Stubborn Inflation & AI Power Demand Fuel the Energy Bull Case

SPEAKER_1 (0:01)

All right, joining me to discuss some of this, particularly the inflationary pressures and the commodity space is Paul Baiocchi, who's the head of fund strategy at SS&C, Alps Advisors. Paul, thank you so much for your time. What have you made of the inflation? Because this seems to have now thrown a bit more sand in the gears of this market. Do you change your strategy around that?

Paul Baiocchi (0:25)

I think you have to be prepared for stubborn inflation. We look at the print we got today and over the course of the past year, gasoline prices are up 35 percent. That's responsible for about half of the past year's increase in inflation. And that hasn't necessarily even reverberated fully through the economy. We see stubbornly high diesel prices, which of course find their way into various parts of the economy eventually. And so even if this is a short-lived energy shock, the expectation is that this will continue to work its way through consumer goods. And if you're an investor or an allocator, what we argue is that commodities are perhaps the most powerful tool in the arsenal for insulating your money against inflation.

SPEAKER_1 (1:09)

Okay, which ones?

Paul Baiocchi (1:10)

So a basket approach is what we advocate because individually a lot of commodities can be very volatile. You look at front month, Brent futures, the WTI futures. There's a lot of volatility in there. But if you use a basket approach that mixes and matches soft, agricultural, energy commodities together, the volatility profile ends up looking a lot like an equity strategy, but with inflation characteristics. If you look historically at commodities, they typically do very well in environments where you have positive growth, which we have both real and nominal and higher than expected inflation.

SPEAKER_1 (1:44)

Have you rode the way of that is refiners this year, which are going through the roof more than AI?

Paul Baiocchi (1:48)

We're actually focused on midstream energy infrastructure companies. The guys who own the pipelines that get natural gas and crude oil from where it's produced to where it's going, and that's a very different business model. You're not as beholden to the spread between what you pull it out of the ground for, what you buy it for, and what you can refine it for. It's a fee-based business model. And on the inflation point, what's interesting about pipelines is their contracts have inflation escalators embedded in them, long-haul pipelines regulated by FERC. You get some inflation protection in the revenue stream, which is also volume-based as opposed to spread-based.

SPEAKER_1 (2:21)

And that sounds to me like more of a long-term play because of kind of, I guess, the wake-up call, the realization of what the US needs to do now given the supply shock we've seen. Is that right?

Paul Baiocchi (2:31)

Indeed. And I would also, the world, after February 28th, I would argue the world is never going to be the same in terms of-

SPEAKER_1 (2:38)

Kind of like COVID.

Paul Baiocchi (2:39)

Exactly. Global energy market. So if you think about what happens on the other side of a resolution in Iran, a lot of these countries are going to be trying to stockpile energy and commodity resources. While the countries in and around, either the Strait of Hormuz or Bob Elam and Deb, they're going to be trying to circumvent those two choke points. And the countries who have been beholden to those choke points are going to start looking for new sources of natural gas, crude oil, which the United States, at least in the case of natural gas, has a significant amount of and has export capacity and room to spare. So I think there's going to be a reconfiguration globally of commodities markets that stands to benefit US energy producers and importantly, also allows us to be insulated somewhat, at least domestically, from the impacts of what goes on in the Middle East.

SPEAKER_1 (3:27)

Yeah. And what across the energy spectrum? Because there's a lot of talk in this country right now about natural gas.

Paul Baiocchi (3:34)

So it's about 42 percent of our electricity generation. It's very critical. We have an abundant supply of natural gas, increasingly so. And we're now expected to grow exports of LNG by another 50 percent by the end of the decade. So our footprint in global natural gas and commodities markets is growing in a way that maybe our economy didn't anticipate 10, 15 years ago.

SPEAKER_1 (3:58)

Is that the biggest opportunity right now? I mean, where is?

Paul Baiocchi (4:00)

So we think the energy infrastructure companies present a great long-term strategy. You play on some of the domestic dynamics around increasing electricity demand. The important role natural gas plays in that, but also the growing opportunity for export markets for natural gas in the form of LNG. But also NGL, think about butane, propane, ethane, byproducts of production. We've seen export share grow there as well.