A wood-burning fireplace on a cold day is a welcoming sight. The crackle and smell of combusting organic matter has provided a place for humans to bond for millennia. Coal replaced wood as the developed world’s chief source of energy in the 19^th century. Because of this some feel a misplaced sentimental attachment to burning firewood. Environmental extremists pursue policies intended to return living standards to pre-1850, before the onset of the industrial revolution with its increase in anthropogenic (ie human-generated) CO2. So it’s not surprising that they’d favor that era’s main energy source.

Coal displaced wood for fuel because it was more efficient. Coal is more energy dense, so generates more BTUs by weight. The ratio depends on the type of coal and wood being compared, but 2X is a fair approximation.

Wood also generates lots of fine particulate matter. That fireplace is cozy, but it’s also a toxic environment. The US Environmental Protection Agency warns of the dangers presented by wood smoke, especially indoors. It’s a big source of pollution and respiratory problems across Africa and in other developing nations where wood is commonly used for cooking and heat. The UN has initiatives aimed at reducing the pollution and CO2 emissions from poor families using wood.

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There is plenty of evidence that burning wood is bad for the planet. Left-leaning outlets such as NPR and the UK’s Guardian have been critical.

Nonetheless, the world is burning more wood to generate power, especially in the UK and EU. Fuzzy math in accounting for the CO2 generated from using wood pellets to produce electricity classifies it as clean energy. This means their CO2 emissions aren’t counted. The US is the largest exporter of wood pellets, often sourced from forests in the south east. Canada is #3. The UK is by far the largest importer.

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The companies that produce and consume wood pellets seem to be exploiting a hole in the EU’s climate change policies (known as RED II).

Wood pellet producer Enviva argues that wood pellets are produced from fallen branches that would otherwise sit on the forest floor and decay, or that only trees cut down for “thinning” a forest are used. But drone footage and Enviva’s public filings show that they’re using freshly cut trees.

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Drax runs the UK’s biggest power station, and thanks to £6BN of UK taxpayer subsidies converted a coal burning power plant to run on wood pellets that provide 12% of the UK’s “renewable” electricity. A BBC documentary found that Canadian forest was being cleared and used for wood pellets.

Trees are nature’s way of absorbing CO2 – research shows that global CO2 levels fluctuate with the seasons. A felled tree stops absorbing CO2, and burning it releases the CO2 it held. Apologists argue that by replanting new trees in the same forest they’ll suck those emissions back in. But researchers at the Massachusetts Institute of Technology have concluded that not only does wood burn dirtier than coal, it takes at least 44 years for replanted trees to absorb the carbon released from burning the ones they replaced.

It seems so obvious that chopping down trees to produce electricity is a dumb idea. Because trees grow back again wood pellets are classified as renewable. That doesn’t mean they’re clean. But since the EU and UK have legal requirements to lower emissions, they’re resorting to slick accounting because solar and wind aren’t going to do it.

It’s too early to say whether the Inflation Reduction Act’s subsidies for biofuels (the catchall within which wood pellets sit) will encourage the same perverse policies the UK has pursued here in the US.

Sometimes it seems as if the lunatics are running the asylum.

My thanks to good friend Mike Shinnick of Naples, FL for bringing this topic to my attention.

Kinder Morgan (KMI) reported earnings last week. They were ho-hum. The quarterly dividend was raised by 2% to $0.2825. A decade ago then-CEO Rich Kinder reacted angrily to criticism from Kevin Kaiser, then at Hedgeye. But within a couple of years they slashed the dividend from $0.51 to $0.125. KMI has an attractive 6% yield because they have a long and mediocre record of capital allocation, which is why the dividend is only slowly recovering.

However, in the press release current CEO Steve Kean, who will soon step aside for CFO Kim Dang, commented on the continued failure of Congress to deal with reforming infrastructure permitting. Kean added that the difficulty in building pipelines in America, “…increases the value of our existing natural gas pipeline systems, which results in a favorable recontracting environment.”

The continued delay in completion of the Mountain Valley Pipeline is frustrating Senator Joe Manchin and is the best example of what’s broken. However, the environmental extremists whose court challenges are the cause are unwittingly increasing the value of existing infrastructure. This is another reason why it’s a good time to be a pipeline investor.

Climate extremists aren’t always deep thinkers in the policies they pursue, but they’re not all bad. If you meet one, give them a hug and offer a drive to their next protest.

We have three funds that seek to profit from this environment:

Energy Mutual Fund

Energy ETF

Inflation Fund

I’m the treasurer for our co-op in Naples, FL. I recently asked our local bank to pay a more competitive rate on our cash balance, which is well over the $250K FDIC insurance limit. Their deposit rate for business accounts was 0.5%, and maybe because Silicon Valley Bank (SVB) had just failed they quickly raised it to 3%.

This is still inadequate, and I’m not done with them yet. Banks are notoriously sluggish in raising rates when the Fed’s tightening. Depositors are slothful in demanding competitive rates. The margin below treasury bills can be thought of as the fee for banking services, although the cost in foregone interest income is more than most depositors would tolerate if asked to write a check for the amount.

Banks don’t make it easy either. Parking cash in treasury bills requires a brokerage account and the ability to easily move money back and forth. Dual sign-off for transactions is often required on business accounts. It can quickly become an administrative headache to earn a competitive rate, and banks know this.

SVB’s failure exposed imprudent risk management, but it prompted depositors to consider where their money sits and what it’s earning. Money has flowed out of regional banks, some of it to the systemically important banks (“too big to fail”). We assume deposits are fully guaranteed even though they’re legally not. There’s a de facto guarantee because allowing depositors to suffer a loss in bankruptcy might lead to another financial crisis. Size matters. A bank deemed small enough to fail is not the place to be.

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Extending FDIC insurance requires legislation, so Treasury Secretary Janet Yellen makes confusing pronouncements. Unable to explicitly guarantee every deposit, she nonetheless leaves the impression that she would.

There are increasing signs that regional banks, those not deemed too big to fail but nonetheless enjoying an implicit guarantee of their deposits, are being squeezed on both sides. They’re being forced to offer depositors higher rates, since their customers are no longer as slothful. SVB’s failure started with customers leaving for higher rates.

On the asset side, the banking system’s increasing duration risk has become problematic given the Fed’s rapid tightening. SVB’s reach for yield ultimately rendered them insolvent. Although they were an outlier in unsecured deposits and interest rate risk, markets and regulators are now pondering the unrealized losses in bond portfolios across the system. Sticky deposits are normally believed to have increased in value when rates rise because of the lethargy with which banks increase the rates they’re paying. But today’s altered dynamic looks likely to force more competitive practices on banks.

Schwab is a good example. Last year they changed their default option for client cash balances to Charles Schwab Bank rather than money market funds. This allowed them to pay low rates and invest the cash in bonds, picking up the spread. This is similar to SVB, but Schwab wasn’t as reckless.

Nonetheless, in their earnings on Monday Schwab revealed that the size of deposit outflows had caught them by surprise, forcing them to borrow money at wholesale rates to fund their bond portfolio. Banks have long argued that revaluing their assets down in response to higher rates without recognizing the implicit higher value in sticky deposits presents an unfair, biased picture. But the problem is that the long duration of liabilities isn’t contractual, it’s just assumed based on history.

Commercial and Industrial loans have dipped in the past several weeks, a first sign of risk appetites being reined in. Banks know regulators will look more closely at duration risk on securities and loans, casting a chill on their willingness to extend credit.

This is what’s behind the gap between where the market expects Fed policy to go and the FOMC’s projections. Tighter financial conditions have increased recession risk. Such differences are usually resolved at the cost of the FOMC’s reputation for forecasting accuracy.

On a different topic, Texas is confronting the problems that come with being the leading state in windpower generation. Storm Uri in early 2021 that caused widespread power outages led some renewables champions to note that natural gas plants stopped producing along with windpower, and that it was incorrect to blame the debacle on intermittent power.

Nonetheless, the Texas state legislature has concluded that more natural gas power plants are just what is needed to prevent a repeat. Having subsidized windmills they’re now going to subsidize reliable power to stabilize the grid. The intermittency of solar and wind creates problems for systems that become too dependent on them. Note that they didn’t opt to invest in battery back-up to compensate for this shortcoming. Instead, lawmakers in Texas have concluded that reliable, dispatchable power is what’s needed.

We have three funds that seek to profit from this environment:

Energy Mutual Fund

Energy ETF

Inflation Fund

Why are people so negative? A recent WSJ article included results to the yes/no question: “Do you feel confident that life for our children’s generation will be better than it has been for us?”

78% of respondents said no. They think the next generation will be worse off. This is the most negative reading in over thirty years of the question being asked. America is a nation of positive, can-do people. I knew that when I moved here 41 years ago. In Britain, where I grew up, the response to challenges is often one of resignation. In America we get mad – like in the 1976 movie Network. “I’m as mad as hell, and I’m not going to take this anymore!”

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By objective measures such as incomes and longevity the next generation has been doing better than prior ones for at least the past couple of centuries. To expect this to change is to bet against a well-established trend.

It’s possible to interpret the answers differently. The four fifths who think the next generation will be worse off than us may be so giddily happy with present circumstances that any further improvement is inconceivable. This is being negative in a positive way, and if true would reflect a warm, optimistic outlook.

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But it’s not supported by other surveys. For example, the University of Michigan index of consumer sentiment goes back to the 1950s and is very negative. The more plausible interpretation is that many people feel life sucks and it’s going to get worse.

Why do people feel like that? Jobs remain plentiful. We’re not at war. The pandemic is over. Things have been worse. Inflation has lowered real living standards, but it’s declining without the economy falling into the perennially forecast recession.

Maybe it’s our increasingly partisan politics which affords extremists in both parties outsized influence.

In March 2020 the pandemic was unfolding. We didn’t know how deadly it might be and dire comparisons were made with the Spanish flu of 1918. We were under the tyranny of lockdowns. Equity markets, especially energy, were collapsing. That was a moment when negative feelings about the future were understandable.

And yet, consumer sentiment was higher than it is now.

Economically, America is hitting it out of the park. The Economist gushes that, “The world’s biggest economy is leaving its peers ever further in the dust.” We’re 58% of G7 GDP compared with 40% in 1990. Even though China has grown enormously, our share of global GDP is roughly unchanged over the same period. Average incomes in Mississippi, America’s poorest state, are higher than in France adjusted for purchasing power. Tell anyone who thinks the American economy is in poor shape that they could be worse off – they could live in the EU.

The 2008 Great Financial Crisis, 1990-1 first Iraq war and recession and the 1979 Iranian capture of US embassy staff were all times when consumer sentiment was understandably negative. People feel as downbeat as at those times, if not more so.

Maybe we just expect more out of life.

Among our family archives is a series of letters sent from the field hospital in northern France where my great grandfather, Harry Lack, lay dying of wounds during World War I in 1917. The letters were sent by the head nurse to my great grandmother, recounting how fondly her husband was talking about her and their baby boy. 84 years later I read them for the first time sitting next to my grandfather, who never met his father. Consumer sentiment wasn’t measured then, but low readings wouldn’t have been shocking.

There have been plenty of times in American history where the outlook wasn’t as bright as it is today.

The Economist warns that “…the more that Americans think their economy is a problem in need of fixing, the more likely their politicians are to mess up the next 30 years.”

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There is one meaningful and tragic negative: life expectancy, which fell in most countries during Covid, has continued to deteriorate in the US by contrast with other rich countries. Even more troubling is that young people are dying. Only 24 out of 25 five-year-olds in America can expect to turn 40, a shockingly high fatality rate 4X that of peer countries. Drugs, notably opioids, are behind this. School shootings are probably another factor since gun violence is now a bigger cause of death among children than automobile accidents. By contrast, older Americans enjoy life expectancy similar to peer countries.

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Negativity over too many young people dying could be forgiven if that was driving morose feelings. But there’s not much evidence that it is the main cause. Moreover, we can solve this problem ourselves as we have so many others in the past.

I moved here from the UK in 1982 drawn by Americans’ sunny optimism, epitomized by my first president Ronald Reagan. To this immigrant, the country’s prospects look at least as bright as they did then. The only political ad in history worth rewatching is It’s Morning Again in America from Reagan’s 1984 presidential campaign. It’s always morning in America.

Don’t be swayed by negativity. America’s best days are still ahead.

We have three funds that seek to profit from this environment:

Energy Mutual Fund

Energy ETF

Inflation Fund

FERC recently approved a request by Williams Companies to expand its Transco natural gas pipeline in New Jersey. As is usually the case, environmental extremists have been opposing this and other enhancements to the state’s energy infrastructure even though Williams, a commercial enterprise, is presumably meeting increased demand for its services.

Of the seven fossil fuel projects opposed by fringe extremist group Empower NJ, the one that residents surely most strongly support is the proposal to widen 60 miles of the NJ Turnpike and 64 miles of the Garden State Parkway. New Jersey is the most densely populated state in America at 1,259 people per square mile, not far behind the Netherlands at 1,355.

America has vast open areas, but not in the northeast. The situation is not helped by liberal policies that promote high-density, low-income housing. It’s likely that the people opposed to reliable energy like Empower NJ are the same ones who believe everyone who wants a home in New Jersey is entitled to one, regardless of whether that creates even more traffic on our major freeways and need for infrastructure.

Widening our highways is scarcely a fossil fuel project, and is necessary because, improbably, people keep moving to the state. Nonetheless, population growth lags the rest of the country. Therefore, New Jersey’s Congressional representation has been shrinking too. Anecdotally and otherwise it’s clear high earners, who are also high taxpayers, are leaving for states where the weather and politics are sunnier.

Empower NJ opposes expansions to the state’s natural gas infrastructure. Williams Companies recently won FERC approval to add 829 Mcf/Day of capacity to their Transco pipeline network. Empower NJ wants Governor Phil Murphy to block the Transco expansion mentioned above and other important projects. Although the governor may step in, so far he hasn’t. To be left of NJ’s governor is to be truly on the fringe of coherent thought.

Meanwhile, Goldman Sachs estimates that the mis-named Inflation Reduction Act (IRA) will cost $1.2TN, more than three times the CBO’s estimate. Energy companies are rushing to create business lines that will benefit from the many tax credits.

The promise of enormous tax credits in the IRA has boosted lobbying efforts by the energy sector, which had been falling for several years. Pharmaceuticals spend more, but the gap is closing.

Climate extremists have long promised with no empirical evidence that solar and wind are cheaper than natural gas. If this was the case our power supply would be dominated by renewables, which it isn’t. The tax credits in the IRA should make intermittent energy so appealing that further investments in oil and gas must offer extraordinarily compelling returns to compete.

Occidental’s Direct Air Capture (DAC) plans were covered recently in the WSJ. They’re building the world’s biggest DAC facility in Texas and plan to add dozens more. DAC has its critics, who contend that the 0.04% concentration of CO2 in ambient air makes capturing it uneconomic.  Occidental’s ambitions extend to selling carbon credits to businesses that can’t reduce emissions (such as airlines). The IRA provides tax credits of $180 per ton for DAC CO2 permanently sequestered underground.

Groups like Empower NJ, more properly named DePower NJ, are pursuing a philosophy of making life miserable for everyone by impeding needed expansions to reliable energy. They lament completed projects such as new gas power plants and pipeline enhancements. They’re trying to foist on us the dysfunctional policies of Massachusetts and New York where access to natural gas is impeded but still needed.

The surest way to lower emissions is to use less energy, most effectively achieved by shrinking NJ’s population. Empower NJ could perform a great service to the Garden State by relocating their dystopian supporters out of the state.

The charts below provide a helpful reminder of key points in considering the world’s use of energy.

China is by far the biggest user of coal, the most prolific source of greenhouse gases. Meaningful progress on climate change won’t happen without China’s participation. Energy consumption has never fallen in human history, yet UN forecasts showing emissions falling assume this will happen.

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Output from renewables has an unfortunate tendency to slump during extreme weather when it’s most needed.

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Higher renewables penetration equals more expensive electricity. This may be a price worth paying to reduce emissions, but climate extremists ignore it.

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Daily power demand follows a predictable cycle, peaking around dinner time. Solar peaks at noon. Wind is unpredictable but is often highest at night.

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Solar and wind contribution to total power generation varies widely and unpredictably. The challenge this creates for grid operators balancing supply with demand increases sharply with more renewables.

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We have three funds that seek to profit from this environment:

Energy Mutual Fund

Energy ETF

Inflation Fund

I was in the UK recently where reducing emissions to zero by 2050 is now law. In spite of the conservative populism that drove Brexit, Britain is a politically liberal place from the eyes of this visitor who last lived there 41 years ago. Illegal immigration is a worldwide problem, and the British face African and Asian refugees crossing the English Channel from France in flimsy boats. The government estimates 45,700 such arrivals last year in the Explanatory Notes to proposed legislation (the Illegal Migration Bill).

The new law would compel deportation back home or to Rwanda which is deemed a “safe third country.” Left-wing critics contend that the country should be more welcoming. Former English footballer Gary Lineker, who now analyzes games on the BBC’s Match of the Day, was briefly taken off the air for equating government policy with Nazi Germany. The middle ground in the UK debate over illegal immigrants and refugees is left of the US. New York City is considering repurposing the Javitz Convention Center to house asylum-seekers, many of whom have been bused north from Arizona and Texas.

Wind power contributed 27% of the UK’s electricity last year. Dozens of wind turbines are visible from the windy coast of Kent in the English Channel where on a clear day you can also see France. They extend up into the North Sea and are all around the country. The UK’s 28.8 Megawatts of wind capacity generated just over 80 Gigawatt Hours of power last year, meaning they ran at about 32% of capacity. This is within the normal range for offshore wind, although a visitor to the blustery English seaside would be forgiven for assuming they generate power more or less permanently.

Although the high renewables share sounds good, wind only supplies 3.3% of Britain’s primary energy because there’s more to modern life than electricity. Fossil fuels provide 81%. In his recent Annual Energy Outlook, JPMorgan’s Mike Cembalest thinks of two energy transitions: (1) decarbonizing electricity generation, and (2) electrifying energy consumption. The world is doing better at (1) than (2).

Electricity is expensive in Britain, because renewables are expensive and because they have to import Liquefied Natural Gas (LNG) at prices that compete with Europe’s failed energy policies. But public opinion generally supports the energy transition.

Across the North Sea, the Netherlands relies on fossil fuels for around 80% of its total energy, about the global average. Wind is 4.9%. We recently spent a couple of days in Amsterdam, a city whose downtown is for walking. Pedestrians face greater risk from the cyclist’s silent approach than from automobiles. Bike lanes are common, although cyclists rarely pause at stop signs or crosswalks.

Europe’s mild winter prevented a shortage of natural gas, but next year presents a bigger problem since Russian gas will no longer boost supplies as it did in the first half of 2022. European prices have plummeted from last year’s high but remain double their pre-war level. There are signs high energy prices are causing a shift in manufacturing to other countries, including the US.

Like much of Europe, Massachusetts imports LNG which exposes them to high global prices. The Bay State has rejected pipelines that could deliver gas cheaply and safely from Pennsylvania because some climate extremists think impeding access to gas will stop its use. Others prefer the lights to stay on, so an LNG tanker recently docked in Boston from Trinidad and Tobago. In January 2022 New England households paid 22.9 cents per Kilowatt Hour  (KwH) of electricity. For all of 2022 the UK averaged 18.9 pence (23.4 cents) per KwH. Higher natural gas and increasing use of renewables mean both are paying more now. UK households expect to pay 34 pence (42 cents) this year.  And that’s only because of a government imposed price cap. The actual price is forecast to average 52 pence (64 cents) per KwH. New England is at 29.7 cents.

The US average is 15.5 cents. Even in liberal New Jersey we only pay 16.9 cents, although Democrat governor Phil Murphy is pursuing policies designed to push this up, such as opposing an expansion of natural gas pipeline capacity planned by Williams Companies and approved by FERC.

For cheap, reliable power natural gas is the solution. Even Texas, which produces more electricity from windpower than any other state, is planning to invest $18BN in natural gas power plants to reduce the risk of another grid failure like the one two years ago.

Florida households pay 15 cents per KWh. Florida Power and Light promotes its growing use of solar but is also reducing rates modestly because of falling natural gas prices. My family and most of my friends are in New Jersey, but you wouldn’t want to start a business there. Florida is a better run state.

Europe’s energy policies, which impose most of the cost of the energy transition on households, explain most of this difference. The embrace of fracking, almost unique to the US as a method of oil and gas extraction, has created our abundant and cheap natural gas.

Your blogger’s recent trip to London included two English Premier League games, at Arsenal and West Ham, seeing old friends and a short visit to Amsterdam. I am now rejuvenated and back in the land of more conservative politics and (mostly) cheap energy.

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We have three funds that seek to profit from this environment:

Energy Mutual Fund

Energy ETF

Inflation Fund

According to the American Automotive Policy Council, the world’s biggest auto companies can use over a thousand silicon chips in each car. This fact from Chip War: The Fight for the World’s Most Critical Technology resonated more than anything else in this fascinating book about the world’s reliance on computing power. Had I been asked to guess at the figure, I would have offered a few dozen as a ridiculously high number. Who knew? It’s estimated that in 2021, chip shortages resulted in 7.7 million fewer cars being produced.

Author Chris Miller walks us through the early days of computer chips which, like the internet, started with the Federal government. Fairchild Semiconductor, founded by Bob Noyce in 1957, found its first big customer in NASA when Sputnik ushered in the space race.

NASA paid top dollar for Fairchild’s chips, but Noyce recognized that to create a market he needed to slash prices. An integrated circuit priced at $120 in December 1961 was cut to $15 by the following October.

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Demand boomed, and soon the Pentagon was looking at chips to guide its warheads. In 1962 the Minuteman II nuclear missile relied on a guidance computer that used Mylar tape with holes punched in it for instructions. Texas Instruments won the business, and by 1964 had supplied one hundred thousand integrated circuits to the Minuteman program.

By 1972 chips were being used in laser guided bombs which dramatically improved accuracy during the later stages of the Vietnam War. Many readers will remember video from the 1991 Iraq War when US bombs were dropped with precision accuracy on bridges and fortifications. I remember watching one missile drop through a ventilation shaft on the roof of the Iraqi Defense Ministry.

Global sales of semiconductors reached $556BN in 2021, but more amazing is that 1.15 trillion discrete semiconductor units were shipped. That’s around 145 new chips for every person on the planet.

Moore’s Law, that the number of transistors on a chip doubles about every eighteen months, tracked progress remarkably well for several decades but is expected to become obsolete by around 2025.

The world has been grappling with chip shortages since the pandemic. Fabrication factories (“fabs”) are wildly expensive to build and operate highly demanding processes with dust-free zones to manufacture ever more miniaturized chips.

Taiwan has 20% of the global market, and a bigger share in high-end chips. Long-time government support has helped the Taiwan Semiconductor Manufacturing Company (TSMC) build a dominant position. High fixed costs because of the complexities of manufacturing create benefits to scale.

Chips have long been a national security concern, both because of their use in modern weapons and their ubiquity in consumer products. This has led to US-led constraints on China’s ability to buy the most advanced chips as well as legislation to encourage domestic investment in fab plants. Last year Congress passed the Creating Helpful Incentives to Produce Semiconductors and Science Act of 2022 (CHIPS Act).

TSMC is investing $40BN in a fab plant to produce sophisticated chips in Arizona. It’s one more example of the reverse of globalization. Companies increasingly want vital inputs to be secure and closer to home. Ronnie Chatterji of the National Economic Council, said, “these two [factories] could meet the entire U.S. demand for U.S. chips when they’re completed.”

At a ceremony marking TSMC’s investment in Arizona in December, TSMC founder Morris Chang lamented that, “Globalization is almost dead and free trade is almost dead.” Recent trends support that. America is better situated than any other country to continue thriving in such an environment.

China’s increasingly bellicose statements regarding Taiwan’s independence have also caused concern about conflict upsetting global chip supply. The Economist recently ran a special section on Taiwan and warned in one article America and China are preparing for a war over Taiwan.

Russia has apparently struggled to access the right kind of chips for its invasion of Ukraine. There have been stories of Russia buying consumer products for the chips. Apparently, EU exports of breast pumps to Armenia almost tripled in the first half of last year, whereas their birth rate did not. But modern weapons systems use hundreds of chips of varying sophistication, and consumer products aren’t believed to be a relevant source of the type most needed. Based on developments on the ground, Russia is getting what they need.

Life without chips is unimaginable. Chip War offers a highly readable history of how we got here.

We have three funds that seek to profit from this environment:

Energy Mutual Fund

Energy ETF

Inflation Fund

90% Of Everything moves by ship, at least according to author Rose George in her 2013 book that’s still fascinating reading today. George traveled as a passenger on a cargo ship called the Maersk Kendal. While onboard she interviewed the captain and crew members, enabling her to present an absorbing picture of maritime freight, an industry that enables free trade that few of us consider.

It costs one cent to ship a can of beer 3,000 miles, approximately the narrowest distance across the north Atlantic Ocean. That statistic reminds how waterborne trade has always been the cheapest way of moving goods. Moving a sweater costs 2.5 cents.

The Congressional Research Service estimates that moving crude oil by rail costs $10-15 per barrel. Just over four years ago the Energy Information Administration (EIA) estimated $3.50 per barrel to move crude by pipeline from Cushing, OK to the Texas gulf coast, around 560 miles.

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A Very Large Crude Carrier (VLCC) that can hold 2 million barrels and costs $50K per day works out to 25 cents per barrel for a ten-day trans-Atlantic journey.

Shipping is incredibly cheap.

George finds that Scottish cod can profitably make a round trip to China and back for filleting, saving money versus employing Scottish filleters.

Ubiquitous steel shipping containers revolutionized the economics. It wasn’t uncommon for transport costs to eat up 25% of the value of the goods being used until TEUs (“twenty foot equivalents units”) created uniformity and reduced theft from longshoremen.

Statista estimates there are 5,589 merchant ships plying the world’s oceans, up from 5,079 in 2013 when Rose published her book. There’s no agreement on how many shipping containers exist – a Google search ranges from 17 million to 170 million.

The number of US-flagged merchant ships was declining until 2016 and remains very low. China has at least 30X as many. George estimates that Filipinos represent more than a third of all crews globally, with 250,000 of them at sea. If you’ve ever been on a cruise, you’ll know Americans are exclusively passengers, never crew. The US taxes its citizens regardless of domicile, contrasting with many other countries. The economics don’t work.

We follow the Maersk Kendal as she traverses the Suez Canal, blocked two years ago when the Ever Given ran aground. Rose George recounts a story from the Kendal’s captain when an error by the Egyptian pilot briefly left his ship stuck on a sandbar. The captain was able to maneuver off and found the pilot outside on deck praying.

The Maersk Kendal then sails off the coast of Somalia, causing George to turn to piracy which was more common in the Gulf of Aden than it is today. She recounts several tales of kidnappings, and the dramatic rescue of a kidnapped merchant captain by US Navy SEAL snipers who shot three pirates in darkness from a nearby boat while both were bobbing around.

Somali pirates are less active today, thanks to more active patrols in the region.

The US Navy plays an unparalleled role in protecting sea lanes for commercial traffic. Global trade rose as a % of GDP for several decades because of US military power as well as the falling cost of shipping. That trend has stalled in recent years.

The pandemic and Russia’s invasion of Ukraine have both caused a rethinking of supply chains. If the US at some point concludes that policing the world’s shipping is a lower priority, there’s no obvious replacement. The Council on Foreign Relations offers some background on this. If cargo ships faced longer routes with increased risk, this would further impede global trade.

The appeal of 90% Of Everything is the visibility it provides on an industry we rarely see and usually take for granted. Rose George describes the choreographed movements of global trade’s enablers and the cramped living conditions, work and tedium of crews who spend months or years away from home. She reminds that at sea, “…the captain is our god; he can marry you, baptize you, and even bury you without anybody’s permission.”

Covid lockdowns were especially tough on crews who were often stranded indefinitely on ships in sight of harbor while health officials wrangled with ship owners over pandemic protocols.

Statista calculates that today 80% of finished goods move by sea, and estimates volumes doubled from 1990-2020. 90% Of Everything may be a decade old but retains most of its relevance. You’ll finish it with a newfound appreciation of the maritime freight industry along with numerous obscure facts to be dropped in casual conversation.

We have three funds that seek to profit from this environment:

Energy Mutual Fund

Energy ETF

Inflation Fund

First Citizens Bancshares has agreed to buy most, but not all, of Silicon Valley Bank’s (SVB) carcass from the FDIC. They’re acquiring $72BN of loans at a discount of $16.5BN. The FDIC estimates SVB’s failure will cost it around $20BN. The Deposit Insurance Fund currently sits at 128BN. It’s funded by banks, which means by customers. Former SVB CEO Greg Becker is hopefully googling “clawback”.

Several former banking colleagues have been dismissive of a recent academic paper (Why do banks invest in MBS?) which estimated bank losses from rising rates of $1.7TN, most of their $2.2TN in capital. The $1.7TN figure has also made it into the WSJ.

The analysis doesn’t consider deposits, which increase in value when the Fed tightens because savings rates lag. Customer funds are often sticky. For asset/liability management banks assume a certain portion of their deposit base has long duration based on prior experience. Revaluing assets based on higher rates without considering liabilities is clearly wrong for the industry, although money market funds and treasury bills are increasingly competing for customer deposits. Many banks will likely have to be more responsive in raising savings rates, although I can report that JPMorgan for one still pays virtually 0%.

Another criticism was the assumed duration of 3.9 years on loans, which underpins the $1.7TN figure. Floating rate loans dominate according to one friend, a former senior banker who would know. He went on to wonder whether some banks even know the interest rate risk of their loan portfolios.

The banking crisis has dominated recent news, but it confirms the upside risk to inflation facing investors. Rates well below inflation are already causing financial stress. Markets expect the Fed to cut within months. Jay Powell is steadily becoming the worst Fed chair any of us can remember. Under his leadership the FOMC embraced temporarily higher inflation in 2020, only to abandon that position when their policies helped generate more than they bargained for. Expect a politically motivated pivot that claims victory is in sight so as to ease the pressure on banks.

This is why energy infrastructure deserves a place in every portfolio. Pipelines often have tariffs that increase with inflation under rules overseen by the Federal Energy Regulatory Commission (FERC). The energy transition is impeding capex in reliable energy while enjoying enormous tax subsides for renewables, hydrogen and carbon capture. This underlies the strong relative performance of the sector in recent years.

Natural gas is especially well situated as a substitute for coal and a source of reliability as power generation adds intermittent, weather-dependent solar and wind.

The Energy Information Administration (EIA) just published its 2023 Annual Energy Outlook (AEO). In recent years they have revised up near term production of natural gas. Compared with their 2017 AEO, the government now expects 8% more natgas output through 2050.

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Domestic consumption has been running higher than expected. Last year we used 18% more than the EIA thought we would in their 2017 forecast. They have a pattern of underestimating near-term demand. Nonetheless, over the forecast period to 2050 the EIA expects the domestic need for natural gas to decline modestly until 2035 when it will start drifting higher again. Production growth is fully due to exports, which are now forecast to be a third higher than in last year’s AEO.

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The EIA also expects renewables (mostly solar and wind) to displace natural gas as our biggest source of power generation by 2025. There are many negatives in this for America – electricity will become more expensive, less reliable and will need more room both for generation and transmission. It is the first time in human history that we’ve pursued an energy transition that is less efficient in every dimension.

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There’s nothing about California, New England or Germany that appeals in terms of energy policy. We should be using more nuclear, displacing coal with natural gas and maintaining reliable power generation with carbon capture which now enjoys even bigger tax credits under the Inflation Reduction Act.

Nonetheless, this utopian vision for climate extremists won’t dent steady production growth because power generation is only 15% of domestic gas consumption

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America has some of the world’s cheapest natural gas, and Russia’s invasion of Ukraine boosted its appeal. Europe’s absence of energy security has resulted in a surge in LNG imports. Regassification terminals have been built in record time by using floating storage and regassification units. The EU now expects to increase its import capacity by almost a third next year by adding 8 additional terminals (27 to 35).

US LNG exports to Europe more than doubled last year to over 7 Billion Cubic Feet per Day (BCF/D). That trend is likely to continue. The EIA continues to forecast a very bright future for reliable energy.

We have three funds that seek to profit from this environment:

Energy Mutual Fund

Energy ETF

Inflation Fund

At some point Congressional oversight of the Federal Reserve should result in a careful examination of the central bank’s error-strewn record under Chair Jay Powell. Below is a roadmap for discriminating legislators willing to conduct a critical review of the Fed’s serial mistakes. 

Above the Fed’s twin mandate of seeking maximum employment with stable prices sits their overarching responsibility for financial stability. The collapse of Silicon Valley Bank (SVB) was an isolated event, the result of a largely non-FDIC insured deposit base that quickly ran when excessive interest rate risk forced the bank to dump bonds at a loss. But the banking system’s challenges are bigger than one bad interest rate bet in Santa Clara.  

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SVB might be the worst run bank since the 2008 Great Financial Crisis (GFC), but similar imprudence is reflected across much of the industry. Loans and securities that are classified as Held To Maturity (HTM) don’t fluctuate in value on bank balance sheets, but they can still cause losses. Tier One equity capital of the US banking system fell by 2.2% last year (from 15.6% to 13.4%) partly due to lower valuations on Mortgage Backed Securities (MBS) and treasury securities. This is a bigger loss than at the outset of the pandemic, when provisions for bad loans soared. Unrealized losses are estimated at $620BN, against capital of around $2.2TN. US government debt carries favorable capital treatment because it has no credit risk. But that doesn’t mean it’s riskless.  

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Including unrealized losses on loans would show bank capital is almost wiped out. Loans are rarely marked to market and are treated like HTM securities. But two recent academic papers show that, if they were valued like securities available for sale and assuming a duration of 3.9 years, banks would show losses of $1.7– $2.0TN.  

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Interest rates have been unrealistically low since the GFC. Banks have responded by loading up on risk – the portion of loans and securities held with longer than three years’ duration has increased from 28% to 40% over the past fifteen years. Quantitative Easing (QE) saw the Fed’s balance sheet expand to $9TN as they acquired almost a fifth of all US government debt and depressed yields. SVB and many peers concluded that lower returns justified greater exposure. 

As a regulator the Federal Reserve has watched over this increase in duration with little public comment. FOMC minutes reveal no concern. Their Summary of Economic Projections (SEP) released quarterly provided little reason until recently for banks to worry that their low-yielding portfolios of assets would continue to be funded with even lower-yielding deposits. In March of last year the SEP still only forecast mildly restrictive policy of 2.8% vs a long run neutral rate of 2.4%. It wasn’t until June that the SEP warned of higher short term rates that would increase banks’ cost of funding and create competition for deposits from money market funds and treasury bills.  

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Banks benefit from lethargy among depositors when rates rise by only slowly increasing the rates they pay. The average savings account pays 0.40%, compared with three month treasury bills at 4.5%. It’s as well most depositors don’t leave banks for higher returns because resorting to the Fed Funds market would create a negative spread against their low-yielding portfolios. SVB’s rejection of this choice led to their sale of bonds, aborted equity raise and FDIC takeover. 

You might think that years of low rates and a steady increase in duration would lead regulators to include the impact of an abrupt reversal among the many stress tests they run on banks. But in an absence of macroprudential foresight, there is no meaningful inflation stress test. They assume a benign 1.25% increase. Regulators model a sharp drop in real estate, jump in unemployment and emerging market crises but monetary accommodation is assumed to ameliorate the impact of any such shocks on the real economy. The only interest rate stress test contemplates a steepening yield curve with a 0.49% increase in ten year treasury yields and three month treasury bill rates up 0.14%. 

The Fed has overseen stress tests since they were introduced in 2013 under Dodd-Frank. The biggest stress banks have undergone since then has been caused by the Fed and wasn’t one of the scenarios they tested.  

Today’s economic and financial environment is the result of a series of errors and poor judgment by the Fed. They have implemented one of the fastest increases in monetary policy in modern times, which if banks marked their assets to market would wipe out virtually all their capital based on reasonable assumptions. FOMC minutes reveal very little awareness of exposure in the banking system the Fed oversees to sharply higher rates.  

Bank portfolios are full of low yielding assets because the Fed incorrectly maintained QE for too long. QE was a singularly useful tool during the GFC with little to justify its subsequent use. The pandemic’s economic hit was severe but brief. The Federal government’s initial fiscal and monetary policy moves were exemplary, but the largesse and accommodation were ultimately excessive, synchronized and damaging.  

Low mortgage rates and a behavioral shift to hybrid work boosted housing. This was evident to all except the FOMC with their slavish devotion to Owners’ Equivalent Rent (OER) and its theoretical notion of the cost of shelter (see The Fed Is Misreading Housing Inflation). Two thirds of American households are homeowners. Home prices matter to almost everyone. OER lags real estate by around eighteen months. The FOMC was similarly late in seeing inflation.  

In summary, the Fed has raised interest rates sharply because they were late, ravaging the capital base of the banking industry they oversee. On their watch banks have increased duration in low-yielding assets because the Fed maintained low yields with QE. The Fed has in effect led ruinous competition with banks for yield-bearing assets, and is now leading competition for cheap deposits with which to fund them, all with little apparent understanding of the industry’s overall exposure. 

SVB failed because of a depositor run, but that was preceded by a steady loss of deposits to higher-yielding money market funds and treasury bills. Banks now depend to a substantial degree on continued acceptance by customers of pygmy yields on cash, so they can continue to fund assets that yield too little. If money keeps leaving the banking system more banks will face SVB’s unenviable choice between funding assets at a loss or dumping them at a loss.  

First Republic National Bank is reported to have a tangible book value of negative $73 per share once their assets are marked to market. Who would buy a bank today? 

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The FOMC released their latest SEP last week, forecasting another rate hike before the end of the year. Based on Fed funds futures, this is wrong by at least 1%. Such a gap between the FOMC and market expectations is testimony to the Fed’s loss of credibility. The inflation fight will be paused or declared won so that reduced short term rates can ease the banking system’s pain.  

The Fed can at least claim success in maximizing employment. Unfortunately, consumers and households report being as pessimistic as ever, reflecting today’s uncertain outlook. This is in spite of what remains, for now, a reasonably strong economy with a job available to anyone that wants one. Perhaps consumers and households have an intuitive understanding of how poorly monetary and regulatory policy have been administered.  

Fed chair Jay Powell should go. 

We have three funds that seek to profit from this environment:

Energy Mutual Fund

Energy ETF

Inflation Fund

An Op-Ed in the Washington Post last week suggested that unrealized losses on fixed income investments are likely much higher than the $640BN on held to maturity MBS. It was written by Sebastian Mallaby, who wrote about hedge funds in More Money Than God and has published several other finance books.

Mallaby relies on two recent academic papers which add interest rate exposure on loans to the MBS unrealized losses. Not much data is publicly available on duration risk in bank loan portfolios. Based on the reasonable assumption that loans have an average duration of 3.9 years, the academic papers Mallaby cites estimate US banking system mark-to-market losses of $1.7TN-$2TN, against a capital base of $2.2TN.

These staggeringly big numbers are theoretical and unrealized. Banks are not going to recognize losses anything like that. That’s not to say this isn’t going to be a problem.

It’s worth remembering how we got here. Since Quantitative Easing (QE) was first unleashed in the 2008 Great Financial Crisis (GFC), the Fed has generally found it easier to grow its balance sheet than shrink it. Their huge bond portfolio has depressed government bond yields, which are the benchmark from which all other fixed income securities are priced. The MBS and loans on bank balance sheets mostly originated within the last few years. From mid 2019 until early last year, the ten year yield was below 2%.

Bankrate.com calculates the average rate paid on savings accounts is 0.23%. The Federal Reserve Bank of St Louis calculates 0.35%. Depositors are normally a lethargic bunch but have been galvanized into action by Silicon Valley. Flight from shaky institutions is the current fear, most vividly represented in First Republic’s collapsing stock price. But this problem will likely be solved with a system-wide guarantee on all deposits, not just those under the FDIC $250K threshold. That is de facto government policy today having found Silicon Valley Bank to be systemically important. As the “too big to fail” tent gets bigger, the moniker no bank will want is “small enough to fail”. This is why Treasury Secretary Janet Yellen announced more support for small regional banks.

QE didn’t just help cause a housing bubble, it’s also weakened the banking system. Applied on a sustained basis, QE left them with little choice but to buy bonds and make loans at rates that only prevailed because of the Fed’s enormous portfolio.

Today’s inverted yield curve shows that the problem still exists. Ten year treasury yields are 1% below the Fed Funds rate.

That makes this week’s Fed announcement more important than most, because it’ll reveal how well they understand the banking system’s sensitivity to the funding costs of their vast portfolios of bonds and fixed rate loans that are theoretically underwater. If they regard the depositor run as localized and temporary it’ll mean higher rates to quell inflation remains their primary objective. This will put further pressure on net interest margins.

Held To Maturity (HTM) accounting has once again come in for criticism. The CFA Institute (I sit on the board of the Naples, FL chapter) thinks “hide to maturity” accounting should be abolished because it obscures information investors need. This was considered after the GFC but rejected in 2010 as adding unnecessary volatility to bank financial statements. The information is there if investors choose to look. The problem is that depositors rarely feel the need to consider creditworthiness.

Depositor inertia is what’s under threat. Last year Charles Schwab changed their sweep feature on brokerage accounts to make Charles Schwab Bank the default choice for cash rather than money market funds. Banks routinely pay paltry deposit rates, and this quiet change boosted Schwab’s profitability.  We duly adjusted client accounts to hold treasury securities.

This is the real threat facing the banking business model, not depositor runs which are solved relatively easily with a blanket guarantee.

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Three academics recently asked Why do banks invest in MBS? in a paper published earlier this month. They include a chart showing how inadequately deposit rates rise during tightening cycles. This captures the banking system’s vulnerability. Deposit rates lag because of inertia among savers. There’s nothing like a banking crisis to make you pay attention to where your money is. Depositors are likely to become more sensitive to savings rates.

Notwithstanding turbulent markets, the case for higher commodity prices remains intact. Goldman’s Jeff Currie believes the commodities supercycle will take oil prices higher by June. Hedge fund manager Pierre Andurand expects oil to reach $140 by year’s end. Citadel’s head of commodities Sebastian Barrack doesn’t expect any long-lasting pressure on commodities.

Inflation risks haven’t meaningfully fallen, but the Fed’s flexibility to confront them has to be balanced with the poor interest rate decisions made across much of the US banking system.

We have three funds that seek to profit from this environment:

Energy Mutual Fund

Energy ETF

Inflation Fund