2022 was a weird year for energy and infrastructure equities, as the easier to navigate commodity markets of 2021 faded away. The post-Covid economy was the perfect storm for most cyclical companies with rising demand, caused by lockdowns easing and expansionary policy, as well as constrained supply, due to a lack of investment over the last decade along with COVID-specific problems such as shutdowns.
In 2022, the ease of the demand-led narrative was challenged by the looming “demand destruction” of higher commodity prices and a worsening economy, as the world went from a mindset of saving the economy to stopping inflation. Inside this macroeconomic sentiment was an overreaction (perhaps needed) from most players to the events of 2021. For example, retailers like Target have been stacking inventories as a reaction to supply chain issues that they now can’t sell. Or for an energy-specific perspective, gas inventories in Europe have been filled to capacity as a response to everyone pointing at “harsh winter, Europe underprepared.” This then caused NG and LNG prices to fall drastically due to inventory buildup (Freeport explosion; a lot of other changes involved as well but bear with me and this oversimplified analysis). Now this is easy to say in hindsight, and we will see how Europe does navigate this winter and whether or not the build-up was executed well, but this quick action from players in the market combined with the macroeconomic uncertainty makes it hard for sweeping, multiyear investment theses that were popular in 2021, especially for commodities.
There are clear question marks on the demand side for commodities that were not there in 2021 (and god knows it’s been priced in, to some extent). On the supply side, things are still very tight across most verticals, only amplified by the Russian-Ukraine war which has changed how people and governments (rightfully) view the importance of these industries and has disrupted the commodity flows that have existed for decades. So demand is uncertain and supply is tight. Keep that in mind as we look more closely at a few of these industries and equities.
Reuters Graphics — Commodity Performance 2022 YTD
Shipping
Let’s start off with by far my favorite industry: shipping. In terms of the impact of the Russia-Ukraine conflict, few of these commodity verticals can compete. I split this section between Tankers (Oil/Refined Products), Dry Bulk (Iron Ore, Coal, and Agri.), and Containers (world trade/goods).
Tankers
Tanker rates exploded after the Russian invasion. The disruption in ton-mile demand was immense, as the 1-2 week journey between the Russian and European ports turned into a multi-month voyage to ship Russian oil to Asian markets. While oil throughput did not change too much relative to expectations, these disruptions in trade flows, insurance, and other elements relating to the response to the Russian invasion led to Worldscale (~100 is the set normal) rates jumping to around 200-300 (2-3x flat rates) for the smaller sizes on the dirty side (Suez and Afras). Even the larger VLs have seen recovery above 100WS on most rates after languishing around 30-50 since 2021. It is even more ridiculous on the clean (refined product) side with rates popping 4-5x this year. Long-term, the supply picture continues to look very good, with a very low orderbook, an old fleet, and new emission regulations continuing to push older vessels out.
Most tanker equities have followed the explosion in spot prices, with 200% returns being normal in the sector. The outlook for 2023, while rosy, does not leave much upside left at current equity prices. Some names to be looking for would be $STNG, $TRMD, and $INSW, but at this point in the cycle be very, very careful with tanker equities. While the long-term situation is promising, volatility and a slow normalization in rates are the name of the game in the short term.
Dry Bulk
The setup in dry bulk is very enticing with the most upside in shipping. With shipyards busy building containerships (and recent orders of tankers), dry bulk has the most compelling supply story. Flat to negative vessel growth is expected for the next few years. On the demand side, the big player is of course, China. Continued Chinese shutdowns have murdered this sector this year, but with the recent policy shift in China, there is a genuine reason for optimism in the sector. The rebound in coal demand has also proven beneficial for rates, especially for larger Capesizes. Iron Ore shipments really need an increase in Chinese steel production to support higher dry bulk rates. At this point in the cycle, and if you buy the thesis of Chinese demand reappearing, you want as much exposure as possible to the spot price. To that end, you either go with an index of the rates themselves ($BDRY) or go for the most leveraged “shitco” of the dry bulk trading basket, my favorite for that category being $SHIP.
Containers
While tankers are having their golden run, and Dry Bulk are positioned to hopefully enter one, Containers have already had their heyday in 2021. But what a heyday it was. Rates jumped 10-12x in a year and dominated headlines for a year. Stocks like $ZIM had incredible returns (1000%+ if you timed it right) but have since collapsed. Demand has questions, mainly if there will be an economic slowdown and unlike essentially every other commodity, excessive ordering of containerships (these shipowners will never learn) has led to a massive orderbook and a terrible supply picture. However, I prefer this type of market for equities even more than the top-of-the-cycle investing of tankers (though the dry bulk setup is far better than both). Now it’s time for scavengers to go through and look through these stocks that have gotten slashed and try to find value.
Luckily, there is a ton of value to be found in this sector as most names just trade in a basket. I love containership stocks that have locked in cash flows for the next few years (mostly inked at top of cycle rates) and can a) outlast a bad market and b) earn truly ridiculous amounts of FCF, especially compared to a market cap that has been slashed even with their minimal spot exposure.
This includes containership lessors like $GSL and $DAC, who have cash flows locked in for 2-3 years and are in the capital return stage, even though $DAC really needs to up the capital returns to be re-rated as they should. After divesting their shares in $ZIM they should start to return more money (certainly have the cash to do so), and if it happens there is tremendous share appreciation possible for $DAC. $GSL is executing well, just needs to stop trading in that containership basket. There are also container box lessors like $TGH and $TRTN which have locked in cash flows for 7-10 years and have minimal exposure, yet are falling like they have full spot exposure to container rates.
Uranium
Another favorite sector of mine… Uranium. The supply/demand mismatch here is one of the clearest in any industry I have seen. On the supply side, the lack of capital expenditure over the last decade combined with current mines being depleted has led to 135M pounds of production compared to 200M pounds of demand. Further changes, including the entry of the new Metal trust by Sprott which is buying a significant amount of uranium out of the market, have led to optimism about crazy spikes in the spot market. Further, new supplies will not be added until the spot price hits $80 (break-even for most producers) and huge security issues mean the industry has been regulated to hell, and it’s very hard for new supply to come online quickly as it needs multiple approvals from governments. Demand is largely dependent on large policy changes from governments, which have been moving closer to nuclear after the energy insecurity issues (such as Japan restarting its nuclear fleet). Finally, the cost of uranium input compared to the overall costs of running the nuclear plant means Utility companies care more about the availability and security of resources rather than price. No demand destruction here. In fact, if supplies dwindle and prices shoot up you will see more demand as utilities scramble to secure long-term uranium shipments.
Playing this thesis, however, needs a bit of work. You can play the spot price through $SRUFF (Sprott Metal Trust) and the overall industry through $URNM (uranium ETF). You need to be very careful with this sector and would prefer going for quality here with the bigger producers like Cameco, Kazatomprom, or a historical major player like Energy Fuels. While the potential returns of juniors and developers are insane, when in an industry like this side with those who can realize the increased cash flows the most if the spot price does move within the next 2-3 years.
Coal
The biggest reason I like this industry is similar to Uranium and Shipping. It’s underfollowed and mostly left alone. That should be a large green sign for investors looking for outsized profits. Two main types: thermal and met. Thermal coal is for heating purposes and serves as an alternative to Natural Gas usually. Met Coal is used for the production of steel, the building block for basically everything. The main exporters are China (domestic usage, exports through their belt and road initiative), Indonesia (currently has strict controls over exports, heavy thermal), Australia (not exporting to China due to tensions, heavy met and thermal), and America (overinvested into oblivion back when Europe actually wanted to use coal, now the industry is relatively small).
Several supply chain constraints are in place: huge rail/shipping issues (transportation), decreased operating mines as people moved away from coal in favor of greener options, and no one wants to increase future production in a dying industry. Demand has recently shot up in recent years as nat gas prices and LNG prices have made coal (in comparison) too cheap to ignore. Countries end up caring less about being green when inflation is hitting 20% in their county because of high energy prices.
Few major players to be in: $BTU (cheapest, both thermal and met coal), $ARCH (met coal mainly), and $CEIX (mainly thermal). Pricing across the board is very, very cheap, go for quality and massive capital return programs. Also be on the lookout for rail issues and an increase in Mongolian coal (there has been more infrastructure being built, especially to service China).
Oil & Gas
What you probably think when you hear energy, and for probably the right reason. By far the biggest sector discussed here, and that means both more analysts and institutions you are competing against. However, it also means more potential deep opportunities just with the number of companies and capital moving around in this sector. The supply side depends mainly on OPEC policy, which has consolidated power away from the U.S. this year for the first time since the shale revolution. However, because of the low levels of capital expenditures in the past, expanding production too much will be difficult, to say the least. While Oil producers are still being cautious, and only paying up for premium acreage, Gas players are spending like there is no tomorrow, especially in the LNG world where terminals are planning to be popping up everywhere in Europe (takes a while though). Demand for both Oil and Gas is about those scary “demand destruction” words again and depends on how soft this landing from the federal reserve really will be. Either way, the outlook for O&G looks decently bright, especially compared to the dreariness of the pre-covid years.
My favorite way to find discounts in this space is to scour the Canadian space. The U.S. refinery reliance on Canadian heavy is as high as possible, without access to Iranian, Venezuelan, and Russian heavy due to sanctions. Companies like $VET, $BTE, and $MEG trade at significant discounts to not just their US upstream counterparts but even their Canadian partners. Midstream companies still remain a strong choice for income investors, with a little price appreciation being possible.
Steel
The first “commodity” industry I learned about and included my first commodity multi-bagger. The demand for iron ore met coal, and dry bulk all are offsets of the Steel trade. China is the big boy in this commodity. 50-60% of global production comes from them and they are also the main consumer as they use it to fuel their real estate bubbles and infrastructure plans.
Steel got a big long-term boost from the demand side due to global infrastructure plans, and demand will have some tailwinds as auto production normalizes (semiconductor shortage). Demand is threatened mainly by China real estate shenanigans and global economic slowdown.
Scrap (recycled steel) and EAF (using electricity to power steel furnaces instead of coal and iron ore) are the two main “green” trends. There is some production using hydrogen too but it sucks in terms of being able to make money. Shipping costs also play a huge role since reduced shipping costs allow China to flood global markets (especially Europe). The US market is a bit more protected from Chinese dumping. The supply side for steel in the Americas, however looks a bit rough, with multiple producers ($TX, $STLD) being a bit irresponsible with bringing on new supply.
ArcelorMittal ($MT) should be your proxy on European production (biggest non-china producer), $CLF/$X/$NUE (a proxy for US Steel). Value-wise, $MT and $TX (Americas/mainly Mexico) should be your favorites, but investors seem to just love $NUE compared to other steel players. $NUE should be your guy for a more sentiment-driven purchase since institutions love ‘em to the death, but I personally have stuck with the more valuation-friendly guys that should be ok even through a downturn. Again, another industry I would approach with caution in terms of buying into now.
Rare Earth/Battery Metals
Another industry that is not discussed as often as it should be. Rare Earths are another commodity dominated by China, which controls around 80-90% of the process chain. End products for these REE magnets include EVs, Electronics, Defense, etc. (Kinda like a metal-semiconductor). As a result of this Chinese domination, there is a bunch of regulatory action in America to secure Rare Earth Supply, especially with its importance in defense. The calculations for global conflict have changed incredibly since the Russian Invasion.
MP Materials ($MP) and Energy Fuels ($UUUU) are companies to look out for in this space as Western companies looking to build out the entire supply chain. Lynas is also worth a shout, as Australia has become such a strong ally with the Quad.
On the battery metal side, there is a lot of hype in this industry which is largely based on Electric Vehicle demand. In the US, most of the mining for these metals centers around Nevada, and the big guys are already fighting over permits from the government to mine. Demand seems like it will continue to grow, the only problem is the cost of extraction. This will likely be a profitable industry, but hard to pick the winners when the technology keeps evolving and with multiples for most miners so high. My favorite name in this vertical is $SBSW, an old gold miner that has become very involved across the entire battery metal and car metal industry. The valuation is very attractive and the equity continues to only be seen by investors by their old legacy business and gets very little credit for their successful expansion into battery metals.
Agriculture
I’ll be honest, I’m not too familiar with the workings of this market and have mostly focused on the fertilizer businesses, however, I will give it my best shot with the little I know.
Ukraine and India are the big players in the Wheat trade which was obviously disrupted by the Russian invasion and the most dependent countries in terms of food insecurity include China and Egypt. For a lot of this agricultural trade, fertilizer is a huge input cost for most of these companies which only got more and more expensive as Russia used to be a huge source of potash. Further, America has some problems relating to droughts in the Mississippi that have been causing problems in supply chains and allowed Brazil and other foreign suppliers to capture some market share globally. This is a sector that is crazy interesting and does not get the importance it deserves, especially as food insecurity will be a bigger issue soon with dwindling supplies of water and a still-growing population.
My ideas for playing this center around fertilizer. A few of the names I find compelling are $MOS, $CF, and $NTR. You can also look into Agriculture trading firms like $BG that benefit wildly from the kind of volatility we are seeing in the market. The final idea would be for agricultural land, there were a few REITS ($CRESY worth a shout) especially in Latin America that centered around this type of ag. thesis.
Closing Thoughts
It’s been a very mixed year for most commodities with the Russian invasion providing supply constraints and the market latching onto the demand destruction narrative. As 2022 comes to an end and we look forward to 2023, there still remain exciting enough opportunities and values even if it is a harder to navigate market than before. To close us off, probably a good idea to throw in a *this is not financial advice* disclaimer here.
Econ Ramblings 