Podcast: Jeff Currie on dunkelflaute and other market mysteries

This transcript has been automatically generated and may contain errors or inaccuracies. It is provided for reference only and should not be considered a fully accurate record of the conversation.

Amrita

Welcome back Jeff. Happy new year.

Jeff

Happy New Year to you. It's great to see you again.

Amrita

Doesn't feel like it's just been a month in January, right? Feels like it's been like—I don't know, it's been a very action-packed start to the year.

Jeff

Yes, it has been.

Amrita

So what are you looking at right now? Is it oil still and gold and like what's your favourite things to look at? Obviously the sanctions, there's Trump in the White House, there's a lot of things to talk about. But with everything that's going on over the last week or so, where's your head space at?

Jeff

My head is on the fact that we have just completed the longest period of stable oil prices since 12, 13 and 14, and we know how it ended.

Amrita

Yes.

Jeff

Oh, yes. However, let's talk about what happened to gold over that time period. Gold collapsed.

Amrita

Yes.

Jeff

Gold collapsed before oil collapsed. What did gold do over the last 30 months? It's gone straight up. You know, what finally broke us out of that pattern? It was supply. Supply is going to break us out of this holding pattern in the same way. But I think there's a bigger question here to ask: look at the level of backwardation in this market. Physically, your inventories are at relatively low levels. You haven't had any reserve replacement. Demand continues to grow. We can talk about spare capacity later. That's usually a pretty bullish setup. Why won't this market move?

Amrita

But that's the question. It's impossible. Like we almost started to see it move a little bit right towards the end of the year. And I will say, you know, we've really defied consensus. We've called for like $80 this year. You and I have talked about it. Everybody was talking about 60 or 40 and so on. But it kind of got there. And now it's kind of retracing again. People are still not convinced by Russian sanctions or the fact that Iranian sanctions could tighten. I've been in Saudi Arabia twice in the last two months. The message from them is very clear. We're not preempting anything. We remember what happened in 2018 with Trump saying he's not going to give waivers, and he gave waivers. In 2022 with the Russia sanctions, which were never really implemented. They've been burned twice. But yet I think there's something in the market that just won't look at these facts, look at the backwardation and stock price, maybe $77.

Jeff

So let's go back 30 months ago when this happened. It was basically somewhere in October, November of 22. Markets just flatlined. Since then, investors loved it. It just wasn't oil, it was a lot of different other assets. And what happened over that time? Rates went up. What am I focused on right now is bond-equity correlations. They flipped for the first time in nearly two and a half decades, 25 years. So up until actually September 11th, 2001, bond and equity prices were basically negatively correlated, meaning the returns were positively correlated. So if growth went up, you sold bonds and bought equities. All of a sudden after September 11th, we just started buying bonds and equities in a synchronous fashion.

Why? Interest rates collapsed down to 1%. Liquidity flooded the market. Around 04–05, we started that terminology: risk on, risk off.

Amrita

Yeah, exactly.

Jeff

You're no longer at 0% interest rates. There was no choice. The question was how much were you going to lever up on bonds, equities, commodities and all that? So everything moved in tandem. Hence, you had risk parity and all of those different trading strategies. I think what's happened here is interest rates went up. Leverage left the system. Inventories have been depleted. You're deleveraging everything at this point right now. So the question is, can oil go up without the leverage? I started at Goldman in 95–96 and I challenge everybody to go back and look at a chart of backwardation and inventories in 96. Looked just like today—you had a dollar level of backwardation on the front end of the curve, no inventory. The price was $18 a barrel. It would not move.

If you think about that time period, you had 6–7% interest rates. There was no leverage. There were no hedge funds in this market. I remember it was Dwight Anderson in 2004—he was the first commodity hedge fund, first one ever.

You look at the world right now, there's no more commodity hedge funds. There's no more leverage in the system. Actually, trading doesn't make any money anymore. What was driving the markets? There were dealmakers and things of that nature. I think we're going back to a world similar to where we were in that environment.

Also, one thing we invented back in the 90s in that environment was commodities as a diversified asset. So let's go back to if bond-equity correlations are now in the old world, going back 30 years ago, where growth—instead of risk on, risk off—growth goes up, you sell bonds, you buy equities. By the way, in that sell-off in—I think it happened on a Monday—it did it there. Basically, it was like the old world again where, hey, I was going to hit growth and therefore everything. I think that if we go into that environment, from 2001 to 2022, it was all about the search for yield because everything got crossed. Everything was correlated. By the way, if equities go up and bond prices go up at the same time, the returns are negatively correlated. If they're negatively correlated, you're naturally hedged. If you're naturally hedged, what do you do? Put on more leverage.

So the amount of leverage in the system was absolutely enormous. If we've taken that correlation and reversed it, you're going to end up having not only your interest rates higher, you're going to be using even less leverage than what you would otherwise. So we don't have any more leverage in the system. So who's going to step in and buy this thing anymore?

Amrita

Yeah. So you know, Nicky—Dr. Nicky Ferguson, he heads up our quant service—he's been highlighting through his research a lot, like, hey, interest rates coming down had improved the liquidity factor to an extent. But still, so much of the trading, it's just changed. To your point, he's been highlighting far more relative value trades rather than flat price. You can even see in the trading houses, everybody's going for the physical asset rather than trying to do the more simplified "this is flat price, let's just put the money in." I do think that just gives us a very different paradigm for price discovery. Like what is the true price of oil when you're—Dubai has been $5 backwardated at the front and then we are flat price $77. There are definitely questions about that.

But one thing you said, which is very interesting, in terms of higher interest rates, but we know the US president in particular—he's already called for OPEC, "you must lower the oil price." And by the way, therefore central banks around the world must cut interest rates. How do you see that playing out? Because that's going to be pretty volatile, I reckon, over the course of the next couple of years.

Jeff

I think the best place you can focus on is going to be in the dollar. His tariff policy should be reflected in the dollar. You should also see sanctions and things of that nature reflected. In fact, if I were to go, what are the three big drivers in 2025 and beyond? One: low inventories. I think we're going back to—if you remember, the term back in 1995–96 was just-in-time inventories. You haven't heard that term in a long time. So as risk on, risk off go out the door, when you go to just-in-time inventories, everybody's looking at the inventories. Why? And with this thing go up, I think we've seen destocking for supply and demand reasons, but we've also seen destocking because of cost to capital reasons. So the market's going to be extraordinarily vulnerable to sentiment shifts and then how you potentially have to resource.

So I think that's one big factor that's going to be there. I think that is part of this whole liquidity thing. It's a liquidity-growth trade-off. From 2001 to 2022, the growth-liquidity mix always favoured liquidity. So growth was down. Growth was not a factor. All you needed to have was growth come in, you moved out of cash and went into all risk assets. Hence why we call that risk on, risk off. Now growth is going to be more important than liquidity. Because let's think about what is Trump trying to do. He's going into the US and he's going to hit the current account, the goods account. He doesn't want them coming in. By the way, that's going to hit the capital account, has to. If it hits the capital account, you have less money going and you have a weaker dollar, which should be supporting to overall commodities, which is why I go, okay, what is your one sufficient statistic you need to look at in terms of that? Your question around tariffs and trade.

Amrita

And I think Trump...

Jeff

It should all be captured...

Amrita

On the dollar. Yeah. And I think that's—we've seen it strengthen a lot given everything right now is inflationary. But I do think that there's a lot of trade-off between what he's talking about versus what he is going to achieve. But sticking to Trump, I think the biggest difference between Trump 1.2 versus Trump 2.2 is US production was growing at about 1.5–2 million barrels per day, 2016 to 2020, like prime time. Now at best, 400,000 is what our estimate is—200 exit 20, but annual average. There are companies telling us it'll be even less. There is a question mark—I'll come back to it because maybe apparently private equity is gearing up to put more money into US shale space. Maybe that's worth talking about. That's kind of one big shift because he keeps talking about drill baby drill. But you can drill as much as you want. If the geology isn't there, it's not going to help.

The second thing I feel the market's really underappreciated is his relationship in the Middle East. I just don't—I think the Middle East is in a very different place right now, Saudi Arabia. Like I said, they will just not make the same mistakes as 2016. Where the policy, especially with Prince Abdulaziz, like he is very, very transparent and he's like, okay, this is what we're going to do. And it's not just about him, it's the eight OPEC plus members, but those two are significant differences because he had 2 million barrels of US shale behind him growth every year and he could pressurise Saudi Arabia and OPEC+ to increase production preemptively. If those two are gone, do you not see this oil market being super tight at some point this year?

Jeff

Yeah, I see it super tight. I'm not so sure the prices...

Amrita

Yeah, I'm with you.

Jeff

I'm with you all the way. But then again, let's go. If you're long and you're the returns and you're rolling the front month of Dubai, maybe the best returns. Commodities were in the 90s, not the 2000s. So yeah, I think the key point here is from owning oil and commodities, things are great. I don't think it's going to be reflected in...

Amrita

The stock price. Exactly.

Jeff

Yeah. Because was the flat price going up in the 2000s just a reflection of liquidity? Yeah. And that actually leveraged-driven liquidity in the leverage is gone out of the system. So the flat price stays the same. But the returns to the investor of being in that space I think are going to go up. Now going to your question about, you know, Trump and drill baby drill. I absolutely agree he can't control the bond market and he can't control physics. That's, you know, nothing you could do. And here's the point I like to make. I saw a chart of it actually the other day—the world was greener under Trump 1.0 than it was under Biden. And it's already baked in. It's going to be greener under Trump 2.0 than Biden because you've already—you know, that investment in solar panels and everything, it's all going to come in. So yeah, it's the cycle. So he can talk all he wants. He's going to get more green energy and less brown energy under his regime than what Biden—and actually, I like to go back to the point, Biden talk, talk, talk about being green. He brought it to 20 million barrels per day of oil production. It's the largest oil producer in the world. So, you know, I just say, okay, we can talk about—so they can both of them can talk, talk, talk all they want. But I think the reality is he's going to have a really hard time getting production higher.

So yeah. Look, if we go back to, you know, the three dynamics seem to be really structurally bullish. Oil: one, low inventories—we have it. Two, no reserve replacement—no, we don't have a reserve replacement. Plus we have the demand growth on top of that. So you're short on reserves. The third is spare capacity.

Amrita

And who's controlling the market gets obsessed by that. Even today there's an article, "Oh, OPEC has this much spare capacity." I'm like, ask the question who is controlling that spare capacity. Right. But people don't do that. But I mean, to be fair, Trump talked about trees yesterday. You know, he's like, we would like to plant more trees. So yeah, you're right about the green versus the brown. But are you seeing private equity kind of push more into US shale oil side at this point?

Jeff

The answer is no. I think the jury's out. We'll see what happens. I think the focus is still more on green assets. We'll see how that changes. But I think in general, it's the whole space, whether it's green or brown, suffers from the fact that the returns just are not there. It goes back—I think if you got great returns in oil and all that money that was sitting in Nvidia moved over to oil, yeah, the whole space could go up. But the problem is, on a vol-adjusted, you're talking about really big returns. And you saw, hey, people just bought the sell-off in the media this week. They did this. I thought, oh, maybe we'll get some rotation.

Amrita

That's exactly right. Come to our direction.

Jeff

We thought the same thing—oh, Nvidia comes off, you're going to see money coming into commodities, energy. Nope. Just the tech caps went straight back.

I think the other thing is I don't think people know—I think they're confused around energy transition. And I think that just makes them want to stay away from the space. Do I buy brown? Do I buy green? Here's the take on this, and I think people forget: energy transition started in 1973 when Nixon kicked off his energy—was that Project Independence? And here's the irony of it all. From 1973 to 2015, energy transition was driven by the fear of running out of oil. From 2015 to now, it was driven by the fear of too much oil. I remember it was right around 2016, I was sitting in this TV interview and they go, what's your view on peak oil? With peak oil, you got to keep getting—you mad and... And I think that this whole—and actually, here's a stat that I love to point out: the speed of energy transition when it was driven by the fear of running out of oil was faster than the energy transition when there's too much oil.

Amrita

High definition. Right.

Jeff

Yeah. So, let's call that the net zero 2050. By the way, those assumptions that were put out by the IEA, I don't think they ever intended on that taking the life that it did. I think it was just...

Amrita

Media doesn't help.

Jeff

It doesn't help. It was an impossibility. If you ask me what is the third thing I'm focused on in 2050, it's the fragility of supply chains, every commodity. Let's talk about, you know, the Dunkelflaute in December. At least I was on a beach in warm weather. You will fly out to hit Germany. For those who don't know, Dunkelflaute is dark and flowers, no wind. So it's dark, no wind, and you have no sun. And it's really cold out. Three conditions. By the way, it went on for two weeks. Power prices went to €1,000 a megawatt hour in that environment.

The key point there is you can't take renewables up to those levels. They went up to like 56%, because the batteries can't last long. They didn't have enough storage to get through it. This morning the Norwegians are going to cut the power cable. So, it created a lot of unstable dynamics there. Now, if the Norwegians are going to hypothetically cut the power cable to Germany because they didn't want their power prices going up much because of what they feel were irresponsible decisions taken on the continent, then you've got a problem. But here's the thing that you learn from that Dunkelflaute: the supply curve from renewables is backward bending, meaning that when the wind blows, you can deliver power. When you can produce it. You cannot deliver power when you need it.

Amrita

Need it. Yeah.

Jeff

That was—I don't think was thought through five years ago when it meant that you had that net zero 2050 push.

Amrita

I would say even now. We've always had a North American power service. I think it's very different when you're talking in the US about it. We've launched our European power service last year and the exposure we're getting, it's been one of our fastest growing services and the conversations we have with policymakers, I don't even think it's five years ago. Even right now, they don't understand the issues with baseload, like what you need. The point, like you said, if the wind is not blowing, you can't produce the power. There's still a lot of talk about it, but technology will help us bridge that gap. There's some areas of sensibility, but I still find Europe is grasping at the utopia of a fully renewable grid.

Jeff

Yeah. But I think we are technology—we can't survive better supply that right now. But what it tells you, I think in terms of investing in energy going forward is invest in the assets that can cater to the consumer, that deliverability. If the road to travel on energy transition started in 73 and you've gone through that, you're not getting off that highway. By the way, the Chinese—they're on the accelerator. The other thing too about the Chinese—they're building nuclear capacity, unprecedented. The technology is being used everywhere. From a national security perspective, in places like US and Europe, you have to continue, because if you fall behind the Chinese...

Amrita

Then you just know it's politically...

Jeff

Yeah. So I think what's happening is if you think about energy, you have energy security followed by competitiveness, followed by the environment. That's your natural ordering of things. What happened in 2019, environment got put above the other two. All we're going to do is return security and competitiveness back to the natural order, which, by the way, again, I want to emphasise, created a faster energy transition than the one that we saw recently with the environment being at the top.

From an investment perspective, it means target things that are going to be able to deliver energy when you need it, not when you produce it, which is batteries, storage, chemical storage, things of that nature. Gas peakers. Most of you know, the less polluting oil—I think it all falls into that category.

Amrita

But so coming back—last question—because what you said, the real reason for the rally in prices in the 2000s was liquidity. There was a lot of liquidity in the system. But if that liquidity is no longer there, do you think these other kind of investments can still give you the returns even if oil prices don't?

Jeff

Absolutely. Let's go over the levelised cost of energy. But let's think about the returns. So levelised cost of energy out of solar and wind has collapsed, the cheapest source of energy from an LCOE basis. By the way, the ROE a bit is the worst. Let's go back to the fact that wind and solar cannot deliver into the market when it's in a deficit, so it'll never be able to get that thousand euro megawatt. The battery can. So the return on equity is—even though it has a low LCOE—is lower. The focus, and this kind of goes to the roll yield, in the 90s—great returns. It's going to be a focus on the ROE. So maybe the LCOE drags down the overall cost level, but the gas peaker is going to be delivering into that market at that thousand euro a megawatt hour. It's going to be printing returns. Despite the fact that it has a higher LCOE. I think that's really the message here: focus on being able to deliver to the consumer and their needs.

Actually, if somebody said you need to entice them to decarbonise, if they want to decarbonise, they will decarbonise. Focus on their needs. The second thing is focusing on profitability, a return on equity. The third one is then it creates alignment across businesses so businesses can go out there and be profitable. But I think it starts with focus on the consumer. By the way, if you really read behind the lines of what I just said, those were the criticisms of communism. Whatever they did, they would make too many red dresses when the people wanted the blue dresses. They didn't focus on return on equity. They focused on the levelised cost of energy. Then you had misalignment in the incentives.

One last point on the supercycle—still a believer in the supercycle thesis. Because what is a commodity supercycle? It's a CapEx cycle. We're seeing it. CapEx booms are going everywhere. Why do you not see it in the market? Here's the difference, and this goes to my number two thing about focus on returns. We had policy push driving that investment, and you ended up with malinvestment. We've got to make it market pull drive it. In my head, we had that supercycle—the 2000s was demand pull. It was economics doing it, not policy push. The policy push created malinvestment. So the thesis during the 2000s was one of underinvestment. This one's malinvestment, which means you're going to have pockets of deficit and surpluses all over the place. That's why, you know, it's like I point out, Spanish power prices can be negative in the morning and plus 250 in the afternoon. I think that kind of supply and demand deficit characterises this supercycle.

The other way I like to call it is like a bubbling cauldron of supply and demand imbalances. It's just little ones here and there, which makes it, I guess, more of a—going back to what you're saying, it won't create that big, steady supercycle. It's going to create great returns, but it's going to be more micro-oriented.

Amrita

Fantastic note to end that. I think it's going to be a fascinating year. I feel more positive as well about it. I think, again, to your point, taking out some of the policy push will actually help us find a better equilibrium. Obviously, we've got Iowa coming up, so we will see you there at our event. I'm sure there will be so much more in just a month's time to talk about, given what January has showed us already. So thank you again, Jeff.

Jeff

Great.

Amrita

See you soon.