Matthew Smith - Natural Gas: The Next Bottleneck

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00:01:11Hello and welcome, everyone. I'm Patrick O'Shaughnessy and this is Invest Like the Best. This show is an open-ended exploration of markets, ideas, stories, and strategies that will help you better invest both your time and your money. If you enjoy these conversations and want to go deeper, check out Colossus, our quarterly publication with in-depth profiles of the people-shaping business and investing. You can find Colossus, along with all of our podcasts at Colossus.com. Patrick O'Shaughnessy is the CEO of Positive Sum. All opinions expressed by Patrick and podcast guests are solely their own opinions and do not reflect the opinion of Positive Sum. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions.

00:01:51Clients of Positive Sum may maintain positions in the securities discussed in this podcast. To learn more, visit PSUM. Our guest today is Matthew Smith. He's been on the show before many years ago, and I always love talking to him about energy markets where he's worked for 20 years. He's the founder and CIO of Chronometer Partners, which invests in energy, industrial, materials, power, and utilities, and related infrastructure. He and his team have modeled nearly every natural gas well pipeline and processing asset in the United States. He's reached the conclusion that most of the market does not share. Starting in 2008, AI data centers and LNG exports will need more gas than the country can produce and deliver.

00:02:34By his math, the U.S. could exhaust its working natural gas storage by 2030 and could lead to a true energy crisis. In his words, the upside risk to prices becomes unbounded and convex. We talk about why this was set in motion long before AI arrived, why the U.S. can't just turn off exports, who wins and loses among producers, nuclear, solar, and hyperscalers, and what he sees as the only long-term solution. Please enjoy my great conversation with Matthew Smith. So Matt, the last time we did this was, I think, during COVID, kind of crazy that it's been six years. I've always loved talking to you about energy markets. You've been working in this space for 20 years.

00:03:11You're about as encyclopedic on this stuff as anyone I've ever met. But you've also been acutely studying the current energy situation in the U.S., rebuilding in a way that you'll describe from the well-level up, a picture of what's happening, especially as AI is creating all this new demand through data centers, et cetera, of what is going on over the last 18 months of concerted effort. You've reached a fascinating and somewhat scary conclusion. I'd love you to just start with the conclusion, and then we're going to talk through how you came to this conclusion, who the winners might be, the losers might be, what's to be done about it. But before we get deep into all the component parts, just tell us what you found after 18 months of study. We are headed into a place where we see an historic deficit in natural gas.

00:03:56supply available in the United States, which does portend some pretty serious consequences. Natural gas, which is over 40% of U.S. power generation, is imminently going to become the most important fuel in the country, overtaking petroleum, given the amount we now use for generation. Our work suggests that in 26, 27, natural gas is appropriately supplied, but as we get into 28 and you plug in this compute and you assign gas to very specific assets that are plugged in as well, and you continue to export LNG as we're planning to do with known projects, we start to eat into our working gas storage, which is the nexus of supply and demand in the country. I think we will come to the conclusion that the upside risk to natural gas is both unbounded and

00:04:48convex. And so where you will feel it most acutely will be electricity prices in 28, 29, 2030 based on our work. How much of this is just attributable to data centers, like just purely we're building a lot more data centers, that's just for AI? Is it that simple or is there something else going on as well? The die was cast long before AI compute came to the scene. If I may set the stage a little bit: U.S. gas was plentiful, starting in about 2010, when shale started to really change, come to the scene and change things. We had been importing natural gas to satisfy consumption on top of what we produced domestically. Shale started to be very productive, surprised to the upside, and became this abundant force. And as natural gas became more abundant,

00:05:34we started to export, starting with Sabine Pass. We've gone from that early Sabine Pass exporting to today. We're exporting about 15 BCF a day of nameplate U.S. export capacity. Now, that 15 BCF is on a base of about 110 to 112 BCF a day of natural gas production in the U.S. So if you think about it, it's become about 12 to 15 percent of the U.S. daily ability to supply the market that we're exporting. As this abundance continued, more and more facilities, projects have been announced. As of today, we're scheduled to export up to 35 BCF a day by the end of 2030. And in that case, the die has been mostly cast: to build an LNG project you need various approvals, they're project financed, you site and permit many years in advance.

00:06:22Most of these projects that get you from 15 or 16 BCF a day nameplate to 35 are well on their way. And so that's the primary incremental demand driver in the country over the last 10 years and will be at least for the next five. We had moderate population growth during the tens and teens into the 2020s. We went through a period of stagnating electricity demand. You had energy efficiency and some other things driving down electricity demand. So you had more demand for gas-driven generation, but it's really been in the recent past where compute has started to pull incrementally. But before that, you had LNG as the main demand driver.

00:07:03Now, let's put those together. I just shared that we're going to go from about 15 to 35 BCF a day of incremental LNG exports. And after evaluating every producing gas well and the entire pipeline and processing and gathering system, we have the capacity to add about 20 BCF a day of gas production, even without AI compute. We had sources and uses matched between our ability to deliver new natural gas from Appalachia, Haynesville, Permian, and that which is supposed to leave the door through LNG. Now bring in our AI compute. There are so many different power generating ideas in order to power compute, time to power,

00:07:42that folks talk about so much. It sort of goes from the large-scale, most efficient assets, which are GE-Vernova combined cycle, all the way down through the distributed generation assets, which we'll call fuel cells, we'll add Wartsila or Caterpillar or Solar Turbines. There are various local field-level behind-the-meter assets. Those assets are also relevant. We have had to assign, with an outside partner, probabilities to all of that stuff. And so what we've gone about doing is we start with our base case, which we'll call P50, everything with a probability of 50% or more. 50% being they have some approvals, they usually have a PPA, someone planning to buy power from them

00:08:23under contract. They usually have some sort of interconnection agreement, or they're in process with the interconnection agreement. Those are the assets we've taken seriously in our base case, so we'll call that the P50 level. And when you do that, it's about 5 BCF a day of very credible incremental natural gas demand associated mostly with AI compute. Now, importantly, there are multiples of what we are considering serious in our base case that have been proposed and will consume natural gas. Every solution today - a six-series Bloom Energy latest-gen fuel cell will take 150 million cubic feet of gas per gigawatt. The market has been assigning a high probability of them obtaining two gigawatts a year of productivity, or of manufacturing capacity.

00:09:13And that's likely to ramp to five gigawatts. There isn't the gas for that unless you take it from something else. In the extreme case, how high does that number get? If you start to move it down - it's a P30 or P10 - that number can more than double and be 12 to 15 BCF a day by the early 2030s if unmitigated. One naive way to approach this is to say, this doesn't sound like that big of a deal - 12 BCF in the extreme case, just shut off the exports, who cares, we didn't export natural gas for a long time.

00:09:43People domestically are not going to tolerate skyrocketing energy prices, especially when they think the simple solution to this is just, stop shipping it out of the country, just use it for ourselves. Why is the solution not just to shut off exports? It's more complicated because of contract law. There are rules. There are really good reasons why we're exporting. And these projects have tens of billions of dollars of project financing and contracts attached to or associated with these LNG projects. And as the U.S. will be about a third of global gas supply in several years, our allies and other FTA and increasingly non-FTA countries are reliant on U.S.

00:10:23free trade agreements. So the answer is that it's both, because it's a third of the global supply, that's really important for the rest of the world, and domestically there are just contracts and investments. And it could be stopped, but it'd be very complicated. Yeah, let's step back for a moment. You have to have a starting place for a base case, which typically starts with signed contracts - what do the words on the page say, what's allowed or what's not allowed.

00:10:46When we set out to build the firm, we've had about 16 plus months to start to model almost every asset at a time at the atomic level. Along the way, there are numerous constraints and rules and regulations and contracts. When we set out to build this, it was about acknowledging those constraints for what they are, assuming that contract law would be followed. And then as we go through and build all of this, we can flex up and down based on the choice to send less LNG out of our terminals, for instance, or slow AI compute growth, which is one solution which we're not really willing to propose because we know that there's insatiable demand. And so it's not

00:11:29popular to say slow AI compute growth, but to the extent that would happen, that would be another lever to reduce the pull or strain we expect in the system as the decade goes on. I'm just going to try to ask really simple questions here - not to minimize it, but it's your view that in the bad-to-worst-case scenarios, this is a full-blown crisis. This is not a small thing, this is like the story of the country. I want to make sure the whole reason we're going into all this detail is that in this scenario, it's really, really bad, and it's bad primarily through prices, but maybe you can continue to articulate why we don't necessarily want this specific outcome and what we can do about it. But help me

00:12:07understand, underneath the United States right now, or North America, there's a certain amount of gas. I'm trying to understand how much of this is that we are literally going to run out of the gas that's under the ground, versus it's just a problem of how quickly we can find where it is, get it out economically, process it, store it, transmit it, use it, et cetera. Those seem like two separate problems - literally how much there is, and then what we can do with it. Is any element of this problem that there's just literally not enough of it?

00:12:38Starting with resource in the ground - there's tremendous data availability. We can measure where we are in the exploitation of most of the major gas-producing basins: Appalachia, which is primarily the Marcellus plus the Utica, the Haynesville, which is a key swing basin, and then of course the Permian and the Eagle Ford, these are oil-directed plays where the decision to drill and produce is driven by oil and gas is a byproduct. So in each of these plays, there are some stacked pay zones

00:13:09where well penetration and output can be measured with a lot of data. What that allows us to do, when you digitize the acreage controlled by each one of these companies with polygon shapes that use a bunch of lat-longs to drop in and associate a well with an area that's controlled, you can figure out what's left. And the reality is there is gas, and as a part of our analysis, we've produced the gas that is logically captured and can be produced from wells on existing acreage positions of all these companies. So there is gas.

00:13:45We're assuming it gets developed - that's how you get to our 20 BCF a day of growth. But there are other constraints. It's unbelievably cool that we can literally know at this precision what is underneath the ground, often deep underneath the ground and hard-to-reach places - it's a technology story that would be fun to tell sometime. But it doesn't sound like the actual problem is that we are literally running out of

00:14:06the stuff underneath the ground. We've also had a history of just finding new stuff we didn't know existed before. So it sounds like the problem is more our ability to serve the demand in this kind of timeframe, not that we're literally going to run out of the resource over the next 20 years. It's a little more complicated than that. We get through most of the existing captured inventory of these companies in the next four or five years. And if you think about it, you bring on a new well, it has a decline rate.

00:14:35And each well, as it's stacked on an existing company-wide portfolio, declines, and a lot of these companies' decline curves are maturing somewhat, so they don't have to - pretty steep in natural gas, right? It's steep initially in natural gas, but companies like Expand and EQT and others have such mature portfolios that the replacement is less costly today than it would have been five years ago. So when you stack all of these wells based on existing acreage across these companies, assuming they're going to drill optimally based on the forward curve, which is depressed - and we'll talk about that -

00:15:02you get to this 128, 130, 132 BCF a day of maximum deliverability. So we are assuming that all of these companies develop the rest of their acreage. But that's a flow metric, not a stock metric. What is possible when you use known well performance parameters to maximize production before you get to midstream and other surface-level constraints, which we'll talk about. There's resource. We are depleting the known resource.

00:15:33If you were to assume prices go up meaningfully, you may unlock additional basins that are legacy known basins. We know a lot about most of the rock in the U.S., there are other known gas basins, but they're uneconomic, and there isn't the infrastructure to really accelerate drilling and activity in those basins to solve this. The constraints are multifold. The first constraint is the rock. We have the ability, we think, to get to 128 to 132 BCF.

00:16:01I started with our highest estimate, which is 132 BCF, as a starting place, because that's how you solve the LNG exports we've committed to. We'll take the under on that, but that's where you can get to. A common pushback as we've gone through this is that there's plenty of resource available to us in the Permian, there's plenty of resource in Appalachia. A number of companies describe themselves as having a lot more inventory of wells to drill than we can justify with the facts, and I'll just leave it at that. But when folks meet with companies, they should ask to understand exact engineered locations on a map - where do they have not just the ability to produce, but plans

00:16:41to have infrastructure on the surface to allow it to flow, for instance, and the ability within financial parameters to invest and produce. The resource in the ground, we're fairly far along in understanding it. We've accounted for all of the major productive basins in the country, and I don't think we're likely to be surprised by some new major shale find - knowledge of those things is pretty mature at this point. To say it back, there's a lot of resource, but at this rate, we're depleting the known resources quite quickly. We are advanced in depleting the known resources, especially as we move to the next layer, which is infrastructure.

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00:18:03Invest Like the Best listeners get a special offer for $1,000 off at Vanta.com/invest. Ridgeline is the first end-to-end system of record with embedded AI for investment management firms, running portfolio accounting, reconciliation, reporting, trading, and compliance on one unified platform. Firms are moving off legacy technology and onto Ridgeline because of how far ahead Ridgeline's AI features are compared to anything else in investment management software, which is why I believe that firms that come out ahead in the AI era will be the ones

00:18:35running on Ridgeline's unified platform. If you're serious about your firm's AI strategy, Ridgeline should be part of that conversation. You can request a demo at ridgeline.ai. There's a bigger, longer-term question about - is this just a parenthetical period of time between 2010 and now when we were awash in gas? Prior to that, we really weren't, and maybe after this, we really won't be. Let's talk now about - okay, we get gas out of the ground, it still has to be processed and transmitted and used.

00:19:06What are the most important rate limiters in that part of the equation? In some cases it's processing the natural gas flows to the surface with natural gas liquids embedded therein. In some cases there's sulfur or nitrogen that has to be dealt with. In some cases it comes with oil, and so you have to have surface-level infrastructure to produce the oil, which is different. Gas primarily has to be produced into a pipeline system, and there's a certain spec on regular pipelines - that's 1,010 to 1,030 BTU is the spec. So you have to remove enough of these other hydrocarbons to get it to pipeline spec, to be able to produce it into the system, to be consumed by

00:19:45folks downstream. So processing is the first major constraint. There are a couple of basins with a little bit of extra processing capacity - we'll fill it up pretty quickly. We do not have processing yet to get to our assumed 20 BCF production target that's necessary. Processing takes two or three years to build at the midpoint. We generally know what processing investments are being made, and projects have been announced by Permian processors or by Appalachian processors. We know where the materials and liquids-handling throughput capacity will be in 27, 28 at least. Even to get to our 20 BCF of incremental gas production, we're willing to estimate you need to have more processing built.

00:20:31Build stuff now, point one - build it now, imminently. Gathering - small-diameter pipe gathering is what takes it from the wellhead to processing or the pipeline system. There is a fair amount of disclosure around processing systems being expanded and built, and we would posit we have put all of those on a map on top of every one of these wells at their lat-longs,

00:20:49in order to grow even a fraction of where we must have natural gas production go in the U.S. Gathering has to be invested in very materially, and imminently, to get to the place where we can achieve 130 BCF a day of production in the U.S. The last one is the interstate gas pipeline system. This is where I come back to your answer on LNG - lots of rules and regulations around these things. Pipelines are monopolies for the most part. Local distribution companies that deliver gas to your stove - those are monopolies or oligopolies. In the last 10 or 12 years, we've really built one interstate gas pipeline, that was Mountain Valley Pipeline, connecting Appalachia to the Mid-Atlantic.

00:21:31The various environmental permitting regime changes have made it very difficult to build interstate gas pipelines. This administration - and this is an apolitical economy topic - this administration has been trying to reduce the barriers to building interstate gas pipes, and we've started to see some more progress to that end. There is an urgency to build more connectivity, to wheel gas around the country, to serve this incremental AI compute load. Before we keep going through this sequence, can you just say what you think the state will be - let's assume there's roughly inertia in the system, nobody listens to this, nobody does anything. A lot of people listen to this and have ideas, but what is going to happen in the world?

00:22:13What will the state of the world be like in 2030 if none of this starts getting addressed sooner rather than later? What's your best guess as to what it looks like? There is a tremendous inertia around natural gas being the primary fuel to power AI. SemiAnalysis, for instance, a leader in many respects, has done excellent work on everything up to the power source, and their behind-the-meter load forecasts and generation and load forecasts match. They do everything up to the point where they don't assess where the gas will come from. And so the market has been focused on understanding the power shortage and trying to solve that.

00:22:56Generation generally - power generation, which could be solar and batteries, wind, nuclear, whether large-scale or small modular reactors (SMRs), or natural gas. Natural gas is well supplied today, 26 and 27, and the result is that nobody is investing in gas. In fact, EQT is shutting in natural gas right now because they think it'll be more valuable later. The rig count, the things we can see real-time to figure out if the market is onto this tightness in 2029, 2030 - it's not apparent today. And so it's perpetuating this view that most Americans have, which is there's plentiful natural gas, because for 15 years it's all we've been taught.

00:23:35And so there's a complacency that's developed, and we think that complacency is going to take us right up to the point where it's too late. So we do think the die has been cast, where gas, which is currently $3.50, $3.60, going out to 26, 27, in 28, the curve is flat - 29, 30, the curve is flat, because people believe the gas is abundant. That's despite all these AI compute announcements, despite what all of the companies are doing for their investments - gas has lulled everybody to sleep. But what happens is these structural things start to fall into place in 27, 28, and we start to draw meaningfully on the middle of 28, early 28, on the gas system like we've never drawn before.

00:24:19And as we look at 28, 29, 2030, we start to cut into the U.S. working gas storage, which is about 4 TCF total gas storage. There's a range of high and low for that storage seasonally as we draw in summer, winter, and then build in the shoulder months in spring and fall. When you get to the middle of 2028, we start to break very materially below where gas available in storage has ever been historically. And by 2029, we drop below all known historical storage evidence. And by 2030, we get pretty close to where we think, ceteris paribus, gas storage looks very, very low. And at that point in time, because it hasn't happened before -

00:25:07we're forced to look at where gas prices have gone during shortages. We can look at Russia-Ukraine - gas went to $8, $9, $10 an MCF because we sent a lot more externally to Europe. We've seen various weather anomalies, the polar vortex in '14, December of '22, and those prices went to $6 or $8 or $10, but those have been transitory. What we're talking about are structural drivers of demand against a known possible production of gas, and they don't match up.

00:25:40You draw down in a very historic way starting in 28, to the point where the deficit gets really convex and unbounded. Meaning that gas prices could be $20 or something like this? I would hesitate to even put a price target on it, but at $8 or $10 we think you potentially shut off some of the U.S. exports - their spot cargoes are leaving the border to capture uplift in Europe or elsewhere. Those spot cargoes may not be lifted, and that gas is left in the system, and we've tried to account for that in our model, but the spot cargoes alone can't solve this. You'd have to get into shutting off contracted cargoes leaving our border via

00:26:21LNG to really start to mitigate some of this, and it's hard for us to count on the choice to shut off contracted cargoes where there's some Japanese utility counterparty who is counting on it for its provision of electricity. In crazy convex outcomes like this, can you tick through who you think the biggest winners and losers are? There are some clear natural gas producer winners. Expand Energy is probably at the top of that list - they probably control 70% of remaining core Haynesville wells,

00:26:53the very closely known parameters of rock where we know it to be very productive. And so Expand, we think, is far and away the biggest winner. Expand needs a CEO right now - there was some turnover, and they're going through a search. The stock has dropped over the last six months as a part of that search. It's trading at four times EBITDA on a forward curve where no one believes what I'm telling you to be the case, even though we think modeling the facts gets you to a much higher gas price.

00:27:26The stock has dropped, the assets have not changed. It has some of the highest-quality rock in the country. The highest-quality upstream company in Appalachia is probably Range. Range has significant room to grow production and materially grow returns to investors. So those would be the upstream companies. It's not going to be obvious in the first pass through this equation for most, but natural gas sets the marginal fuel for the next-in-line power-generating asset in each power market.

00:27:53As natural gas goes, power prices go in the country. So if you think about the dispatch curve of different generating assets in the country, there are some where the fuel is free - that would be solar, to a lesser extent wind, hydro. Solar assets, which are growing meaningfully, have been 90% of the interconnection queue with batteries in the last 10 years in terms of new assets coming on other than gas. Solar assets stand to benefit from a windfall where electricity prices are going up, because the margin of a plant taking free fuel is rising while sun costs the same. We think there are some companies positioned very well for margin expansion with no incremental capital costs.

00:28:37XPLR, ticker XIFR, formerly NextEra Energy Yield Co, is an interesting set of assets - they have a windfall coming in the latter part of the decade because they mark their PPAs to market at much higher values without any capex. Clearway Energy would be another one, similar circumstance. So solar assets at utility scale especially stand to win. Maybe more interestingly, as it relates to some of our past discussions, residential solar, which has been suffering from the first removal of tax incentives to install residential solar since the late '70s, is really one of the only ways to protect yourself from what's going to happen from 10 a.m. to 6 p.m. once gas gets really tight in the electricity markets - what you pay for electricity

00:29:25at your house. So we think residential solar grows exponentially from here, even without tax incentives. For the first time it's very economic given where electricity prices are likely to go to install solar, especially when it accompanies batteries, which make the electricity much more available around the clock. I think it's important to say you're an investor, you have money behind this work. Beyond those two categories, are there any other surprising winners, do you think, in all of this? What about nuclear, what about Westinghouse or places like that? What we're talking about is a complex dynamic system where there will be choices to consume

00:30:01electricity or not at different times. And as I go through this, I want to make sure I acknowledge there's no silver-bullet solution for what I described as a convex situation with natural gas, and therefore electricity prices, as the decade closes. There's no bridge fuel other than solar and wind, because currently natural gas is the only flex fuel to get us to when we can bring on nuclear. We have spent a fair amount of time as well in the nuclear ecosystem. To us, large-scale nukes are the only solution that makes sense,

00:30:33which points us primarily to the AP-1000 Westinghouse units. Don't those take like five years to build, or more? More than that, but at least they have a track record. Very brief history - we've built two nuclear reactor units in 30 years in the U.S., Vogtle 3 and 4. Around that time we also tried to build one in South Carolina called V.C. Summer, another nuclear project at the time that nearly bankrupted SCANA, which was later pushed into the arms of Dominion and the project was shut down. The muscle memory from trying to build large-scale nukes,

00:31:03especially in the wake of Fukushima in 2011, Chernobyl through Three Mile Island - for three decades, nuclear engineers, scientists, and companies moved away from nuclear. And then the Vogtle 3 and 4 experiment, where it cost three times as much and took, I think, 15 years from birth to commercial service - that's the recent memory of these nuclear units. But if you go out to the 2030s, what I'm describing in terms of gas deficit only gets worse in '31, '32, and beyond. So in our mind, the only viable solution is to build large-scale nuclear as fast as possible, which would mean it needs to come on in 2033 or 2034, as soon as it can come on. Regular utilities, hyperscalers, regulators should all align around that goal. But because -

00:31:51because people don't really believe that gas is in short supply as the decade goes along, they don't believe in the problem, they don't like the solution - they need to be convinced of the problem. And the country has a history of building pipelines to solve problems that exist today, not problems that will exist in five or ten years. So we're trying to get out ahead and see where the puck's going, and where it's going is we are going to need large-scale nuclear by 2033, 2034. You don't think SMRs can be a solution, where you use smaller reactors to power individual data centers behind the meter and

00:32:21never touch the system? Many of the SMRs are still science experiments. The NRC and the U.S. government are actually doing a fair number of things to break down the barriers to bringing those to market, to see if they work or not and what the cost will be and whether they can be scaled. But many of these SMR companies are not set up to manufacture and truly scale for the solution that's needed to solve this problem, which is tens of gigawatts as you go into the 2030s. That points us to these large-scale reactors.

00:32:48Since Vogtle 4 came on - and Vogtle 4 experienced very material improvements over Vogtle 3 - today China is building 39 plus or minus nuclear reactors, 34 of them are one gigawatt plus, and I think a third of those are modeled after the AP-1000. We know a lot more today about building large-scale nukes than we did when these mistakes were made. Large-scale, where it can be commercialized on a known timeline and where the costs are probably better than a space where we don't even know if we can scale the business - large scale versus small probably wins in our mind. The two companies most levered to that would be Cameco, which owns 49%, and Brookfield, 51%,

00:33:31of Westinghouse. You'll probably find that the U.S. government agrees with what I'm describing - they seem to really be lining up and trying to facilitate commitments and early procurement, which will de-risk some of the supply chain and help put timelines on this. And when Westinghouse comes public, it's deeply undervalued within Cameco today, so that's an interesting one. BWXT, which is a super interesting company - they're the primary supplier of nuclear for the U.S. Navy - significantly benefits from the coming nuclear cycle as well,

00:34:02with lots of dollar content in the AP-1000. What are the big losers, do you think, in this future? Well, sadly, the biggest loser of this would be the U.S. consumer. To the point where you take what I'm saying, and if we're even partially right, electricity prices rise, which you can see some of on the forward curves in these different markets, as electricity prices rise, you start to think about the trade-off -

00:34:23are we going to export natural gas to foreign buyers, are we going to use it for AI compute, or are we going to try to keep consumer electricity bills down? It's an awful trade-off. I think it will probably start to contribute more to the public dialogue, the NIMBYism we're already seeing pop up in some places. We think AI is tremendously transformational, we're not anti-AI, but it consumes a lot

00:34:49of power, and we need to really focus on the 2030 to 2035 period, and the U.S. consumer is probably going to pay the bill in the meantime. Please note that most of the solutions being proposed by the government are to consume more gas, because everybody believes it's plentiful. Bring Your Own Generator (BYOG) is a thing today - that's what the hyperscalers are being asked to do, to site their data center in a certain lat-long. Well, that means more gas, not less. Every time you read a press release from Bloom or from - think more gas, think more gas.

00:35:25And you can use the energy efficiency of each of these units and understand exactly how much more incremental gas beyond the base case I just shared is dangerously tight. Another loser, and I want to be respectful, but some of the biggest winners so far, at least in the stock market, have been the manufacturers of gas turbines or distributed power gen sets. When you think about those companies, it's been somewhat boom and bust since the early 2000s -

00:35:51there was a boom to build as many gas plants as we could, the capacity was overbuilt, and the industry really languished for a long time until now. You've had tremendous profitability and equity returns from these companies over the last two years, but as you look at 2028, 2029, most of them are adding more capacity, again, just like they did in the early 2000s. What kinds of companies are these? Caterpillar, for instance - they're doubling their Solar Turbines capacity between now and the end of '29, which I would judge is just at the exact wrong time, when people may be questioning whether they even want to deploy those assets because the gas is much more expensive than they planned. Bloom Energy has been topical recently because of other things people are talking about, the rare-earth risks in their manufacturing, for instance.

00:36:34But for us, we don't think that Bloom Energy's assets at two gigawatts or more will be able to get natural gas, in competition with all of the other assets that are being deployed and will consume gas, given the scarcity that we see. So those are two - we'll call it manufacturers of distributed generation or behind-the-meter generation - that we think are probably more poorly positioned than investors appreciate. It really doesn't make sense to us, beyond 2029, 2030, to build large-scale natural gas generation until we ramp up production meaningfully and can secure deliverability of gas consistent with our model. We could see orders slow very meaningfully for natural gas generating assets, even at large scale, as 26 progresses. Those could be some of the losers.

00:37:25It just may not make sense to use gas for power generation for new or incremental assets after a certain point. It seems like this whole memory shortage thing we're going through right now - hyperscalers might also be in trouble here, if this is a key input to what they're doing. Do you think that's a big problem for them? As we've been socializing this a little bit, trying to learn more and have people poke holes, I shared this with one of your recent guests, and he said, well, this sounds like DRAM two years ago, slowly at first and then all at once.

00:37:52The lack of investment in capacity expansion is going to come back to bite us, and I think that's where the analog starts. When we think about the way this plays out and other analogs, that's probably the best one. When we think about the cost structure of the hyperscalers, right now energy is budgeted to be about 10% of their cost - depreciation, memory, and other things factor in as well - but total cost of energy is supposed to be about 10%. If you plug in all of this compute and it's gas-powered, and we think gas could double or triple structurally,

00:38:28even without weather, it could end up being 20 or 30% of the cost of compute by 2029. We do think it becomes a much more material issue. Now, levelized cost of energy (LCOE), as it's referred to, takes into account capex, it takes into account cost of fuel. Everybody making decisions in this moment is using the forward curve for natural gas, which is flat, a little

00:38:51backward-dated, a little contango, mostly flat out into the 2030s in the mid-$3s. That is a very attractive, low-cost fuel for the hyperscalers to commit to when they're focused on solving everything else, like how do I get compute in place to manifest revenue growth for Anthropic or elsewhere. For us, we're just focused on modeling objectively - when you plug in this compute, this power-gen source here and there, how exactly does it pull on the system of companies that we focus on? If you were forced to play devil's advocate in all of this, and come up with the set of circumstances such that this is all much ado about nothing, and we're sitting here in 2030 and gas costs three bucks,

00:39:32what do you think is the most likely reason? Is it that data center power requirements are much lower because we make performance breakthroughs, or AI demand isn't what we think it's going to be? What is this most sensitive to, such that we'd be wrong? So after we did most of our work, we went on a bit of a listening tour, targeting conversations with who we think are maybe the subject-matter experts - on energy storage, or hyperscaler compute deployment and energy consumption. The common pushbacks, which we've spent a lot of time understanding, are: the Permian is an oil play, oil is high, the Permian has lots of gas

00:40:08associated with it, why can't Permian productivity just fix the problem? Our base case model already accounts for the seven-plus billion cubic feet today of pipelines that are already being built or developed and coming on between 26 and 2030. If there were a new gas pipeline coming on between now and 2030, we would know about it, because of the regulatory processes and the time it takes to build these pipes. So we've mitigated the risk of being surprised by the Permian by moving into the midstream to understand the bottleneck constraints - beyond the deliverability of the resource or the gas in the ground itself, how much can actually get to market and either leave via LNG export terminals or be consumed in

00:40:54Texas or nearby - we've already included that in our base case model. So one of the pushbacks is there's plenty of gas in the Permian. But I'd posit, and this may be controversial, there was plenty of oil in the world before the Iran conflict surfaced - eventually there will be oil aplenty again, that's why it was $55 a barrel before the Iran conflict. In order to make more Permian natural gas, you also have to be incentivized to make more Permian oil, and those incentives didn't exist until Iran. To produce a lot more Permian gas than even these seven-plus BCF of pipelines being built that we're already modeling, you'd need much, much higher oil for longer, which only exacerbates the consumer crisis we're concerned about.

00:41:40So we don't think the Permian solves the problem. The other pushback is, well, you can locate a bunch of behind-the-meter local Permian power generation, which is happening, but we are modeling what has been announced and proposed, and if it's going to consume local Permian gas, that means it's not going to make it into the pipeline downstream - we can accommodate that in our model. In any case, we always try to think about technologies that could disrupt or structurally change the need and consumption of natural gas, and that often leads us to focus on battery technologies. There's sodium and other battery technologies that are currently not commercial, but

00:42:19in development, and people are getting a bit more enthusiastic about. The vast majority of economic battery deployment today is lithium-ion, which has a fairly fast discharge cycle - those are being deployed in earnest across the system, and yes, we are also modeling known battery deployments as part of modeling this generating system across all fuel types. A step-function battery technology change could be something that would affect this,

00:42:43but it would affect some of the pieces I described - winners and losers - in meaningful ways. It would be a watershed moment that I would welcome, because it would solve a problem we're pretty concerned about. Your finance team isn't losing money on big mistakes, it's leaking through a thousand tiny decisions nobody's watching. Ramp puts guardrails on spending before it happens - real-time limits, automatic rules, zero firefighting.

00:43:07Try it at ramp.com/invest. As your business grows, Vanta scales with you, automating compliance and giving you a single source of truth for security and risk. Learn more at Vanta.com/invest. The best AI and software companies, from OpenAI to Cursor to Perplexity, use WorkOS to become enterprise-ready overnight, not in months. Visit WorkOS.com to skip the unglamorous infrastructure work and focus on your product. Ridgeline offers one unified platform that automates away the complexity across portfolio accounting,

00:43:38reconciliation, reporting, trading, compliance, and more, all at scale. Schedule a demo at ridgeline.ai. Every investment firm is unique, and generic AI doesn't understand your process - Rogo does. It's an AI platform built specifically for Wall Street, connected to your data, understanding your process, and producing real outputs. Check them out at rogo.ai/invest. If you were czar for a day, and you got to decide everything that gets started,

00:44:04to solve this problem, what are all the things you would do to most solve and mitigate this? If I were the U.S. government, I would find a way to build entirely, from beginning to end, two to four AP-1000 nuclear reactors. That would de-risk the supply chain, it would invite in and really open doors to folks who want to see somebody do it first before they do it, with the hopes that we get more people trying to build 30 of them.

00:44:37Currently there are 10 to 20 envisioned by the U.S. government through different groups in terms of nuclear reactors coming on, but no one wants to be first. I think we're close to a few stepping forward, but if the U.S. just said, hey, we have $260 billion to spend at the Loan Program Office, the LPO, $260 billion I think to spend by the end of 28, we need to build four nukes with this - that would de-risk this materially, and I think you'd see a jumpstart of the nuclear equation. Energy and resource availability, egress, and knowledge, we think, are the biggest bottlenecks to

00:45:14productivity and deploying all this incredible technology America has really led in developing. When we set up our firm and started building a team, things were happening pretty quickly in AI, especially with regard to power. We didn't set out to understand the now - it's important to understand the now, but we set out to understand where the puck is going, and where it's going looks like it will meaningfully diminish growth if not dealt with. That's why it brings me to the nuclear solution as maybe the most viable long term.

00:45:46My comments on solar are probably the most important thing I would do. I think everybody should get a solar system on their houses - it won't be perfect, it will deliver electricity when there's sun out, it may not deliver electricity when it's cloudy, but it's a way to protect yourself from very high peak power prices from 10 a.m. until 6 p.m., which are the biggest part of your bill. I would incentivize people to study their state's rules

00:46:09and try to put incentives in place to really start to grow residential solar faster than what's been a kind of stagnating industry over the last year after some incentives were removed. That would be one place to reinvigorate solar incentives, because they're going to be needed in a few years. Can we build a giant pipeline from Canada or something, try to tap our neighbors to help us solve this problem?

00:46:31Canada is an interesting partner of ours. They have the capability of delivering about 11 or 12 BCF, usually in January, periodically, and there are meaningful pipelines from Canada to the U.S., but largely it's seasonal and helps us solve winter - otherwise we're net importers most of the year, but we're not really set up to take from Canada year-round. There are a few reasons for that - one is Canada has limited storage, about a quarter of the U.S. storage capacity.

00:46:58If I think about this on a three-to-five-year-plus basis, Canada by far has the deepest and richest resource of economic gas in the ground, but it's been trapped behind pipe. I would build a one-to-two BCF a day pipe, at least, into the U.S. Midwest, the MISO power market, and then wheel it around MISO, PJM, SPP, or ERCOT, and try to satisfy this demand, because I really don't want to see demand slow, I really don't want to see consumers' bills go up. What are the implications of this for the rest of the world? The U.S. has become the leading provider of natural gas, with our exports going from virtually zero to starting in the teens and now we're at 15 BCF a day, headed to 35. Many countries in the world are building gas-generating

00:47:46assets that are dependent on our delivery of that gas to them. There are lots of political and conflict-related tensions or bottlenecks - Russia-Ukraine, for instance, Russia used to be one of the biggest deliverers of gas to Europe, and we filled the gap. To the extent we cannot deliver our 30-to-35-plus BCF a day of gas to the global consumer, rebalancing will be required - you probably impact Europe meaningfully, and they're left with a trade-off of taking Russian gas or much higher-cost U.S. gas, because they can't produce enough domestically to satisfy their need. Asia is a large consumer - the largest consumer, until Russia-Ukraine, of U.S. natural gas - and they will probably be, at some point, the largest

00:48:34consumer again, given some of the outages in the Middle East. We potentially hurt important allies at a time when we really want them to be allies, if we can't send them the gas they need. So it's pretty important that we don't curtail LNG, although that will certainly be one of the levers we're forced to think about as we go out to the late decade to deal with rising electricity prices in the country. Anything that we haven't talked about that has surprised you in this year-and-a-half-long analysis of trying to understand the state of things and where we're going - obviously we've covered the big conclusion, which is scary and hard to deal with even if we start acting now - anything else that surprised you, either in your work or in people's reaction to it as you've started to share it? Really, for the last two or three years, the phenomenon where CEOs and CFOs of companies, all of whom have worked -

00:49:29have really been asked by their investors, or their products lend themselves well to deploying products to capture AI compute rent - what CEOs have said versus what is possible from the system, I think, is an interesting study that will play out over time. The amount of capital made available to companies to make investments that are really short-sighted in the context of our work, like the incremental distributed natural gas gen set - it's an inefficient, high-heat-rate, high-cost, inefficient asset that really should only serve as backup generation in any context outside of this fast-time-to-power setting,

00:50:13where AI compute needs the power now. Over four or five years, those assets may not even run. So you've had tens of billions flow into these distributed power assets, all of which are short and will consume natural gas. We really haven't seen anybody, including firms we really respect, question at any point whether there will be enough gas and what the cost will be when the time comes. It's been surprising that enough folks haven't put pen to paper to start contracting gas to make sure they have supply certainty.

00:50:52We haven't seen more financial contracting - 28 is somewhat illiquid. This is why we really haven't seen the forward curve move, and we think that's where the action starts. As soon as utilities turn the page and start to really hedge or buy gas in 28, and we start to see all these natural gas generating companies start to think about securing supply -

00:51:12you're going to start to see a knife fight to secure physical natural gas in 28, like we really haven't seen before. And it's been surprising we haven't really seen any of this yet, because 28-29 the physical market tightens materially, depending on where you are, and the amount of money that's gone into unproven, untested projects, and the amount of capital being raised for things

00:51:35that really may not happen until 2035, maybe, has been surprising, especially as it relates to - you've got Expand trading at four times EBITDA, low-to-mid-teens free cash yield, on a gas forward curve that is complacent about all of the objective things we already know are likely to get plugged in. People are not really willing to look past summer heat or a slight outage in an LNG facility right now, but in six months, as these companies roll forward to look at 28, you can start to see the forward curve really move up materially.

00:52:12And investors are not willing to look past a near-term, appropriately-supplied gas market, but they're willing to pay for something in 2035 that is totally untested or unproven. It's been surprising, the assumptions and the inconsistency across sectors and industries we follow. So maybe in closing, what would be the healthy challenge to pose to anyone out there whose business has, directly or indirectly, energy prices as an input? How would you encourage those CEOs, what questions should they ask of themselves or their business? Make sure that when your assets are deployed, you understand exactly what the source of your natural gas will be.

00:52:54Make sure you have physical supply locked up, and that you understand your counterparties and what will likely be very meaningful counterparty risk in two or three years. Counterparty risk isn't something we've really talked about during the last couple of years in the AI boom, but when it comes to parties being long and short something that is moving a lot - imagine being short memory a year or 18 months ago and finding out all of a sudden you're short memory. That is what this natural gas market looks like to us, not two years out, but six-plus months out. Making sure you understand the physical provisioning of gas for your assets is important for the hyperscalers and for the buyers of simple-cycle and CCGT large-scale plants, but especially for fuel cells -

00:53:41we are very cynical about whether you can deploy fuel cells at scale, because there isn't the gas in the system to power those 24-7-365. So we treat them in our base case, as I described, as backup generation. To the extent you were to deploy fuel cells as baseload generation, that only pulls forward and is additive to the convexity I described. CEOs and partners on projects - whether you are the E&C company trading at 25 times cash flow, which is a historically high multiple for an engineering and construction firm, and your main business is building natural gas plants, and we may not be able to build or deploy more gas plants at a certain point in 2029, 2030, because gas is much more expensive and you may have regulators asking questions - the focus for you should be on how you do creative M&A to backfill

00:54:41and diversify your business so you're not entirely beholden to natural gas generating asset build. For hyperscalers, I know memory has been a pain point - natural gas could be 20, 30, or 40% of their cost of doing business, at a time when they're supposed to be reaching escape velocity with profitability. Performance-per-watt is probably a compute metric we're going to care more and more about. I'd say the questions or challenges for each industry of companies are a little different, but it's all focused on making sure you're managing risk and understand exactly, when your plans play out, how it can go wrong - which in this case means, what if gas

00:55:21is not $3.50, but $10 or more? What happens if physical gas is questioned? What happens when consumers, and therefore regulators, start to ask questions? Matt, I love talking about the energy system with you. This was an especially fun one, on the back of so much of your work - so fascinating and interesting. I hope, as the U.S. has been very good at doing historically, that lots of people listen and start to imagine solutions, and also create the right amount of urgency to get those solutions in place, and that we emerge from this more resilient, more capable, more efficient - all these things.

00:55:56Thanks so much for your time. If you enjoyed this episode, visit colossus.com. You'll find every episode of this podcast complete with hand-edited transcripts. You can also subscribe to Colossus, our quarterly print, digital, and private audio publication featuring in-depth profiles of the founders, investors, and companies we admire most. Learn more at colossus.com/subscribe. You know how small advantages compound over time - that's true in investing, and just as true in how you run your company. Your spending system is your capital allocation strategy. Ramp makes it smarter by default - better data, better decisions,

00:56:48better economics over time. See how at ramp.com. As your business grows, Vanta scales with you, automating compliance and giving you a single source of truth for security and risk. Learn more at Vanta.com/invest. The best AI and software companies, from OpenAI to Cursor to Perplexity, use WorkOS to become enterprise-ready overnight, not in months. Visit WorkOS.com to skip the unglamorous infrastructure work and focus on your product. Ridgeline is redefining asset management technology as a true partner, not just a software

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00:57:36and producing real outputs. Check them out at rogo.ai/invest.