Shorting Oil, Hedging Tesla

[adiggs]

The death march of the IOCs continues:

Shell To Sell Another $5B In Assets, Misses Profit Expectations | OilPrice.com

The assets being auctioned by the IOCs are being bought by companies which are already losing money. I wonder who will be left holding the bag.

I've never been so glad to be out of the major market indexes. Both the financials and the oil companies are riding for a fall and they dominate the indexes.

I've been starting to think more about this, but outside of moving to individual company shares (which I have some of, but far from the bulk of my portfolio), any ideas for how to accomplish that? I already exited my one individual company in the O&G sector (pipeline MLP), but I don't know a way to get the S&P 500 minus O&G (and not also pile on a high expense ratio).

 

[kenliles]

I've been starting to think more about this, but outside of moving to individual company shares (which I have some of, but far from the bulk of my portfolio), any ideas for how to accomplish that? I already exited my one individual company in the O&G sector (pipeline MLP), but I don't know a way to get the S&P 500 minus O&G (and not also pile on a high expense ratio).

The most liquid way I've done this (outside individual stocks) is a set of targeted ETFs.

 

[neroden]

I've been starting to think more about this, but outside of moving to individual company shares (which I have some of, but far from the bulk of my portfolio), any ideas for how to accomplish that? I already exited my one individual company in the O&G sector (pipeline MLP), but I don't know a way to get the S&P 500 minus O&G (and not also pile on a high expense ratio).

Well, I did it by going ultra-concentrated in individual stocks, but then I learned my investing from someone who predated the invention of index funds and didn't believe in "diversification" into anything you hadn't analyzed personally.

A set of targeted ETFs is one way, if you like "diversification"

I'm curious if anyone has a good handle on modeling the currency moves that will accompany the oil industry valuation drop we're predicting. Intuitively I think moving out of securities but holding US dollars nominated assets still isn't really a proper hedge, but I am fairly clueless what that proper hedge would be.

No clue. Currency movements are not something I understand. I expected Trump's election to cause the dollar to go down.

On the longer timescale I did get it right once (I predicted that the insane "fiscal tightening" policy of the ECB would cause the euro to go up for the first few years and crash through the floor in the later years). But all my other predictions have been wrong, because I simply don't understand what's going on.

I might say you probably shouldn't invest large amounts in the Saudi Riyal, but hell, I might even be wrong about that

-----
On the topic of oil, I went and looked at the latest revision of Rystad's Global Liquids Supply Cost Curve -- projections for 2020. There's something interesting about these numbers. Their breakevens are using a 7.5% discount rate. (And have been consistently, FWIW, so they're comparable from year to year.)

Global liquids supply cost curve: New shale and oil sands are marginal sources of supply in 2020

This is an advert, but I believe them: they're claiming IRRs of 12% for solar farms.
Solar Farms Attracting Energy Investors Due to High IRR and No Dry Holes

Not the only claim of 12%:
What’s an Internal Rate of Return (IRR) and what does it have to do with solar? - Solar Power Rocks
Um... so... if you can get 12% on a solar farm, then 7.5% is the wrong discount rate to use for oil and gas.

So, that probably includes subsidies. Here's an unsubsidized set of numbers:
http://solarenergypartners.co.uk/investment-overview
7% for UK projects, 8% for continental projects? Hmmm. Maybe 7.5% is the right discount rate... except surely projects in the American Southwest will do even better... Basically this seems on the low end.

So solar power is a stable, predictable, reliable investment (unlike oil!) with IRRs of 7% and up.

This means the Rystad numbers are *optimistic* for oil. Most oil projects are poor investments even at the Rystad numbers because there are very obvious alternative investments -- solar farms -- which are safer and have higher rates of return. This is going to become obvious to the investing community *eventually* and they'll start pricing in a higher risk premium for oil & gas projects. No doubt some hobbyists will keep throwing money at oil and gas. But effectively large portions of that curve are non-financeable at those prices.

I reran my gas-vs-electric comparison with $32/bbl oil, and I still get that it's cheaper to run your car off electricity at average electric prices, and comparable at rooftop-solar prices. So it really is just a question of car production volume now.

 

[jhm]

Neroden, that is interesting stuff on IRR of different investments. IIRC, SolarCity was getting something like a 12% rate of return, which was great for an income producing asset, but too capital dependent for a growth stock. The solar industry was so hungry to grow in part because it could chase such a rich rate of return.

BTW if you want a rate of return higher than 7% from an asset that has a 7% IRR, then all you need to do is borrow money to leverage up. Borrow about half your capital and you can get a 15% return on your equity. So in a sense IRR is not so relevant given that an investor has an option to lever their investment.

But where this becomes interesting is in considering the aggregate investment going into different types of investments. So when we look at all the capital flowing into solar and all flowing into oil, if the return on oil is lower and riskier than solar, then we know there is overinvestment in oil relative to solar. Moreover, we know for a fact that there is overinvestment in oil, the oil glut is the quintessential fruit of bad investment. Solar investments usually have a locked in buyer of power, while oil producers are exposed to enormous market risk.

So this should equalize on a risk-adjusted basis, and that means the oil supply gets tighter, while renewables grow faster. I also think a Gigafactory is a much better investment than an oilfield.

 

[ggr]

BTW if you want a rate of return higher than 7% from an asset that has a 7% IRR, then all you need to do is borrow money to leverage up. Borrow about half your capital and you can get a 15% return on your equity. So in a sense IRR is not so relevant given that an investor has an option to lever their investment.

You're ignoring the interest on the borrowing. If I pay 7% on the loan, leveraging does nothing.

 

[jhm]

You're ignoring the interest on the borrowing. If I pay 7% on the loan, leveraging does nothing.

True. But you could mortgage your home for 2.5%, not saying that would be wise.

 

[dakh]

A fair question. I can only offer that I use income producing real-estate to hedge all securities (operating that macro moves of the market play against all securities and liquid currencies). But there are probably some good specific hedges for currency moves - not an area I trade, so maybe others can chime in

Yeah I'm asking a bit much here. This essentially is a question of purchasing power preservation during events like oil bubble burst. Complicated topic. Could be just holding some non-trivial part of the portfolio in GLD is a simple and good enough answer.

 

[neroden]

The main point about leverage is that leverage increases risk. I've read discussions by old hands in the oil & gas business. They say they never borrowed money to drill wells, because there was such high risk to start with (of dry holes, etc.) Adding the borrowing creates too much risk.

Solar farms have very little risk so they can be safely leveraged more.

So my main point here is that there's a risk-adjusted mispricing. Oil & gas investors are taking high risk for low returns, while solar farm investors are taking low risk for high returns. *Eventually* the investment world in general will notice!

 

[neroden]

Yeah I'm asking a bit much here. This essentially is a question of purchasing power preservation during events like oil bubble burst. Complicated topic. Could be just holding some non-trivial part of the portfolio in GLD is a simple and good enough answer.

Ah. I would figure out which countries I was going to be purchasing things from and attempt to hedge proportional to that. If I buy most of my stuff in the US, really, I might as well keep most of my money in US currency. If I constantly import kangaroos from Australia, maybe I'd better hold some Australian dollars.

My hedges against sustained general market downturns are (a) rental real estate funds, (b) simply owning my home outright and having it fully equipped with low operating costs (so, y'know, insulation, solar and batteries), and (c) cash in my local currency.

 

[jhm]

The main point about leverage is that leverage increases risk. I've read discussions by old hands in the oil & gas business. They say they never borrowed money to drill wells, because there was such high risk to start with (of dry holes, etc.) Adding the borrowing creates too much risk.

Solar farms have very little risk so they can be safely leveraged more.

So my main point here is that there's a risk-adjusted mispricing. Oil & gas investors are taking high risk for low returns, while solar farm investors are taking low risk for high returns. *Eventually* the investment world in general will notice!

Yes, I agree. I did not mean to derail the discussion.

As I've mentioned before, tightening credit can be the undoing of the oil industry.

 

[jhm]

Chinese EV Manufacturer Partners With Mexican Company To Build Electric Cars

This is interesting. China and Mexico want to work together to build EVs in Mexico. Note the little electric delivery trucks that have a cost per km that is 75% to 80% less than comparable gas powered vehicles. The economics seem to be in place. It's just up to entrepreneurs to build up the supply.

Again I think the oil industry is deluded to think that demand for oil will continue to grow in developing countries. The reality is that developing countries have everything to gain by building up renewables and EVs within the developing world.

 

[rallykeeper]

I've been starting to think more about this, but outside of moving to individual company shares (which I have some of, but far from the bulk of my portfolio), any ideas for how to accomplish that? I already exited my one individual company in the O&G sector (pipeline MLP), but I don't know a way to get the S&P 500 minus O&G (and not also pile on a high expense ratio).

For an ETF, there are some brand-new ETFs out of State Street called EFAX, EEMX and SPYX. They match their respective indices, but kick out companies that own fossil fuel reserves.

In addition to the ETFs, there are also some actively-managed fossil-free mutual funds out there. Can't say that any are better are better than another, so I'll let you do your own research.

 

[adiggs]

Thanks for the tip @rallykeeper. I'll look for those - sounds like exactly what I'm looking for (based on your description - I'll do my own research ).

 

[jhm]

Chevrolet Bolt To Launch In Mexico In Mid-2017

Ok, more news about an EV market in Mexico. Does anyone know about EV incentives in Mexico?

It looks like GM wants to position the Bolt nicely in Mexico before the Model 3 comes out. I suspect that the Bolt will have a hard time competing with the Model 3 in the US, but Tesla lacks the sales and distribution network that GM must have in Mexico. So the Bolt should have an easy time outselling Tesla in Mexico.

As a Tesla investor, I'm not at all worried. Rather I am very excited to see an EV market get going in less affluent countries like Mexico.

 

[neroden]

Linked from Electrek:

Richard Meyer on Twitter

New solar and wind built in 2016 will produce more electricity per year than new natgas built in 2016.

The interesting thing about this? The guy who tweeted this correction is the "Director of Energy Analysis and Standards at the American Gas Association". He has a strong incentive *not* to admit this. But he's honest enough -- or the numbers are so overwhelming -- that he corrected himself and admitted it.

The end is nigh for fossils.

 

[jhm]

Here's how I like to look at the distribution of Gigafactories.

Imagine we are in an alternative world of light much like our own except that we use renewable energy and batteries for all our energy needs. So we've got about 1B vehicles with about 70 to 100 TWh of batteries in them, and we've got 6 TW of power generation capacity backed up with about 30 to 60 TWh of batteries. So on an annual basis to maintain this worlds energy system, we need to replace about 10% of these 100 to 160 TWh of batteries. Thus we need to produce about 13,000 GWh batteries this year. This is how much Gigafactory capacity our alternative world needs.

Ok, back to this present darkness, according to the 2016 BP energy review, total primary energy consumption was 13,147.3 million tonnes of oil equivalent (Mtoe). And can see how that consumption is distributed across the globe here (http://www.bp.com/content/dam/bp/pdf/energy-economics/statistical-review-2016/bp-statistical-review-of-world-energy-2016-primary-energy.pdf).

So let's bridge from the world of light to this present darkness. We need about 1 GWh of annual Gigafactory capacity per Mtoe of current consumption, about 13,000 of each. Naturally, there are advantages to have much of this GF capacity close to where energy is consumed.
So here is what each region needs roughly:

China ....................................3000 GWh
Asia Pacific, excl. China .......2500 GWh
Europe & Eurasia .................2800 GWh
US ........................................2300 GWh
Americas, excl. US ..............1200 GWh
Middle East ...........................900 GWh
Africa .....................................450 GWh

Naturally some regions may be better suited for exporting by virtue of proximity to raw materials, abundant cheap solar and other renewable energy, infrastructure, trade agreements and other issues. The Americas, ME and Africa may prove to be exceptional exporters. Regions which must import lots of raw materials may do well to focus on recycling and import recyclables. Additionally some regions are growing faster than others, so this needs to be anticipated.

So I'd like to see our world grow into roughly this distribution of GF capacity by 2030. If Tesla wants to own say 10% of this market, then it will need 2 or 3 campuses in each of the top four regions, 1 or 2 in the Americas (excl. US) and the Middle East, and 1 in Africa. This is 11 to 15 campuses worldwide for Tesla.

The beauty of rolling out this 13,150 GWh capacity by 2030 is that this alternative world of light is will not lag too far behind. Sure, this is about a 130 fold increase in capacity over 14 years, but growing GF capacity at about 41.5% per year achieves this. Seven doublings in 14 years, and the dark age of oil will fade from sight.

 

[EinSV]

Here's how I like to look at the distribution of Gigafactories.

Imagine we are in an alternative world of light much like our own except that we use renewable energy and batteries for all our energy needs. So we've got about 1B vehicles with about 70 to 100 TWh of batteries in them, and we've got 6 TW of power generation capacity backed up with about 30 to 60 TWh of batteries. So on an annual basis to maintain this worlds energy system, we need to replace about 10% of these 100 to 160 TWh of batteries. Thus we need to produce about 13,000 GWh batteries this year. This is how much Gigafactory capacity our alternative world needs.

Ok, back to this present darkness, according to the 2016 BP energy review, total primary energy consumption was 13,147.3 million tonnes of oil equivalent (Mtoe). And can see how that consumption is distributed across the globe here (http://www.bp.com/content/dam/bp/pdf/energy-economics/statistical-review-2016/bp-statistical-review-of-world-energy-2016-primary-energy.pdf).

So let's bridge from the world of light to this present darkness. We need about 1 GWh of annual Gigafactory capacity per Mtoe of current consumption, about 13,000 of each. Naturally, there are advantages to have much of this GF capacity close to where energy is consumed.
So here is what each region needs roughly:

China ....................................3000 GWh
Asia Pacific, excl. China .......2500 GWh
Europe & Eurasia .................2800 GWh
US ........................................2300 GWh
Americas, excl. US ..............1200 GWh
Middle East ...........................900 GWh
Africa .....................................450 GWh

Naturally some regions may be better suited for exporting by virtue of proximity to raw materials, abundant cheap solar and other renewable energy, infrastructure, trade agreements and other issues. The Americas, ME and Africa may prove to be exceptional exporters. Regions which must import lots of raw materials may do well to focus on recycling and import recyclables. Additionally some regions are growing faster than others, so this needs to be anticipated.

So I'd like to see our world grow into roughly this distribution of GF capacity by 2030. If Tesla wants to own say 10% of this market, then it will need 2 or 3 campuses in each of the top four regions, 1 or 2 in the Americas (excl. US) and the Middle East, and 1 in Africa. This is 11 to 15 campuses worldwide for Tesla.

The beauty of rolling out this 13,150 GWh capacity by 2030 is that this alternative world of light is will not lag too far behind. Sure, this is about a 130 fold increase in capacity over 14 years, but growing GF capacity at about 41.5% per year achieves this. Seven doublings in 14 years, and the dark age of oil will fade from sight.

@jhm, I generally agree with all of this, but still believe there is a reasonable argument in favor of moving China back in the line for Gigafactories:

1. Arguably, they need a GF less than any.other country. BYD and many other China-based companies are already producing higher volumes of batteries and BEVs than anyone else in the world. If Tesla were a non-profit (it's not, obviously), you could make a strong argument there is a greater "need" elsewhere in the world.
2. China does not respect IP, and Tesla's manufacturing trade secrets are put at risk if it locates a GF in China.
3. China has a record of not playing fair in world trade. I think there is a legitimate risk that China tries to repeat with storage and BEV batteries what it did with the PV market. (Trump may actually help counter this, but who knows).

Having said that, I think Tesla is likely to move forward with a GF in China, probably after Europe. I would put my money on @Ovulation's theory that Tesla will bank on being able to continue innovating and staying a couple steps ahead, and that the opportunity in China is just too enormous and immediate to pass up.

I am just making the point that since Tesla does not have unlimited access to capital, there is an argument to be made in favor of deferring GFs in China and prioritizing other locations first, to allow Tesla to continue to build a lead on manufacturing technology, and make it harder to catch up.

 

[kenliles]

A recession indicator mysteriously sprang up in January, and analysts don't know why

"In a report Wednesday, Goldman Sachs analysts said while they don't believe there is a recession, they noted that the implied drop of 460,000 barrels a day in January, or 5.2 percent year over yea, is the kind of tumble seen only during a recession."

 

[Oil4AsphaultOnly]

Here's how I like to look at the distribution of Gigafactories.

Imagine we are in an alternative world of light much like our own except that we use renewable energy and batteries for all our energy needs. So we've got about 1B vehicles with about 70 to 100 TWh of batteries in them, and we've got 6 TW of power generation capacity backed up with about 30 to 60 TWh of batteries. So on an annual basis to maintain this worlds energy system, we need to replace about 10% of these 100 to 160 TWh of batteries. Thus we need to produce about 13,000 GWh batteries this year. This is how much Gigafactory capacity our alternative world needs.

Ok, back to this present darkness, according to the 2016 BP energy review, total primary energy consumption was 13,147.3 million tonnes of oil equivalent (Mtoe). And can see how that consumption is distributed across the globe here (http://www.bp.com/content/dam/bp/pdf/energy-economics/statistical-review-2016/bp-statistical-review-of-world-energy-2016-primary-energy.pdf).

So let's bridge from the world of light to this present darkness. We need about 1 GWh of annual Gigafactory capacity per Mtoe of current consumption, about 13,000 of each. Naturally, there are advantages to have much of this GF capacity close to where energy is consumed.
So here is what each region needs roughly:

China ....................................3000 GWh
Asia Pacific, excl. China .......2500 GWh
Europe & Eurasia .................2800 GWh
US ........................................2300 GWh
Americas, excl. US ..............1200 GWh
Middle East ...........................900 GWh
Africa .....................................450 GWh

Naturally some regions may be better suited for exporting by virtue of proximity to raw materials, abundant cheap solar and other renewable energy, infrastructure, trade agreements and other issues. The Americas, ME and Africa may prove to be exceptional exporters. Regions which must import lots of raw materials may do well to focus on recycling and import recyclables. Additionally some regions are growing faster than others, so this needs to be anticipated.

So I'd like to see our world grow into roughly this distribution of GF capacity by 2030. If Tesla wants to own say 10% of this market, then it will need 2 or 3 campuses in each of the top four regions, 1 or 2 in the Americas (excl. US) and the Middle East, and 1 in Africa. This is 11 to 15 campuses worldwide for Tesla.

The beauty of rolling out this 13,150 GWh capacity by 2030 is that this alternative world of light is will not lag too far behind. Sure, this is about a 130 fold increase in capacity over 14 years, but growing GF capacity at about 41.5% per year achieves this. Seven doublings in 14 years, and the dark age of oil will fade from sight.

Sorry if I missed something, but I think there's a huge hole in this analysis. You're conflating GWh of battery capacity (essentially a nameplate label) with GWh of energy consumed. A 100KWh powerpack (cycled daily @ 50% DoD) would provide 18.25 MWh of energy (365 days * 50KWh per day) per year.

Now if that's already accounted for by the 1GWh = 1Mtoe of consumption equivalence, then the result is still off by the life-cycle of battery packs.

A factory that produces 1GWh of batteries annually would be displacing 10Mtoe of consumption by year 10. Much like wind and solar, once the product is deployed, no additional production is required to utilize that capacity.

Does this change your analysis or did I miss something?

 

[jhm]

@jhm, I generally agree with all of this, but still believe there is a reasonable argument in favor of moving China back in the line for Gigafactories:

1. Arguably, they need a GF less than any.other country. BYD and many other China-based companies are already producing higher volumes of batteries and BEVs than anyone else in the world. If Tesla were a non-profit (it's not, obviously), you could make a strong argument there is a greater "need" elsewhere in the world.
2. China does not respect IP, and Tesla's manufacturing trade secrets are put at risk if it locates a GF in China.
3. China has a record of not playing fair in world trade. I think there is a legitimate risk that China tries to repeat with storage and BEV batteries what it did with the PV market. (Trump may actually help counter this, but who knows).

Having said that, I think Tesla is likely to move forward with a GF in China, probably after Europe. I would put my money on @Ovulation's theory that Tesla will bank on being able to continue innovating and staying a couple steps ahead, and that the opportunity in China is just too enormous and immediate to pass up.

I am just making the point that since Tesla does not have unlimited access to capital, there is an argument to be made in favor of deferring GFs in China and prioritizing other locations first, to allow Tesla to continue to build a lead on manufacturing technology, and make it harder to catch up.

I hear you objections. That the sort of thing that falls under "trade agreements and other issues." The view I am taking is that somebody will build out 3000 GWh over the next 15 years. I don't know how much of that will be owned by Tesla. I suppose that would depend on the quality of partners Tesla can find in China. If they can find a partner that can be trusted not to rip off their IP, that could be a good thing.