In today’s Exponential Investor

  • Production gapping: what it is
  • Production gapping: why it matters
  • Production gapping: who is responsible

[Your regular editor Kit Winder is out and about somewhere… most likely skiing. And so, as he has so often done for me, I’m plugging the gap for today. But do keep in mind that there’s no company line to be toed in Exponential Investor. We’re free to disagree… and we often do.]

Over at Gold Stock Fortunes, my favourite type of gold stock to buy is what I call a “production gapper”. But it is also the gold stock I fear owning most.

The thing is, if you apply the same thinking to our global energy system… well, you should either be panicking or rubbing your hands in glee. Depending on your investment allocation, that is.

But before we can get to the meltdown of energy, or the profitable trade behind it, let me explain the analogy’s source…

Gapping in gold

The idea of a “production gapper” is very simple. It’s a company that runs out of gold to mine, but only temporarily. But the details make things more interesting.

Gold, like most energy creation, is an extractive business. You make money by selling gold and energy, but you must invest some of those profits into finding more. Otherwise, you run out. And then you’re toast.

So there’s a constant race on for finding new resources, and managing a gold or energy producer is all about finding the right balance between reaping profits and reinvesting them into future production.

Add to this the key issue of timing. It takes years, sometimes a decade, to develop a gold mine or an energy resource. That’s a lot of time and money to finance. And it’s these two factors – timing and money – which I’m worried about when it comes to energy. But first, just a little more detail on production gappers so you can understand what’s about to happen to the global energy market.

What I call a production gapper is a good gold mining company with operating mines, gold sales, and promising gold deposits to tap into in the future. But it has mucked up badly when it comes to timing.

Specifically, the next deposit is not yet ready to mine when the current one is winding up. Gold production is about to plunge, which means revenue and cashflow is too.

And without revenue, but vast expenses to get the next mine up and running, the company is going to need fresh financing. A lot of it, which usually means a capital raising. And that’s just awful for the share price.

That is both the moment I fear most as a holder of a gold stock, but also the best possible point at which to invest. Because the share price has fallen to reflect the need for new financing, but it’s only the timing that the management got wrong – the gold is still there, waiting to be mined.

My worry is that all this is about to happen to the global energy system too. And those investors who own assets that don’t sputter will make a lot of money, while those who are stuck paying the bill… will be stuck paying their dramatically higher energy bills.

Gapping in energy

Governments are shutting down undesirable energy exploration, infrastructure and production. But they haven’t got the future energy supply we’re supposed to transition to ready in time. Put the two together and you get a production gap of the most important resource in the world: energy.

Yes, it is more important than food. Food is, after all, just energy in a different form.

OK, it’s probably not more important than water… but you still get the idea.

A production gapping energy system is one that failed to invest in future production that will come online in time for the old to peter out. The result is a temporary shortfall.

The good news is that, unlike an individual gold mining stock, the global system of energy is a lot more than just a few gold mines. What we’re really talking about here is a spike in prices to unaffordable levels for many people, not an outright shortage of energy.

Unless governments really muck things up and prevent price spikes, of course. Then you get shortages too.

Gapping in common sense…

The consequences of a misallocation of capital when it comes to energy, or the attempt at managing energy prices, are the likes of Kazakhstan’s riots, the Yellow Vest movement in France, the UK’s bust energy companies and similar episodes around the world. But I’m getting ahead of myself.

One of the best interview/podcast/video things I’ve seen lately is this one with Doomberg on Palisades Gold Radio. Ignore the title and introductory video, and strap yourself in for a real lesson in energy economics.

Doomberg is… claims to be… an anonymous group of commodity industry experts (not analysts) with experience in the real world of heavy industry and actually getting “things” done. Doomberg publishes analysis on Substack for a fee. Think of it as an insiders’ group.

A thread throughout its work is to explain how government policies are going to make a mess of things. Doomberg likes to point out, “The menu of terrible choices that our political leaders find themselves in because of the pressures of the environmental movement when they run up against the laws of physics.”

Which sounds simplistic and not very useful. But when I say “how” I mean that the experts dig into the details, including the consequences of the policies and, it seems, how to profit from them.

One of the golden morsels offered up in the interview is this one, when discussing energy supply:

We come from heavy industry. We understand that it takes many many years and lots of capital to develop new supply. And if you’re going to frustrate the flows of capital to that industry, it’s going to manifest itself in substantial increases in cost. […] The price elasticity of demand for energy is actually just the price elasticity of demand for life because energy is life.

The ”if” is of course them being polite. Politicians have been busily frustrating flows of capital to the industry of undesirable energies, while also supporting the flow to desirable forms. The Keystone Pipeline, gas fields, Nord Stream 2, and fracking are a few examples of the former.

Of course, sometimes politicians wake up and smell the lack of gas. The Dutch have reactivated the Groningen gas fields after all, only months after I reported on the denial that they would do so…

The Americans are furious with OPEC for not pumping more oil, while refusing to do so themselves… As Forbes put it, “OPEC Says To Biden: If You Want More Oil, Pump It Yourself”.

All this might seem like global geo-politicking. But when protest movements, bankruptcies and retail energy prices start spiking, things get problematic.

Doomberg explains the results:

The real consequences of some of our decisions ultimately manifest in the form of some human winning and some humans losing and these are tradeoffs that people don’t like to discuss or don’t even like to admit exist. But eventually the price of physics has to be paid.

The good news is, you can choose to be amongst those that benefit… or lose.

Companies that have secured future production, in spite of government attempts to stop them, stand to benefit. I wonder what they might be…

Nick Hubble
Guest Editor, Exponential Investor

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