Berman Capital returned 2.41% net of fees for the first quarter of 2024.

The market sentiment on the commodity complex started the quarter decidedly bearish before finishing on a more optimistic note. Our top-performing positions were long positions in Tidewater (TDW), Siemens Energy (ENR), Vista Energy S.A.B de C.V (VIST), Berry Corp (BRY), and several long positions in the gold miner stocks as well as long gold futures. Our bottom-performing positions were our short investment in YPF (YPF), our long investment in Ferroglobe PLC (GSM), a long investment in Warrior Met Coal (HCC), and a long position in rare earth elements miner MP Materials.

The bulk of our first-quarter returns came from our portfolio’s oil and gas equities exposure. Siemens Energy has been the standout performer among our equity investments with exposure to clean energy. However, we believe much of Siemens Energy’s performance to date has been due to the company’s manufacturing of electrical transformers and switchgear, which continue to be in short supply and not necessarily from any improvement in expectations for its wind turbine manufacturing business, Siemens Gamesa.

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Commodity Complex Outlook

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Crude Oil

Crude oil remained mostly range-bound for much of the first quarter. Brent traded in a narrow band between $75 and $85 until mid-March, when it rallied higher on news of the revision of the International Energy Agency’s (IEA) crude oil forecast, suggesting crude may be in a deficit for 2024. While the supply and demand balance for crude continues to look favorable through the end of the year, there remains a sword of Damocles suspended over the market: OPEC+ production cuts. We have thus far been surprised by the overwhelmingly bullish market sentiment that crude oil will remain north of $90 per barrel for the remainder of the year. While the supply and demand balances remain tight, there is a price at which OPEC will unwind its production cuts. OPEC does not have a formal price target that it makes public, but based on OPEC 2023production cuts taking place in a range from the mid-$70s to the low-$80s, it can be assumed that OPEC will be looking to increase production if oil price reaches the high-$90s. OPEC’s production cuts will likely need to be unwound at some point this year; otherwise, they will continue to incentivize US shale production growth, losing more market share and sowing discontent among the cartel members. It should be noted that the OPEC cuts will not be unwound all at once but it will be a gradual process. Still, we think regardless of how gradual it is, the first sign of OPEC unwinding any production cuts will likely have an outsized negative effect on crude oil prices and the stock price of producers.

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Battery Metals

Battery metals have continued to underperform the rest of the commodity complex, as oversupply and less demand than forecasted have hurt prices. We think that the current pricing is necessary to create some much-needed supply destruction. Between 2019 and 2021, the battery metal complex enjoyed a period of frenzied expansion, driven by the unrealistic market narrative that electric vehicle adoption would grow exponentially, causing production capacity to outstrip demand. We think that there likely needs to be a longer period of sustained low prices for the high-cost supply to be wrung out of the system. Especially in markets like nickel, this appears to be exactly what is happening as the Indonesian government has suggested that they see no need to constrict the supply growth of Indonesian nickel at all and supply is likely to continue growing. We think recent arguments that we have seen a bottom for prices in the battery metals complex will likely be proven wrong.  

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Copper

We continue to be extremely bullish on copper over both the short term and long term. In the short term, several developments have put copper into a supply deficit for the year, the biggest of which was the closure of First Quantum’s Cobre Panama mine, which has taken over 300,000 metric tons, or about 1.5% of global annual production, out of the market. Anglo-American also cut its copper production forecast for 2024 by over 200,000 metric tons. Over the long term, we continue to see a major trend of sustained underinvestment and declining ore grades, which increase the cost of production. Copper will be an essential commodity for the energy transition, and although we are doubtful about the timeline for the energy transition, demand for copper will certainly increase substantially. Current copper prices have not been enough to increase new mine developments, and permitting and red tape continue to extend the time it takes to build a new mine in places like the United States and Canada.

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Tin

We are extremely bullish on tin. Supply is continuing to become more constrained, and demand shows no sign of stagnation. Demand growth for tin comes from its use in soldering electronics. There are only a few large tin mining regions, and recent geopolitical developments have been constraining the supply of tin to the market. Indonesia, usually a supplier of around 30% of global tin production, has delayed the exportation of tin due to a corruption investigation. Myanmar, the world's third-largest producer, is currently dealing with a quickly deteriorating security situation as the Three Brotherhood Alliance, a collaboration of smaller militia groups, is making progress in its fight against the ruling junta. Armed militia groups like M23in the eastern Democratic Republic of the Congo (DRC) are causing further consternation. While they have yet to meaningfully impact tin production in the Congo, they remain a potential source of supply disruption for the already supply-constrained commodity.

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Our Views on the Energy Transition

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Discourse on climate change and the energy transition has become a divisive issue. We often see the parroting of information that is, at best, misleading and, at worst, outright lies. So, we thought we would take the opportunity to offer you a more nuanced perspective that most people outside of the energy and natural resource industry rarely hear.

Let's start with the obvious: climate change is real, and the eventual transition away from fossil fuels is likely the best course of action. The problem starts when we dive into the details of how we can bring about that transition. The “Net-zero by 2050” narrative is never going to happen. It is neither economically nor physically feasible, and the sooner people realize that, the better. Policymakers are aiming at a goal that is impossible to achieve and likely to cause more problems than it solves.

We subscribe to the view of a “messy” energy transition. We think that the world will continue to need more of every imaginable energy source, including hydrocarbons, to meet the growing demand for energy. This energy transition is being run by government policy rather than market forces, which will create market distortions and misallocation of capital. We are likely entering a period of history in which we will see massive imbalances in the supply and demand for critical commodities, volatile energy prices, and uncoordinated energy policy.

This transition represents a seismic shift in the global energy and natural resources landscape. It will be one of the defining themes for the entire commodity complex for decades to come. The market dislocations in the commodity complex will create high dispersion in investment outcomes, producing unique opportunities for substantial outperformance compared to passive investments in the sector.  

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Clean Energy’s Limitations

Simply put, clean energy technologies are not yet ready for prime time. They either are still too early in development to be relied upon, like hydrogen, or they are unreliable or not widely deployable, like renewables or hydroelectric.  

Hydrogen and other alternative fuels like methanol will likely be extremely useful in decarbonizing hard-to-abate industries like shipping, fertilizer production, or cement production. However, they still have one substantial stumbling block: they are very energy-intensive to produce, so they will not be able to reduce emissions until we have a critical mass of zero-emission energy sources to produce them.

Renewable energy technologies have one major hurdle they have yet to overcome: they are an unreliable source of energy. Renewable energy is an intermittent power generation source. It only generates electricity when the wind is blowing or the sun is shining, meaning the electricity might not be there when it is actually needed. Many pundits have suggested using grid-scale battery storage, but it is not economically feasible with current battery technology. This is not to say that one day we may have a technological development that makes it feasible to economically store the gargantuan amount of electricity required to power the grid, but until that day, running a substantial portion of the electricity grid off renewable energy will lead to regular power shortages, often during the times when electricity is needed the most. Grids run on baseload dispatchable power generation, and renewable energy will not be able to make up a major portion of the electricity grid until it can produce baseload dispatchable power with grid-scale battery storage.

Hydroelectric power generation is one of the few clean energy sources that can generate baseload power. It has been shown to be reliable and has low emissions, but its geographic requirements and land usage mean that there are limited opportunities to expand its use. It is simply not feasible in locations that do not have rivers with a substantial enough flow rate to be dammed. Hydroelectric power will continue to generate a meaningful amount of electricity, but it will not be an engine of growth for decarbonization.

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A Population Issue and Malthusian Policy

We think one of the largest current limitations to energy policy is the divide in views between the developed and developing worlds. Outside of the roughly 1billion people in the Western World (North America and Europe) who enjoy nearly endless energy abundance, there are 7 billion who live in energy poverty. On average, people in the Western World consume 14 barrels of oil per capita per year, compared to those in the developing world, who consume 3 barrels per capita per year. Even China, one of the wealthiest developing economies, still only uses around 5 barrels per capita per year.

We believe that the current set of Malthusian energy policies proposed by the developed world are not possible, both as a matter of physics and because it would require developing economies to sacrifice their economic growth and prosperity. Until the energy policies of the developed world adequately address the growing energy needs of the other 7 billion people on Earth, we will continue to see minimal effects from all the investment dollars flowing into decarbonization.

Let's not forget that the United States only contributes about 12% of global emissions annually; without the buy-in of developing economies that are growing their populations and emissions at a faster rate than anyone, there will be no significant advancement towards reducing global emissions no matter how fast the Western world transitions to lower-emission fuel sources.

The energy policy proposed by policymakers wants the developing world to use less energy-dense and less reliable sources of power generation to grow their economies. This is simply not something that they will agree to. Those in the developed world pushing these policies need to understand that climate change is not as high on the list of concerns for those living in energy poverty.

There is a direct correlation between economic prosperity and energy consumption, and quite simply, the developed world is not going to be able to convince those in the developing world to stay poor for the sake of climate change, and that is the logical conclusion that many in the developing world reach when they receive a lecture from Western countries that consume multiple times per capita the amount of energy then they do, on how they need to be more responsible about utilizing their natural resource and lowering their emissions. Until the energy policy coming out of the developed world includes realistic measures to decrease energy poverty in developing economies, little progress is going to be made on climate change.

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The Short-Term Solution - Natural Gas

In the short run, what could the world do to meaningfully reduce emissions globally? Help developing nations transition from thermal coal and biomass to natural gas. Thermal coal and biomass are the primary fuels for power generation in the developing world, which makes a lot of sense; thermal coal and trees are cheap and widely available. Building out natural gas infrastructure would require a level of spending that few developing economies can readily afford. Natural gas produces far fewer emissions than coal and biomass; it produces around 117pounds of CO2 per million British thermal units (MMBtu), while thermal coal produces 205 pounds of CO2 per MMBtu, and biomass is even worse at 213 pounds per MMBtu.

The lowest-hanging fruit for meaningfully impacting emissions is coal-to-gas switching for power generation. The developed world will not be able to convince developing economies to exchange reliable base-load thermal coal generation for non-dispatchable, intermittent renewable energy. However, they will be willing to switch to natural gas if provided with the necessary financing.

If the developed economies of the world really want to make relatively fast and meaningful progress on global emissions, they should incentivize organizations like the World Bank to provide low-interest infrastructure loans to developing countries to build natural gas infrastructure. Leaders in energy-abundant countries like the United States and Norway should also champion the expansion of their liquified natural gas (LNG) industry so that LNG becomes a reliable source of primary power generation for developing economies.

In developed nations that have invested heavily in renewable energy production, natural gas-fired power plants can act as “peaker” plants to smooth out the intermittent generation inherent to renewables. Natural gas combined cycle power plants are unique among power generation sources; they can go from idle to producing full power in as little as 30 minutes, a fraction of the time for other base-load power sources. As mentioned, until we develop economic grid-scale battery storage, all renewable energy sources will need natural gas-fired backup power plants that can generate regardless of the weather.

We are not optimistic that natural gas will receive the acceptance it deserves as an integral part of the energy transition. Everyone appears to be looking for the perfect solution rather than the best available solution. In the short run, the energy transition will ultimately be about picking the least bad option that is within the limits of our technological capabilities. Natural gas is certainly the least bad option compared to other fossil fuels. The perfect is truly the enemy of the good, and the world could be making significant progress toward reducing the emissions intensity of the grid globally while we continue to develop cleaner energy technologies that can provide reliable baseload power.

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The Long-term Solution - Nuclear Energy

Nuclear energy is the only technology we currently have that has the potential to meet all three essential requirements for power generation: reliability, affordability, and low emissions. Nuclear plants operate with uptimes of around 90% and produce no emissions. The only drawback to nuclear energy is that, currently, in the Western world at least, it is expensive to build new nuclear facilities. Still, with recent developments in nuclear reactor technology, the so-called IV-generation reactors, these reactors are designed to be more efficient, require less fuel, produce less waste, and are substantially safer, often employing passive safety mechanisms. There is hope that small modular reactors(SMR) that can be built offsite in a factory before being delivered for final assembly can further reduce the cost of construction.

A nuclear energy renaissance will take decades to come to fruition. IV-generation reactors still need to clear significant regulatory hurdles before entering service. Still, in the long run, nuclear energy is the only option currently available that provides the world with zero-emissions baseload power generation. Decarbonizing is not feasible without its wide-scale adoption.

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Conclusion

We hope we have provided context for why we think the energy transition will not play out as many policymakers suggest. Past energy transitions from wood to coal and then from coal to oil and natural gas have taken an average of 50-60 years to complete; this one will certainly not be completed within the next 26. The world needs to be more realistic about what can actually be accomplished and in what time frame. One thing that is clear to us is that the current dogmatic approach to climate change and the energy transition is not working.