Inflation Update, Realistic Energy Transition, Stablecoins

Inflation Update

The next Fed rate hike on September 21 depends on inflation metrics. One place to get an early peek at inflation is in commodity markets movements:

• Gasoline is down -35% from its peak in June, but still up y/y.
• Oil is down -20% from the high in June but still up 40% over the past year.
• Lumber, one of my favorite markets, is now officially negative y/y.
• Copper is also down -15% y/y.
• Corn and wheat are meaningfully lower than their panic levels but still elevated since the onset of covid.
• The housing market is cooling slightly, with July sales down -20% y/y. Real estate markets that were massive beneficiaries of Covid, like Boise, Idaho, are seeing up to 70% of listings drop their prices. However, only one real estate market, San Francisco, saw a price decrease over the past year and the national average is still up 11% y/y.

These indicators feed into the eventual inflation numbers, influencing the Fed’s rate hike decision. Natural gas, for example, is at a new all-time high, up 146% y/y. You’ll see more about the importance of natural gas below. Water scarcity appears to be a growing and severe problem in the western US, adding another factor to supply-driven price shocks.

All of the above factors when added up, indicate high inflation, albeit rising at a slower rate than its peak of 9.1%. The Fed has a lot of work to do before it can even hint at a lower rate of increase in the Fed funds rate. It’s a great time to practice patience as our post-Covid economy continues to find its footing.

Realistic Energy Transition

The path to carbon emission reduction is full of interesting challenges and opportunities. Vaclav Smil’s perspective has been an excellent resource for learning more about how we approach energy strategy collectively. Realistically, we can’t fully decarbonize in the short term. This is because much of the necessary technology either doesn’t exist or is too experimental at this stage and, therefore, not cost-effective to implement. The good news is that US carbon emissions have decreased ~25% since the peak in 2007, primarily due to the transition from coal to natural gas.

Electricity production is the “easiest” to decarbonize because cost-effective alternatives exist. The rate of electricity decarbonization is country-specific, and China and India will be slower due to the size and stage of economic development. Natural gas is a good alternative for the energy transition because it’s easily transportable, produces lower emissions than coal and has dramatically higher efficiency (60% conversion efficiency) than other fossil fuels used to generate electricity.

Efficiency gains play a significant. Fifty years ago, electricity production via steam turbine was only 30% efficient, and today it is 60% efficient. Internal combustion engines used to be 15-20% efficient, and today they are approaching 50% efficiency. Electric vehicles are 90% efficient in converting energy into movement, but there are still 200mm gasoline-powered cars in the US to replace. Jets consume 70% less kerosene per passenger than they did in the late 1950s. Steel production today uses 75% less energy per ton. This efficiency allows us to produce more GDP per unit of energy. Energy is a direct input into the economic equation, so increasing energy efficiency plays a meaningful role in creating more economic output for less energy consumption.

Energy storage is still a problem. Batteries are nowhere near as energy-dense as fossil fuels. A kilogram of lithium-ion batteries can produce approximately 300 Watt-hours (Wh), while a kilogram of gasoline can produce 12,000 Watt-hours. This is why it takes 1,000 lbs of Tesla batteries to move you the same distance as 60 lbs of gasoline. We will not decarbonize transportation until we get breakthroughs in battery storage. Planes cannot fly with batteries that weigh 40x more than the current fossil fuel source.

Nuclear fission electricity in the US has not changed since the 90s. About 20% of US electricity is generated by nuclear power. Unfortunately for nuclear, natural gas, wind and solar are cheaper methods of producing electricity. Germany has elected to shut down nuclear production altogether. However, Europe is realizing that it cannot hit its decarbonization goals without including nuclear. Nuclear risk perception as a whole is irrationally negative. France generates 70% of its electricity via nuclear with no perceivable health impact on its citizens, who have the second highest lifespans in the EU. People are generally not good at intuitive risk assessments. What will be interesting here is when nuclear fusion enters the arena as the first net energy-producing facility is expected within the next few years. In total, the energy transition will be gradual and has room for improved fossil fuels like liquid natural gas that can help us progress toward the ultimate decarbonization goal.

Stablecoins

Jeremy Allaire, the founder of the Boston crypto company Circle, was recently on the Bloomberg OddLots podcast to discuss the role of stablecoins and their product USDC. USDC is a 1:1 representation of US dollars on the Ethereum blockchain. For each USDC, an equivalent amount must be held in an account separate from the company’s operating capital. Before USDC and Ethereum, there were no protocol standards on the internet that could interact with money (stores of value and mediums of exchange). USDC is the first example of a real-life asset moving onto the blockchain, a trend that will eventually include securitization or other assets like debt, equity and real estate. Circle makes money by keeping the interest it earns on the $50b+ in current USDC reserves. Using a low estimate of 1.5%, that’s close to $750mm in annual revenue for Circle. Since no traditional banking or money transfer businesses pay out the interest earned on balances, Circle has no competitive reason to pass on the interest to the end user.

USDC is emerging as a serious competitor for money transfer systems like SWIFT or Western Union due to its simplicity and cost. USDC doesn’t require paperwork or permission to access the system as it’s as open as the full Ethereum network. Anyone can instantly move $1 or $1mm to any Ethereum wallet at a low cost. For countries with unstable or failing currencies, citizens can buy Ethereum and convert the balance to USDC at a low cost to store value. If you’re looking to profit from the potential of USDC and stablecoin growth, it’s not yet clear where the advantage lies. USDC does not require Ethereum loyalty as it works on Solana, Avalanche and other alternative layer-1 solutions. Either way, stablecoins like USDC will play a significant role in blockchain’s next growth phase. You can track the total assets held in stablecoins here; know that not all stablecoins are created equal.

Intelligent Speed Assistance – ISA Systems

The EU voted last week to require all new cars to include ISA systems that force drivers to comply with the stated speed limit. The system can enforce speed limits via passive warnings or active speed restrictions. The EU expects a 20% reduction in auto-related deaths as a result. New York is rolling out an active-only pilot program in their municipal vehicles that will force taxis and parks department trucks to drive no faster than the stated limit. You can bet there will be a robust market for devices that can override these limits. When insurance gets involved, you can also bet that people will be willing to accept ISAs if it means lower car insurance payments. Just like the seatbelt reminder alert, you can imagine that ISAs will become the standard in the coming decade. As cars become more like rolling computers, they require more semiconductor technology to operate these new systems. Long-time readers know that the semiconductor industry is one of our favorite growth sectors due to the natural long-term tailwinds that drive the industry.