Connect with us

Commodities

Rough Waters Ahead For The US Dollar

Historical cycles and paradigm shifts in monetary policy can give us a look into Bitcoin’s potential and the future value of the U.S. dollar.

Published

on

Historical cycles and paradigm shifts in monetary policy can give us a look into Bitcoin’s potential and the future value of the U.S. dollar.

A “paradigm,” as defined by Ray Dalio, is a period of time during which “Markets and market relationships operate in a certain way that most people adapt to and eventually extrapolate.” A “paradigm shift” occurs when those relationships are overdone, resulting in “markets that operate more opposite than similar to how they operated during the prior paradigm.”

Prior to 2008, there were four such paradigm shifts, each identified by a material change in the Federal Reserve Board’s monetary policy framework in response to unsustainable debt growth. In 2008, we saw the fifth and most recent paradigm shift, when former Fed Chair Ben Bernanke introduced quantitative easing (QE) in response to the Great Recession. Since then, the Fed has been operating in uncharted territory, launching multiple rounds of an already unconventional monetary policy with detrimental outcomes.

A significant and painful consequence of the past five paradigm shifts has been the devaluation of the U.S. dollar. Since the first shift in 1933, the dollar has lost 99% of its value against gold.

Gold purchased per U.S. dollar has drastically declined since 1930

We are currently living through a period with unprecedented levels of national debt, increasing inflationary pressures and escalating geopolitical conflicts. This is also coming at a time when the global influence of the United States is waning and the dollar’s reserve currency status is being called into question. All of this indicates that the end of the current paradigm is fast approaching.

Analyzing past paradigm shifts will lead some to anticipate a return to the gold standard, but we now live in a world with an alternative and superior monetary asset – bitcoin – which is quickly gaining adoption among individuals and nations. Unlike in past paradigms, the invention of bitcoin introduces the potential for a new monetary framework – a Bitcoin standard.

To better assess the potential impact from a change to the current monetary system, it is important to understand how we arrived at this point. Armed with this knowledge, we will be better positioned to navigate the upcoming paradigm shift, the associated economic volatility, and understand the potential impact on the dollar’s value. Bitcoin will likely play a central role in this transition, not only as a savings tool, but also in shaping future monetary policy.

Debt’s Role In The Business Cycle

A business cycle refers to the recurrent sequence of increases and decreases in economic activity over time. The four stages of a business cycle include expansion, peak, contraction and trough. The expansionary phase is characterized by improving economic conditions, rising consumer confidence and declining interest rates. As growth accelerates and the supply of credit expands, borrowers are incentivized to take on leverage to fund asset purchases. However, as the economy reaches the later years of the cycle, inflation tends to increase and asset bubbles are formed. Peak economic conditions can be sustained for years, but eventually, growth turns negative, leading to the contraction phase of the cycle. The severity and length of these downturns can vary from a mild recession lasting six months to a depression that lasts for years.

The amount of debt accumulated during the expansionary phase of the business cycle plays a vital role in how policymakers react to economic crises. Historically, the Fed navigated most recessions by relying on its three monetary policy tools: open market operations, the discount rate and reserve requirements. However, there were four instances prior to 2008 where the Fed pivoted from historical norms and introduced a new monetary policy framework, marking the end of one paradigm and the beginning of another — a paradigm shift.

Historical Paradigm Shifts

The first paradigm shift occurred in 1933 during the Great Depression when President Franklin D. Roosevelt suspended the convertibility of dollars to gold, effectively abandoning the gold standard. Severing the dollar’s link to gold allowed the Fed to increase the money supply without constraint to stimulate the economy.

Following years of global central banks funding their country’s military efforts in WWII, the monetary system experienced another paradigm shift in 1945 with the signing of the Bretton Woods Agreement, which reintroduced the dollar’s peg to gold. Reverting to the gold standard led to nearly 15 years of mostly prosperous times for the U.S. economy. Nominal gross domestic product (GDP) averaged 6% growth, while inflation remained muted around 3.5%, despite very accommodative interest rate policies.

However, government spending picked up in the 1960s to support social spending programs and to fund the Vietnam War. Before long, the government found itself saddled again with too much debt, rising inflation and a growing fiscal deficit. On the evening of August 15, 1971, Richard Nixon announced that he would close the gold window, ending dollar convertibility to gold — an explicit default on its debt obligations — in order to curb inflation and prevent foreign nations from retrieving any gold that was still owed to them. Nixon’s announcement officially marked the end of the gold standard, and the transition to a purely fiat-based monetary system.

Like in the 1930s, abandoning the gold standard allowed the Fed to increase the money supply at will. The expansionary policies that followed fueled one of the strongest inflationary periods in history. With inflation exceeding 10% by 1979, then-Fed Chair Paul Volcker made a surprise announcement that the Fed would begin managing the volume of bank reserves in the financial system, as opposed to specifically targeting the money supply’s growth rate and daily federal funds rate. He warned that the change in policy would allow interest rates to have “substantial freedom in the market,” subjecting it to more “fluctuations.” The federal funds rate subsequently began to increase and eventually exceeded 19%, sending the economy into a recession. Volcker’s policy change and the reset of interest rates to all-time highs marked the end of 40 years of a rising rate environment.

Historical Paradigm Shifts

The first paradigm shift occurred in 1933 during the Great Depression when President Franklin D. Roosevelt suspended the convertibility of dollars to gold, effectively abandoning the gold standard. Severing the dollar’s link to gold allowed the Fed to increase the money supply without constraint to stimulate the economy.

Following years of global central banks funding their country’s military efforts in WWII, the monetary system experienced another paradigm shift in 1945 with the signing of the Bretton Woods Agreement, which reintroduced the dollar’s peg to gold. Reverting to the gold standard led to nearly 15 years of mostly prosperous times for the U.S. economy. Nominal gross domestic product (GDP) averaged 6% growth, while inflation remained muted around 3.5%, despite very accommodative interest rate policies.

However, government spending picked up in the 1960s to support social spending programs and to fund the Vietnam War. Before long, the government found itself saddled again with too much debt, rising inflation and a growing fiscal deficit. On the evening of August 15, 1971, Richard Nixon announced that he would close the gold window, ending dollar convertibility to gold — an explicit default on its debt obligations — in order to curb inflation and prevent foreign nations from retrieving any gold that was still owed to them. Nixon’s announcement officially marked the end of the gold standard, and the transition to a purely fiat-based monetary system.

Like in the 1930s, abandoning the gold standard allowed the Fed to increase the money supply at will. The expansionary policies that followed fueled one of the strongest inflationary periods in history. With inflation exceeding 10% by 1979, then-Fed Chair Paul Volcker made a surprise announcement that the Fed would begin managing the volume of bank reserves in the financial system, as opposed to specifically targeting the money supply’s growth rate and daily federal funds rate. He warned that the change in policy would allow interest rates to have “substantial freedom in the market,” subjecting it to more “fluctuations.” The federal funds rate subsequently began to increase and eventually exceeded 19%, sending the economy into a recession. Volcker’s policy change and the reset of interest rates to all-time highs marked the end of 40 years of a rising rate environment.

Historical paradigm shifts prior to 2008

Impact of Paradigm Shifts On The U.S. Dollar

Gold is one of the few commodities that has been used throughout history as both a store-of-value asset and as a currency, evidenced by its role in monetary systems around the world, i.e., “the gold standard.” Regardless of its physical form, gold is measured by its weight and purity. Within the United States, a troy ounce is the standard measure for gold’s weight and karats for its purity. Once measured, its value can be quoted in various exchange rates, including one that references the U.S. dollar.

With gold having a standard unit of measure, any fluctuation in its exchange rate reflects an increase or decrease in the respective currency’s purchasing power. For example, when the purchasing power of the dollar increases, owners of dollars can buy more units of gold. When the dollar’s value declines, it can be exchanged for fewer units of gold.

At the time of writing, the U.S. dollar price for one troy ounce of gold with 99.9% purity is roughly $2,000. At this exchange rate, $10,000 can be exchanged for five ounces of gold. If the purchasing power of the dollar strengthens by 20%, the price for gold would decline to $1,667, allowing the buyer to purchase six ounces for $10,000 compared to five ounces from the first example. Alternatively, if the dollar weakens by 20%, gold’s price would increase to $2,500, allowing the buyer to purchase only four ounces.

With this relationship in mind when observing gold’s historic price chart, the decline in the dollar’s purchasing power during historical paradigm shifts becomes obvious. 

Gold priced in USD from 1920-1987

Quantitative Easing In The Current Paradigm

The most recent paradigm shift occurred at the end of 2008 when the Fed introduced the first round of quantitative easing in response to the Great Recession.

While rising interest rates and weakness in home prices were the key catalysts for the recession, the seeds were sown long before, dating back to 2000 when the Fed first began lowering interest rates. Over the following seven years, the federal funds rate was lowered from 6.5% to a meager 1.0%, which concurrently drove a $6 trillion increase in home mortgage loans to over $11 trillion. By 2007, household debt had increased from 70% to 100% of GDP, a debt burden that proved to be unsustainable as interest rates rose and the economy softened. 

Historical paradigm shifts after 2007

Like past shifts, the unsustainable debt burden was the key factor that ultimately led the Fed to adjust its policy framework. Not surprisingly, the outcome from implementing its new policy was consistent with history — a large increase in the money supply and a 50% devaluation in the value of the dollar against gold.

Gold priced in USD from 1920 through the present

However, this paradigm has been unlike any other in history. Despite taking unprecedented actions — four rounds of QE totaling $8 trillion of stimulus over the last 14 years — the Fed has not been able to improve its control of the broader economy. Rather, its grip has only weakened, while the nation’s debt has ballooned.

Quantitative easing by program

With national debt now exceeding $30 trillion, or 120% of GDP, a federal budget deficit nearing $3 trillion, an effective federal funds rate of just 0.33% and 8% inflation, the economy is in its most vulnerable position compared to any other time in history.

U.S. economic indicators by time period

Government Funding Needs Will Increase In Economic Instability

While the Fed discusses further tapering of its financial support, any tightening measures are likely to be short-lived, given the economy’s continued weakness and reliance on debt to drive economic growth.

Less than four months ago, Congress increased the debt ceiling for the 78th time since the 1960s. Given the nation’s historically high debt level and its current fiscal situation, its need for future borrowing is unlikely to change.

However, the funding market for the government’s debt has changed. Since the pandemic-related lockdowns and the associated financial relief programs that were announced in 2020, demand for U.S. debt has dried up. The government has since relied on the Fed to fund the majority of its spending needs. 

U.S. debt purchases differentiated by domestic, foreign and Federal Reserve buyers

As demand for U.S. debt from domestic and foreign investors continues to wane, it’s likely that the Fed will remain the largest financier of the U.S. government. This will drive further increases in the money supply, inflation, and a decline in the value of the dollar.

Bitcoin Is The Best Form Of Money

As the nation’s debt burden grows and the purchasing power of the dollar continues to decline over the coming months and years, demand for a better form of money and/or store-of-value asset will increase.

This leads to the questions, what is money and what makes one form better than another? Money is a tool that is used to facilitate economic exchange. According to Austrian economist Carl Menger, the best form of money is that which is most saleable, having the ability to easily be sold in any quantity, at any point in time and for a price that is desired. That which has “almost unlimited saleableness” will be deemed the best money, for which other lesser forms of money are measured.

Saleability of a good can be assessed across three dimensions: space, scale and time. Space refers to the degree to which a good can be easily transported over distances. Scale means a good performs well as a medium of exchange. Lastly, and most importantly, time refers to a good’s scarcity and its ability to preserve value over long periods.

"Good" money has many specific traits

As seen many times throughout history, gold has often been sought for its saleability. The dollar has also been viewed similarly, but its monetary traits have degraded meaningfully since losing its gold backing. However, with the advent of the internet and Satoshi Nakamoto’s invention of Bitcoin in 2009, there is now a superior monetary alternative.

Bitcoin shares many similarities with gold but improves upon its weaknesses. Bitcoin has the highest saleability — it is more portable, verifiable, divisible, fungible, and scarce. The one area where it remains inferior is its durability, given that gold has been around for thousands of years compared to only 13 years for bitcoin. It is only a matter of time before bitcoin demonstrates its durability. 

Comparing bitcoin to other forms of money

The Next Paradigm Shift

The dollar’s loss of its reserve currency status will prompt the sixth paradigm shift in U.S. monetary policy. With it will come yet another significant decline in the value of the dollar.

Historical precedents will lead some to believe that a transition back to the gold standard is most likely. While this is entirely possible, another probable and realistic monetary alternative in the digital age is the adoption of a Bitcoin standard. Fundamentally, bitcoin is a superior monetary good compared to all of its predecessors. As history has shown in the case of gold, the asset that is most saleable, with the strongest monetary traits, is the one that everyone will converge to.

Bitcoin is the hardest form of money the world has ever seen. Some have already realized this, but with time, everyone from individuals to nation-states will come to the same conclusion.

This is a guest post by Ryan Deedy. Opinions expressed are entirely their own and do not necessarily reflect those of BTC Inc. or Bitcoin Magazine.

Read More

Continue Reading

Commodities

The Case For Bitcoin To Separate Money From The State

By separating money from the government, Bitcoin takes the control of money out of the hands of politicians and gives it back to the citizens.

Published

on

By separating money from the government, Bitcoin takes the control of money out of the hands of politicians and gives it back to the citizens.

This is an opinion editorial by Ryan Bansal, a professional software engineer and author of a Bitcoin newsletter.

“The computer can be used as a tool to liberate and protect people, rather than to control them.” — Hal Finney

Technologies are just amplifiers, not arbiters of morality. By extrapolating from the above quote, it is within reason to claim that any technology can be both a tool for either tyranny or for freedom depending on whose hands are on the power lever.

The principle of checks and balances shows that in any kind of system that relies on concentrated power, that central institution becomes the honeypot for malicious actors. Also, keep in mind the democratic principle that more distributed decision-making is more robust and fair for any society. So it sounds like a no-brainer that the best way moving forward is to develop and adopt technologies with no single ultimate power lever?

Having said that, let’s now talk about one of the most important technologies of all: money. In the evolution of monetary technology from barter systems to seashells to metal coins to gold-backed banknotes and now a central-bank-controlled fiat digital currency, the power distribution has gone from being more decentralized to being more centralized to the point where governments have managed to establish a coercive monopoly on money.

Now, I think it is a fairly non-controversial statement to say: Government corrupts anything it touches. Sure, the convenience of digital money is unmatched, but it is also important to understand the other side of it, i.e., the counterparty risk, which means needing to trust a custody provider to secure your assets — along with the fact that the historical track record of keeping this trust is not great.

However fortunately or unfortunately, recently this breach in the contract has started to happen more widely and openly. Take for example a developed democratic country like Canada, freezing the bank accounts of its citizens for protesting against COVID-19 restrictions or a country like Russia putting restrictions on its people trying to withdraw their funds after the country invaded its neighbor. In a world run purely on physical cash, this kind of power to unconstitutionally violate private property rights would be impossible to execute.

(Source)

Apart from the worsening financial censorship and geopolitical sanctions — which are a relatively recent phenomenon now that money has become almost fully digital — the corruption arising from the advent of fiat money and its problems goes further back to 1971. What do I mean? The plethora of metrics one can use to measure the health of an economy like index funds price-earnings ratios, Gini index for wealth inequality, consumer price index for inflation and cost of living, the ratio of income growth versus productivity growth, individual homeownership rates and many others have all gone haywire since the then President Richard Nixon decided to move away from the gold standard.

If you haven’t guessed the next move of governments by now, allow me to introduce you to central bank digital currencies (CBDCs). Think today’s digital money is bad enough as is? Now imagine what if it was also programmable?

You can say goodbye to any last sliver of financial autonomy. Before we know it, we’ll be living in a surveillance state with social credit scores, just like the Chinese citizens. If you’ve seen politicians trying to put a positive spin on them by randomly throwing around buzzwords, like “blockchain,” go back to the top of this article and read the first line again.

The problems that the government creates can be spoken of at great lengths, but let us move on to the solution: How to take the control of money out of the hands of politicians and give it back to the citizens?

“I don’t believe we shall ever have good money again before we take it out of the hands of governments.” — Friedrich Hayek

Imagine if our monetary system had the privacy and autonomy of cash; the convenience of being instantly and digitally transferrable all over the globe; all the while also retaining the properties of gold, i.e., nobody can steal your purchasing power over time by arbitrarily manipulating its supply only to serve their perverse political incentives?

Moreover, what if it was also running on an open-source codebase and used a public database making it globally accessible, completely transparent and fully auditable by anyone? Plus, what if it also allowed anyone with an internet connection and a computer the ability to weigh in on its monetary policy?

Finally, what if the proposed system was also decentralized in a way that it becomes impossible to stop, controlled or corrupted by anyone due to the lack of a single point of failure or by any central authority?

Sounds like a monetary technology on steroids, doesn’t it? Well, in 2008, a solution to these problems was proposed by someone using the pseudonym of Satoshi Nakamoto. I’d also like to highlight that it didn’t just come out of the blue, it has been in the making ever since the central bankers established control over the money. More precisely, it took almost 40 years of research and multiple failed attempts to engineer this masterpiece. The following visual is more tangible:

(Source)

I’d like to close by reiterating that the notion of separation of the money from the State may seem radical to you at first, but it is actually not. As I mentioned before, the monetary technologies we’ve used throughout most of our history were way more outside of the state control than current fiat money. In one way or another, the State managed to capture them. Gold is the best example of such a non-sovereign asset that people used as money for the longest time, but it had obvious attack vectors in the form of various physical limitations, i.e., hard to store, hard to secure and hard to move.

Historically speaking, there has been a tug-of-war between fiat and non-government monies. Therefore, the real issue at hand is not one of “if” money will separate from government control, but of “when.” With Bitcoin, I think the moment is finally here.

Now obviously if this article has not managed to fully convince you how Bitcoin was designed to be a truly democratic and inclusive monetary system and if you still insist on calling it a scam, I hope you’ll at least consider it is something worth taking a harder look at.

This is a guest post by Ryan Bansal. Opinions expressed are entirely their own and do not necessarily reflect those of BTC Inc. or Bitcoin Magazine.

Read More

Continue Reading

Economics

A Tale Of Two Recessions: One Excellent, One Tumultuous

A Tale Of Two Recessions: One Excellent, One Tumultuous

Authored by Charles Hugh Smith via OfTwoMinds blog,

Events may show that there are…

Published

on

A Tale Of Two Recessions: One Excellent, One Tumultuous

Authored by Charles Hugh Smith via OfTwoMinds blog,

Events may show that there are no winners, only survivors and those who failed to adapt.

Some recessions are brief, necessary cleansings in which extremes of leverage and speculation are unwound via painful defaults, reductions of risk and bear markets.

Some are reactions to exogenous shocks such as war or pandemic. The uncertainty triggers a mass reduction of risk which recedes once the worst is known and priced in.

Far less frequently, structural recessions are lengthy, tumultuous upheavals that can set the stage for excellent long-term expansion or unraveling and collapse. In these structural recessions, 10% to 20% of the workforce loses their jobs as entire sectors are obsoleted and jobs that depend on excesses of debt and speculation go away.

In the U.S. economy of today, this would translate into a minimum of 14 million jobs vanishing, never to return in their previous form and compensation.

The old jobs don't come back and new jobs demand different enterprises, training and skills. Unemployment remains elevated, spending is weak and productivity is low for years as enterprises and workers have to adjust to radically different conditions. If the economy and society persevere through this transition, the stage is set for the reworked economy to enjoy an era of renewed prosperity and opportunity.

If an economy and society can't complete this transition, stagnation decays into collapse.

I've annotated a St. Louis Federal Reserve chart of U.S. recessions since 1970 to show the taxonomy described above. The stagflationary 1970s / early 1980s were a lengthy, tumultuous structural upheaval; the 1990-91 recession was triggered by the First Gulf War; the Dot-Com Bust in 2000-2002 was largely the unwinding of speculative excesses in the technology sectors (similar to the radio-technology bubble of the 1920s); the Global Financial Meltdown (aka the Global Financial Crisis) was the structural reckoning of unregulated global financialization excesses, and the 2020 recession was the result of policy responses to the Covid pandemic.

Chart courtesy of St. Louis Federal Reserve Database (FRED)

Each of these resulted in a multi-quarter decline in GDP, the classic (though flawed) definition of recession.

Recessions that cleanse the system of financial deadwood are necessary and yield excellent results. Per the Yellowstone Analogy ( The Yellowstone Analogy and The Crisis of Neoliberal Capitalism (May 18, 2009) and No Recession Ever Again? The Yellowstone Analogy (November 8, 2019), the deadwood of excessive speculation, leverage, fraud and debt issued to poor credit risks must be burned off lest the deadwood pile up and consume the entire forest in a conflagration of the sort that was narrowly averted in 2008-09 when fraud and risk-taking had reached systemically destructive extremes.

The problem with letting deadwood pile up so it threatens the entire forest is the policy reaction creates its own extremes. The coordinated central bank policies unleashed in 2008 and beyond established new and unhealthy expectations and norms, the equivalent of counting on central bank water tankers to fly over and extinguish every firestorm of excessive risk-taking and fraud.

Those emergency measures create their own deadwood, distortions and risk, and are not a replacement for prudent forest management, i.e. maintaining a transparent market where excessive risk is continually reduced to ashes in semi-controlled burns.

When systemic changes in the economy and society demand structural transitions, the resulting tumult can either creatively rework entire sectors, weeding out what no longer works in favor of new methods and processes, or those benefiting most from the old structure can thwart desperately needed evolution to protect their gravy trains.

If change is stifled as a threat, the entire economy enters a death-spiral to collapse. Some eras present an economy with a stark choice: adapt or die. Adaptation in inherently messy, as new approaches are tried in a trial-and-error fashion and improvements are costly as the learning curve is steep.

Sacrifices must be made to achieve greater goals. as I outlined yesterday in A Most Peculiar Recession, in the 1970s the U.S. economy was forced to adapt to three simultaneous structural changes:

1. The peak of U.S. oil production and the dramatic repricing of oil globally by newly empowered OPEC oil exporters.

2. The pressing need to reconfigure the vast U.S. industrial base to limit pollution and clean up decades of environmental damage and become more efficient in response to higher energy prices.

3. The national security / geopolitical need to encourage the first wave of Globalization in the 1960s and 1970s to support the mercantilist economies of America's European and Asian allies to counter Soviet influence.

Coincidentally, this last goal required the U.S. expand the exorbitant privilege of the U.S. dollar, the primary reserve currency by exporting dollars to fund overseas expansion of U.S. allies like Japan and Germany and running permanent trade deficits to benefit mercantilist allies.

These measures created their own distortions which led to the Plaza Accord in 1985 and other structural adjustments. Ultimately, the U.S. managed to adapt to a knowledge economy (Peter Drucker's phrase) and a more efficient means of production, resulting in a much cleaner environment and a leaner, more adaptable economy.

The deadwood of hyper-financialization and the distortions of hyper-globalization have now piled up so high that they threaten the entire global economy. Those who have feasted most freely on hyper-financialization and hyper-globalization must now pay the heavy price of adjusting to definancialization and deglobalization.

Those who have been living on expanding debt and soaring exports are in for a drawn-out, wrenching structural adjustment to the reversal of these trends and the fires sweeping through the deadwood that's piled up for the past two decades.

There will winners and losers in this global structural upheaval. Mercantilist economies that feasted on 60 years of export expansion will be losers because there is no domestic sector large enough to absorb their excess production, and those who feasted on the expansion of debt to inflate asset bubbles will find their reluctance to conduct controlled burns of their speculative debt-laden deadwood will exact a devastating price when their entire financial system burns down.

Those who didn't rely on exports for growth will find the transition much less traumatic, as will those who maintained a regulated, transparent market for credit that limited excesses of leverage and high-risk debt.

Those who adjust to structurally higher energy costs by becoming more efficient and limiting waste via Degrowth will prosper, all others will sag under the crushing weight of waste is growth Landfill Economies. I explain why this is so in my new book Global Crisis, National Renewal.

Recessions which are allowed to clear the deadwood and encourage adaptation yield excellent results. Those which don't lead to the entire forest burning down. Economies optimized for graft, corruption, opacity and benefiting insiders will burn down, along with those that optimized speculative extremes of debt and those too rigid and rigged to allow any creative destruction of insiders' skims and scams.

Events may show that there are no winners, only survivors and those who failed to adapt and slid into the dustbin of history.

*  *  *

My new book is now available at a 10% discount this month: When You Can't Go On: Burnout, Reckoning and Renewal. If you found value in this content, please join me in seeking solutions by becoming a $1/month patron of my work via patreon.com.

Tyler Durden Fri, 08/12/2022 - 12:20

Read More

Continue Reading

Economics

This Shale Pioneer Refocusing on Natural Gas

Investors Alley
This Shale Pioneer Refocusing on Natural Gas
Forget oil—the real money is in natural gas. Or at least that’s the message coming from…

Published

on

Investors Alley
This Shale Pioneer Refocusing on Natural Gas

Forget oil—the real money is in natural gas.

Or at least that’s the message coming from a pioneer of the U.S. shale revolution, Chesapeake Energy (CHK).

From Prince to Pauper to Prince Again?

Once upon a time—when its stock was valued at more than $35 billion and its CEO, Aubrey McClendon, had the biggest pay package of any CEO of a listed firm—Chesapeake Energy was America’s best-known fracker.

But those glory days disappeared quickly, and Chesapeake became the poster child for the shale sector’s excesses.

About a year and a half ago, in the autumn of 2020, Chesapeake was in the midst of bankruptcy proceedings after the coronavirus pandemic-led crash in energy demand proved to be the final straw in the company’s fall from grace.

And for the industry more broadly, the prospects for liquefied natural gas (LNG) exports were looking bleak after a $7 billion contract to supply the French utility Engie went down the tubes on concerns over the emissions profile of U.S. natural gas.

Fast forward to 2022 and the picture has changed dramatically. Natural gas exports are booming!

Thanks to the Russian invasion of Ukraine and subsequent sanctions, Europe is in the middle of an energy crisis. It is buying up as much American LNG as it can. Those concerns about emissions are long forgotten.

In the first four months of the year, the U.S. exported 11.5 billion cubic feet a day of gas in the form of LNG, an 18% increase from 2021. Three-quarters of those exports went to Europe. And European leaders have pledged to ratchet up their imports by the end of the decade. There is also a massive opportunity in Asia, where LNG demand is set to quadruple to 44 billion cubic feet a day by 2050, according to a recent report released by think-tank, the Progressive Policy Institute.

And even here in the U.S., natural gas supplies look set to be tight this winter. Hot summer weather and high demands for power generation are sucking up supplies and leaving storage precariously low.

The investment bank Piper Sandler believes U.S. storage is on pace to fill just 3.4 trillion cubic feet of gas by the time winter arrives. That would be short of the 3.8 trillion cubic feet buffer usually needed to heat the country through a cold winter season. That could send already-elevated natural gas prices even higher in the months ahead.

These factors combined were behind the decision by Chesapeake Energy management to ditch oil in favor of gas.

Chesapeake: All in on Gas

OnAugust 2, Chesapeake announced its plan to exit oil completely and return to its roots as a natural gas producer. The company said it would offload oil producing assets in south Texas’s Eagle Ford basin, allowing it to focus solely on gas production from Louisiana’s Haynesville basin and the Marcellus Shale in Appalachia.

Its CEO Nick Dell’Osso said the company made the decision because of better returns from its gas assets—it has had more success driving down costs and improving efficiency there when compared with oil.

Chesapeake emerged from bankruptcy in February 2021, vowing to shift from its previous model of growth at all costs to one of capital discipline and higher shareholder returns.

The company has expanded its natural gas portfolio of assets since its emergence from bankruptcy. It bought gas producer Vine Energy for $2.2 billion last August to bolster its position in the Haynesville, which sits close to gas-export facilities on the US Gulf Coast. And in January, it bought Chief Oil & Gas, a gas operator in north-eastern Pennsylvania’s section of the prolific Marcellus shale field, for $2.6 billion. Chesapeake also recently offloaded its Wyoming oil business to Continental Resources, the company controlled by shale billionaire Harold Hamm.

In summarizing Chesapeake Energy’s strategy, Dell’Osso said, “What’s different today than the past… is that we are allocating capital in a way that maximizes returns to shareholders, rather than maximizing [production] growth.”

Speaking with the Financial Times, Del’Osso added: “The industry was built on [oil and gas production] growth expectations, and company stocks were valued on growth expectations. That all had to get broken down.” The “reset” had been painful, but management teams would stick with the new model, the CEO said.

The strategy seems to be working. In May, Chesapeake reported record-high adjusted quarterly free cash flow of $532 million from the first three months of 2022.

Also in the second quarter, it announced an agreement to supply gas with the Golden Pass LNG facility. Golden Pass LNG is a joint venture company formed by affiliates of two of the world’s largest and most experienced oil and gas companies: QatarEnergy (70%) and ExxonMobil (30%).

The company now plans to pay $7 billion in dividends over the next five years. That is equivalent to well over half of its current market capitalization!

Chesapeake boasts of its best-in-class shareholder return program. It has completed about a third of its $2 billion share and warrant repurchase program, and it raised the base dividend by 10%, to $2.20 per share annually.

The company has a juicy variable dividend as well. Its next quarterly dividend will consist of the $0.55 per share base dividend and a variable dividend of $1.77. Management projects that, in the third quarter, it will pay out total dividends of $275 million to $285 million. The total dividend payout for 2022 should come in at between $1.3 billion and $1.5 billion.

Chesapeake’s yield is a very impressive 10% and I do not see that changing much as gas prices stay elevated. The stock is a buy anywhere in the $90s.

Odd trade turns every Friday into PAYDAY [ad]

This shocking video has been causing quite a stir… It exposes a unique trade that has paid out 321 out of 324 trades… with the majority of the trades making 100% or more… every 3-10 days. The details outlined here… and the profit potential behind these trades are very real. Discover how a simple 10 minute trade on Tuesday could double your money by Friday. Click here.

This Shale Pioneer Refocusing on Natural Gas
Tony Daltorio

Read More

Continue Reading

Trending