of use a semi-defensible

37:30 financial metric. Like I'm trading at three times EBITDA or two and a half times EBITDA So. The market is basically giving me credit if I can grow at something a creative to 40 cash flow yield.

37:45 Even in

37:49 today's market where oil field inflation is 60, 50, 40 throw in whatever number you like, I don't have a lot of things that are rock solid locks for being life of asset, 40 e-bit dot or better

38:02 because in

38:05 order for me to do it, I'm taking risk and I have to be a creative to my current implied - Or your engineer screwed up the engineering - I mean, let's be real - Right, if anything looks that good -

38:16 Right, there is a failure rate, there is an air margin in

38:21 everything that involves dynamite diesel fuel and being outside in 120 degrees, right? Like we all know that. And so there's a certain amount of, I think, a rational CEO who a few years ago said,

38:37 Dude, I'm being valued at like a - five or a 10 EBITDA yield, I can find wells that deliver more than a 10 EBITDA yield. The market's giving me, like for every dollar I put into a well, the

38:49 market's giving me a buck and a half of value. I am a rational actor and I am putting a buck in the ground and getting a buck and a buck and a half out of the stock market. Today you put a buck in

38:60 the ground and the stock market gives you 70 cents and you're the same dude reacting to incentives as you were before. You're not Ebenezer Scrooge, there is no kind of deathbed conversion going on.

39:14 The same CEO that was like, Stock market was telling me a buck and a half was the value of my dollars. Today is now telling me I'm worth 60 or 70 cents. Returning cash is the rational actor move.

39:27 I think the reality is it's funny in the 70s, you'll get a kick, I think, out of this little anecdote but like going through and reading I like Why isn't anyone buying back their stock in the 70s

39:38 when things were good, but the government was preventing more drilling? Well, there was effectively a stock manipulation rule that meant you couldn't buy back your own stock because you must have

39:48 insider info and you're manipulating your own stock valuation. And so you have all these hilarious press releases of oil and gas companies going out because they can't buy their own stock. They're

39:60 scared to death of drilling a well and finding out that the government allowed oil price has gone from five to three. And so they go out and they buy department stores. Oh yeah, a Montgomery ward.

40:11 Yeah, exactly. I'm not a Montgomery ward, right? Like you're looking through this stuff and all of like the, like, this isn't a bad CEO. Like I don't have any reason to think the CEO of Mobile

40:24 was a dumb guy, but he's like, we need a business where we can charge what the product costs and ladies fur coats are the only business that I see That is, that if we can charge what the business

40:34 costs to run.

40:39 And you see these hilarious things where you're like, like, why did these guys buy a speedboat manufacturer? And it's like, oh, 'cause they had all this cash flow. They were scared of what would

40:46 happen if they reinvested. The market was not giving them the valuation premium for them to take that risk. And it's very similar to where we are today. So, you know, again, I would be shocked

40:56 if Pioneer traded at five times book value of assets Scott Sheffield should, would, will go back and drill wells. Because the market's saying, like, hey, even with all the chances of failure,

41:11 we're giving you a huge premium to the book value of your assets to go out and grow that business. But as long as those multiples are, you know, 05 or 07 or one times, there's no incentive to go

41:23 out and be really aggressive about growth, especially if you have to go ask an investor who's like, I don't have any new money coming into it like, you know, XLE is a passive fund, but the XLE is

41:34 seen only out. in the last 12 months. And you're like, if the best energy tape in years is, hey, the index representative ETF is seeing only outflows, it kind of gives you an idea of how a CEO

41:49 would be received if he went to BlackRock and said, Hey, can you guys like put a little side pocket together for me to go drill wells with? It's like, we're only getting outflows from our energy

42:01 products. So why would we give you money to go drill more energy - Yeah, no, that makes a lot of sense 'cause Charlie Munger's right. Show me your incentives, I'll show you your behavior. You

42:13 know, he's definitely right about that. The other thing to

42:20 your point and Mark Meyer, your former compatriot at Tudor Pickering Holt, co-host of BDE with me, and his whole point about profitability was quarter Exxon, they made more money than God, all

42:36 that. They still had, even when you take out the shutting down the Russian operation and the loss there, their net income margin was 10. I mean, the average income margin of an SP 500, company's

42:51 12. So profitability-wise, I mean, if that's gouging,

42:57 I don't get it Well, yeah, I mean, again, time is a flat circle or whatever that true detective Matthew McConaughey quote is.

43:07 Doing all this research over the last couple of months, the Senate in 1973 or '74 commissioned a report to look into the extraordinary profits of the 10 largest American oil companies And they came

43:21 back with the damning conclusion that after a Arab oil embargo, this industry was earning half a percent more return on capital than the average. Dow Jones industrial constituent. And you can just

43:34 kind of imagine

43:37 like the Senator in 1975 being like, who put this together? You know, like, I asked you for numbers. I didn't ask you for these numbers. I asked you for something I could kind of sell to the

43:50 public - Who am I firing on the staff - I know, and you look back and you kind of say like, look, this is the natural, you know, unfortunately, right? Nobody ever buys oil because it's like,

44:01 hey, dad, I think when I turn 18, I'm gonna take all my saved up money and just buy oil, right? Like there's nothing you buy only what you need. And so people resent having to pay more for what

44:11 they need. And there's just a certain amount of like, why is nobody mad about Apple's 30 net income margin? 'Cause everybody kind of made a, you know, consensual decision of buying the iPhone or

44:22 the watch rather than buying a competitor product or, you know, they didn't, you didn't need necessarily the Apple product. But with oil, it's like, it's a commodity, right? Nobody ever says

44:33 like. Thanks for finding it for only 2 a gallon. And you shouldn't expect them to. I mean, all commodity markets are kind of treated this way, but it is amazing that every, when we talk about

44:46 kind of why it's so important to do historical research, I graduated in the mid 2000s. I haven't seen anything other than the kind of beginning or the middle innings of a China-driven, inflationary

44:60 mini-cycle, really in retrospect, that oil cycle was significant, but it wasn't as long dated as the 70s. So I saw the China cycle, I saw the collapse of the China cycle, and I saw shale kind of

45:12 come and shoot a bazooka at the

45:16 rubble that remained after the China inflationary cycle was over. I ain't shot a 5 million barrel of tape, a zooka, right there. Yeah, hey, I heard you guys needed this.

45:27 And so looking back now, the crazy thing is, my dad is visiting right now and he's 76 and my dad's been retired for a few years and he's like, yeah, I guess, yeah, I remember the gas lines, I

45:42 remember the outrage at how much money the oil industry was making, but he's a guy who has no economic incentive to work anymore, he's retired. And so his experience is kind of just rattling around.

45:55 There's none of that making its way into the investment profession today. And even Bill Ackman, who put out an interesting and thoughtful discussion of how the 70s are similar to today, and I hate

46:07 it when people put out reports around the time I'm putting out or we're putting out or we're like, I hope you didn't say the same thing. But Bill Ackman was like, you know, Arthur Burns was a

46:18 wimpy fed guy, Volker was a strong man. Yeah, you know, it's like, we need to be as courageous as Volker. By the way, it would also be helpful if you were allowed to export energy or drill

46:30 wells, and you're kind of like, Energy's role in inflation as Europe pays 300 a barrel equivalent for gas and the world is experiencing high dollar adjusted oil prices to 300 when you adjust for how

46:47 much the dollar has gone up. You look at all these things and you say like, Oil got one bullet on the last page of Bill Ackman's, how we defeat inflation

47:00 This whole pitch was basically we jack up rates until people stop going to shopping malls. And you kind of say like, But when people decide to go to shopping malls again, won't inflation come back?

47:11 You know, like won't the exact same issues persist? And because when the Fed Jacks rates, it historically also slows the rate of drilling, right? The energy industry is just as scared of a

47:22 recession as the rest of the economy is like, Why would I add a rig into a recession? And so, you know, these kind of, it's interesting that all of these. super brains all across Wall Street

47:34 talk about inflation, and they don't even really look into the fact that there's been an energy cycle coincident with every inflationary cycle. And without an energy cycle, you never have an

47:47 inflationary cycle. But yet people talk about inflation in terms of the Fed and Paul Volcker, and does Jay Powell have the co-honies of

47:58 Paul Volcker? And if he doesn't, we're in for a terrible decade, all that kind of stuff. And I think the one guy who has that institutional memory, Warren Buffett and Charlie Munger are out there,

48:10 they're buying Oxystock, like, bros on Reddit.

48:15 What do you mean I can't buy more than 10 of daily volume like Warren like chill out, chill out dude. You're not trying to blow up Melvin Capitol here. You don't have to buy it this fast, but I

48:26 think it's a good indicator of like guys who do remember that cycle kind of say like, This is kind of a sleep at night investment if you believe in the inflationary cycle, even though everyone looks

48:37 at energy as the riskiest thing you can buy in today's market -

48:44 You talked about a paper? Are you putting a paper out - Yeah, I mean - Do you get a copy of it? Do other people get a copy - Absolutely, you know, we, one of the big things we do, just I mean,

48:53 for our own, I'll say for our own kind of investment process as well as our own sanity, right? Like, wait, what happened? Like, hey, in the middle of the biggest energy cycle ever, energy

49:04 went down 25 for no reason in 1974. Like, okay, okay, you know, it's happened. It's not just us, but yeah, the paper will be out on our website, recurndadvisorscom.

49:19 In, you know, as of the time this video gets published, it should be on our website and obviously we'll send you a copy and - Yeah, look, I'm more than anything. I hope it starts an interesting

49:28 debate because there are a lot of folks out there that just say, you know, COVID proved, COVID proved recessions are bad for energy. And you say like, well, that was the most mobility targeted

49:38 recession in human history. Maybe not the perfect analog for all other recessions going forward - And the thing I still say is, I mean, we shut the world down and we were still using 80 million

49:51 barrels of oil a day - Yeah - I mean, we shut it down - Yeah, no, that's exactly right. I mean, how hard oil is to kill in an economic sense should be very obvious post COVID, but the reality is,

50:05 right? Everything you learned about investing, you learned it in your high school cafeteria. And when you walk into a room filled with allocators and you're like, this guy is kind of the biggest

50:17 talker. If he hates energy, that's kind of it. You know, it's just like, you kind of remember in high school, you'd be like. I don't know, I think Chelsea's pretty cute. And then like the one

50:27 guy that they was like, Brad thinks Chelsea's cute. And you're like, I will never say anything ever again. And when you go into a meeting and guys are like, I don't know, we could have a 1970s

50:38 style inflationary episode and like, you know, the 38 year old CIO is like, wow, this guy doesn't understand that technology destroys inflation over time. Do you, have you not read any books

50:51 about what Silicon Valley has done to the economy? And you're like, okay, the CIO said that we can shuffle our feet to the exits at this point. So here's my, my, my piece of advice for you when

51:01 you're out fundraising and you run into that person. Make the analogy to stranger things. 'Cause you can at least get them back to the 80s. Right. You

51:13 can at least get them back. You can at least get them back there. There you go. Yeah, exactly. So no, it's good advice. I mean, I think like the, the reality is it took eight years for the

51:22 United States to wake up to investment is the only cure for inflation. Well, I should say like it took six to eight years. And so if we're in year two of our inflationary episode, we're still in

51:34 deep in the denial phase. And it feels like acceptance of the, hey, you actually have to drill wells if you want oil price to go down. You can't just build solar and ask Saudi Arabia for more oil.

51:46 We're still kind of going through the deny and ask for more solar phase

51:52 And it might, I hope it doesn't take as many years as it did in the 70s and 80s, but it's a reminder that it takes a while for civilization to realize that like denial and punishment are not the

52:03 ways to cure an investment shortage. So I'll close with this. I was having drinks with a very prominent investor. And his or her prediction was a trouncing of Biden of Biden in the

52:21 November midterm elections. and that shortly thereafter we will actually see incentives for drilling out of this White House. Now, I don't know that I believe that. I don't know that I can see

52:34 that happening, but that was the prediction and to your point - Yeah, well, fingers crossed. Brad, thanks for coming on. It was good to see you again - Yeah, it was a lot of fun.