Energy Transition Implications from the Russian/Ukrainian Conflict

We don’t have any particular insights into the geopolitical or macro impacts of Russia’s invasion of the Ukraine. Today’s events seem to run counter to conventional wisdom that Putin was saber rattling, and our hearts and prayers are with the people of Ukraine and the soldiers on the ground.

From a supply perspective, Russia and the Ukraine are major exporters of oil, natural gas, coal, wheat, and certain metals, particularly palladium where Russia comprises almost 40% of global refined supply but also aluminum and nickel. Russia is also a major producer and exporter of enriched uranium.

Most immediately, the challenge for many of these markets is that above ground inventories are already very low and supply deficits were emerging given the lack of capital investment made in most upstream commodities over the last five to ten years.

The issue is particularly acute in Europe, which relies on Russia for natural gas as the result of a series of misguided policy decisions which we discussed here. Fortunately, we are through the heart of winter, but inventories are well below historical norms.

It is also likely that many power-intensive industries in Europe will have to further curtail production to balance the energy markets, reinforcing and propagating the supply issues. Across many commodities, western sanctions could further exacerbate these imbalances, although for oil, it is unclear what will happen with the “OPEC+” arrangement which has so skillfully managed the market for the last few years.

At least in the short term, higher commodity prices seem certain, as there is a long history of commodity price spikes related to geopolitical events.

Of course, the offset to supply deficits and higher inflation is the potential for a meaningful slowdown in the global economy.  Neither consumers nor producers benefit from rapid increases in commodity prices.

Related to natural resources and the Energy Transition, we believe that there are five main implications from recent events:

1. Security of Supply – Western governments and corporations, already nervous about China’s dominance of key raw materials, will now be forced to either take action to secure, develop, and protect strategic resources or allow themselves to be manipulated at will. See European gas above. Beyond raw materials, global supply chains will be further disintermediated.
2. Energy Security – Acceleration of natural gas, renewables, long duration storage and nuclear power as a means to ensure sanctity of supply as well as protect consumers and economies from geopolitical disruptions. North America is incredibly well positioned in this regard.
3. Scarcity Value – Points 1 and 2 reinforce the idea of scarcity value that we have been discussing for the last several years. A decade of deflation and the dominance of “all things tech” has provided a false sense of security related to the availability of key raw materials that are necessary for both everyday life and the decarbonized future that we are all working towards.
4. Inflationary Pressures – Putting short-term price spikes aside, sanctions, supply chain disruptions, an acceleration of renewables, an increased emphasis on security of supply, etc. will all place upward pressure on commodity prices. This is a net negative for consumers and the global economy.
5. The Benefits of Diversification – Buying homeowners insurance after the fire is pointless. The value of long duration, low-cost producers of agricultural goods, key metals and energy commodities located in geopolitically safe jurisdictions is not reflected in current asset values and stock prices.

It’s impossible to forecast how the current situation will pan out, and our strongest hopes are for a fast, peaceful resolution. However, it is equally impossible to conclude that the risks of escalating geopolitical tensions, with all of the concomitant outcomes discussed above, aren’t rising.

Summary

In summary, we believe recent events increase the likelihood of stagflation, an outcome we believed was already probable given the consequences of prolonged capital constraints on new supply, the material requirements of the Energy Transition and the post-stimulus hangover facing the global economy.

Disclosures

This information is intended solely for educational purposes. No other distribution or use of these materials has been authorized. The opinions expressed in these materials represent the personal views of the investment professionals of SailingStone Capital Partners, are not definitive investment advice, and are based on their broad-based investment knowledge, experience, research, and analysis. It must be noted, however, that no one can accurately predict the future of the market with certainty or guarantee future investment performance. Past performance is not a guarantee of future results. Certain statements in this communication are forward-looking statements. The forward-looking statements and other views expressed herein are as of the date of this letter. Actual future results or occurrences may differ significantly from those anticipated in any forward-looking statements, and there is no guarantee that any predictions will come to pass. The views expressed herein are subject to change at any time, due to numerous market and other factors. SailingStone Capital Partners disclaims any obligation to update publicly or revise any forward-looking statements or views expressed herein. This information is neither an offer to sell nor a solicitation of any offer to buy any securities. Any offering or solicitation will be made only to eligible investors and pursuant to any applicable Private Placement Memorandum and other governing documents, all of which must be read in their entirety.

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