“The captive's real raw material is the parent's credit rating” - Grant's Interest Rate Observer

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Editor’s Note: last week, I stared at a rabbit hole. This weekend, I hopped down it. Over the course of this past week, there was a fair amount of discussion about Nvidia’s credit insurance & captive finance businesses. This was an itch I had to scratch - as banker, I covered GE Capital & GM Financial. I wrapped-up my thoughts below -

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CAPTIVE FINANCE.

Last quarter, Nvidia reported operating income of $53.5BN & other income of $15.9BN.

Almost 25% every pre-tax dollar came from marking-up their portfolio of investments.

Without selling anything -

That’s a large - volatile - non-operating component sourced from the same end-market as the operating one.

This isn't a criticism.

It's a classification problem, and classification problems are where most analytical errors begin.

Ask which reference class a situation belongs to, before asking what will happen inside it. The base rates for a chip company and for a financial guarantor are not remotely the same.

A semis analyst asks about ASPs, mix, the next architecture, etc.

A guarantor asks about attachment points, correlation, collateral triggers, and what happens to the asset side when the liability side is called.

What’s unusual & worth calling out about Nvidia is that it’s two things (and not simply flagging it as the Central Bank of AI):

1. A monoline financial guarantor, selling its credit rating - writing protection on third-party obligations, earning a fee, living or dying on whether the book is diversified. Nvidia's capacity backstops, revenue floors and lease guarantees are functionally this, with the premium taken in kind rather than in cash

2. A captive finance company, existing to move product by financing the buyer. Historically, analogs included GMAC, GE Capital, and IBM Credit. Nvidia's equity book and its role as originator for the recently announced platforms are functionally this - delivered as equity & guarantees rather than loans, so it never appears as a receivable

Traditionally, a monoline's risk is concentration. A captive's risk is funding.

And both have credit exposure.

Nvidia has taken on a monoline's concentration profile while avoiding a captive's funding profile, and almost everything below follows from that split:

Source: Nvidia Form 10-Q, 26 Apr ‘26; counterparty 8-Ks & press reporting. %s derived against $195.5BN of shareholders’ equity. [Note, I’m skeptical of the OpenAI / Ohio bit] -

The signed, capped contingent book is $16.2BN, or 8.3% of book equity.

The tail everyone is actually worried about is twenty times larger and consists of:

• One set of talks; and,

• One set of MOUs…

…nothing material is committed -

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THE EQUITY BOOK.

Instead of traditional debt financing that captives typically focus on, Nvidia has leaned into direct equity investing in its customers. [for what it’s worth, GE Capital did do this - at a smaller scale - for many years ago, without major issues].

And performance is great.

This book has never seen a down cycle: $5.3BN of unrealized gains against $199MM of cumulative losses and impairments.

The cause for pause is the growth of the book:

• Nvidia invested $17.5BN in private companies & infrastructure funds across the whole last year

• In the first quarter of fiscal 2027 alone it purchased $18.6BN - against $649MM in the same quarter a year earlier

One quarter exceed last year’s total.

And then there’s OpenAI…

…which most commentary read backwards.

In Sept ‘25, Nvidia announced an LOI to invest “up to $100BN in OpenAI progressively as each gigawatt is deployed.”

• By December, the CFO confirmed no definitive agreement existed

  • The commitment was excluded from data center bookings guidance; by January reporting had negotiations on ice

• In Feb ‘26 it was replaced with a $30BN direct equity stake, closing at an $852BN post-money valuation

Read as a retreat, that’s a 70% reduction in exposure.

Read as risk, it’s closer to the opposite.

The LOI was economically a strip of deployment-contingent call options.

• Nvidia would fund only as gigawatts came online

  • If OpenAI deteriorated, Nvidia could simply stop

• The optionality sat with Nvidia and cost nothing to hold. The replacement is unconditional equity at a fixed valuation

Nvidia gave up the option and took the position.

The notional fell 70%; the delta went to one -

CREDIT INSURANCE COMP.

On correlation, the analogy holds exactly.

In a world where AI compute demand decelerates, the equity book falls, the capacity backstops trigger, the lease guarantees trigger, the residual support triggers, the receivables deteriorate, the supply commitments become excess inventory, and core product revenue falls.

That’s textbook wrong-way risk: the protection pays out precisely in the states where the protection seller’s own value is impaired.

AIG FP & the monolines that failed in ‘08 ran net par outstanding at roughly 100-150x claims-paying resources.

That leverage was the business model.

Nvidia’s contracted contingent notional is 0.1x book equity , and only ~2.0x including the entire unsigned tail.

A sustained 50%-utilisation stress across the signed book costs roughly $13-16BN over six-year windows on a gross cash view: 2-3 weeks of quarterly revenue, before crediting the ~105k GPUs of capacity Nvidia takes delivery of and can use internally, and before the $10BN+ of hardware margin already booked selling those fleets.

The question of capitalization is answered - it’s a non-issue -

THE COMPUTE FACTOR RISK.

On its captive programs (investments & OTC credit derivatives), Nvidia’s risk is really on the residual value of its GPUs.

And that is a derivative of the compute forward curve (demand).

It goes without saying that the current zeitgeist is that we are in a compute shortage - and that demand could not be stronger.

Data supports the narrative:

• Coreweave recently signed a contract to rent out (six-year old) Nvidia A100 GPUs into ‘29

• Nebius’s earnings call included auctioning their services

• CCIR’s research (excellent) shows consistently strong demand

Both for Nvidia’s captive programs & anything beyond Nvidia (GPU-related), the answer to all of this is building a compute factor / beta.

For Nvidia’s exposures, it reasonably straight-forward (as I showed last week via SharonAI example).

The further you get away from those direct relationships, the more likely it will be a regression against historical compute prices / forward curve movements -

THE AI CAPTIVE.

Nvidia is not the Central Bank of AI.

Nvidia is currently the bridge to accelerating the AI buildout.

To Jensen’s credit, he’s figured out how to:

1. Accomplish being the bridge,

2. While making money,

3. In a (financially-speaking) regulatory-light manner

But he can only bridge so-far; that’s what this week’s announcement was about.

Step 1 was finding the capital - check.

Step 2 is finding or bridging the credit insurance (on residual values).

There is a market precedent outside of Nvidia.

Earlier this year, USD.AI partnered with Barker, who underwrote the residual risk, with it being reinsured by Munich Re.

The next step for Nvidia either looks like that at scale, or continuing to onboard that risk & building the world’s largest Captive Finance business -

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OTHER NEWS.

• Malaysia is booming (you guessed it)

• Peter Thiel buys into Argentine Shale

• Oracle data center has a pipeline delay

• Geopolitics move sideways

• Europe heads into winter with 17yr-low gas inventories

Hope y’all had a good weekend -

“It is hard for us … to even see a scenario … that would see us losing one dollar in any of those transactions” - Joseph Cassano, president of AIG FP, August 2007.

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AI FINANCIAL PRODUCTS.

The failure & bankruptcy of Lehman Brothers kicked off the financial crisis.

The next day, AIG (specifically, the subsidiary AIG Financial Products) almost took down the global financial system, with the last-minute US government bailout preventing the a total system collapse.

That AIG (an insurance company) was so exposed to Lehman Brothers - to the extent that AIG was going to be forced to file for bankruptcy the following day - caught the world by surprise.

Absent that bailout, a bigger surprise would have followed - a cascade of American bank failures, rolling into global bank failures (again, absent many more bailouts).

The culprit - AIG Financial Products - focused principally on OTC derivatives.

Earlier this summer, SharonAI (a NeoCloud customer of Nvidia) disclosed enough of their contract terms with Nvidia to work out the contract economics (SemiAnalysis has a very good note on that topic, if you’re curious).

Putting the contract economics aside, the backstop provided by Nvidia is an OTC derivative - one of many.

In options language, this specific trade is short skew, short the left tail, collecting participation carry...

… aka the payoff signature of an insurance underwriter.

And that sounds like AIG FP.

This trade is exposed to wrong-way risk - the put pays out precisely in the scenario where:

• Nvidia’s core chip demand;

• Its equity; and,

• Its other backstops are all deteriorating, simultaneously.

Which, today, is … hard for us … to even see a scenario …

All that said - if I was Nvidia, I’d do the trade.

But I’d also press for the development of compute futures, and I’d do whatever I could to develop a robust third-party derivatives market.

The risk exposures from these transactions are both complex and - once a competitive derivatives market is developed - not strategic.

Technically, this Nvidia OTC derivative is a strip of physically-settled, volumetric put options on GPU rental revenue with declining strikes, premium received as fractional call participation at the same strikes - a vendor-written participating collar whose function is credit-wrapping merchant compute risk.

Also known as a mouthful…

…which the market hasn’t fully digested -

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OTHER NEWS.

• A Yen-tervention

• Warsh is a hard-read

• ConocoPhillips change of guard

Hope y’all had a good weekend -

“This isn't the last situation I will have to deal with this week” - John Tuld (Margin Call)

Editor’s Note: having tied the knot earlier this summer, I sympathise with Leopold Aschenbrenner’s last minute wedding challenges -

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MAJOR EARNINGS.

Exxon & Chevron reported a combined - incredible, but expected - Q2 earnings of $26.5BN, on higher realised upstream & downstream prices, as the war in the Middle East continues.

Despite Exxon being more exposed to the Middle East than some of its larger peers (Strait of Hormuz closure reduced production by ~750kboed), production ex-Middle East was strong.

Chevron had the better quarter of the two, with much strong than expected US downstream results, reflecting strong refining & chemicals volumes + margins, helped by export / policy tailwinds (Jones Act relief, etc.).

Ironically, the geopolitical tailwinds - driving these heighten levels of success - are shifting at home; in the weeks leading up to earnings, Trump ordered a DoJ probe into domestic energy price gauging, calling out Exxon & Chevron specifically.

While these politcal events are - and will continue to be - out of the control of management, it’s clear that levers within their control are being executed to perfection -

AWARENESS.

Leopold Aschenbrenner - professionally - had a rough week.

Putting this week aside, he had been on one of the best two-year runs in recent history.

It all kicked off on June 4th, 2024:

• Leopold publishes: SITUATIONAL AWARENESS: The Decade Ahead

• He goes on Dwarkesh - for 4.5 hours - outlining what is to come in AI

• He announces he is setting up a hedge fund to bet on it

What he wrote & said was compelling: >10MM people saw the Tweet, listened to the Pod, or read his document.

The initial result:

• As a 22yr-old, he was able to initially raise >$200MM for his fund

• His initial investors were up 10x from inception on June 30th ‘26

• His fund was up >400% in H1 ‘26

Along the way, Leopold discovered fund leverage…

…unfortunately, before he could develop a situational awareness of volatilty.

Last week, he navigated margin calls from his lenders with a block sale of much of his public portfolio to Citadel.

However, Leopold did manage to - in his own words - live to fight another day (and attend his wedding) -

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OTHER.

• IYKYK: very entertaining post, on many levels

• Love to see an Alpine High reference

Final thought on Aschenbrenner: I think he’ll continue to be ahead of AI-related catalysts / trends, and I think he’s very well liked by many Anthropic employees, who will likely invest in him once they have liquidity, which means that he has a chance to pull this off -

“Tell me what you pay attention to & I will tell you who you are” - José Ortega y Gasset

Editor’s note: weekly publishing going forward.

Last week, we published on Nebius (a NeoCloud), highlighting the lack of substance to Jim Chanos’s critiques of the NeoCloud buiness model; the share price has rebounded by 30%+.

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BEHIND THE METER.

Go-forward datacenter power demand is beyond grid capacity.

That’s not new news.

In 2025, ~10% of US datacenters had any onsite generation.

Regarding new datacenter projects, we expect that over half will prominently feature onsite generation.

Per Bank of America, ~160GW of planned onsite gas generation projects are in the works (by the way, BoA’s latest report is excellent & well worth the read).

Unsurprisingly, gas producing regions represent most of the projects. Texas alone is responsible for ~60GW of projects in various stages of development.

Ohio, Pennsylvania, & West Virginia combine represent another ~40GW.

Assuming half of the projects come to fruition at ~80GW of BTM gas, 440 TWh of implied BTM gas generation works out to roughly 10-11 Bcf/d of incremental demand, at simple-cycle heat rates if fully realized.

And, this demand forecast has been a hot conversation…

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DYNAMIC SYSTEMS.

Matt Smith has made a controversial return as a podcast guest to Invest Like the Best.

Among other ventures, Smith was previously the Founder / CIO of Deep Basin, a data driven energy equities hedge fund.

In his latest podcast appearance, Smith put forward a natural gas thesis which was a masterclass in precision applied to a static picture.

His forecast is granular, modeling every well, pipeline, and processing plant in the incumbent basins, and - in doing so - he has built a snapshot of the gas market as it exists at $3.50/mcf, extrapolating that snapshot into a world where prices supposedly go "unbounded".

The flaw: his demand side is dynamic, but his supply side is frozen.

The ever-clever X account NextWaveEFT succintly captured the analytical flaw & the major implication in his review of the interview:

“What I believe Matt [Smith] and many others miss is in 10 years, in a $4-5/mcf world, it’s likely we once again have 100 nat gas operators across the L48”

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OTHER NEWS.

• Brent hit $100 on continued Iran-related conflicts

• Lastest disconnects on datacenter discourse

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That’s it for this week - hope y’all enjoy the weekend -

“Compute is the new oil. Like every commodity before it, it needs a real derivatives market,” Tarek Mansour, CEO of Kalshi

Editor’s Note: This note was bumped up, given recent developments; a second primer
- on NeoClouds / GPU Datacenters - has been uploaded & will be freely available for a limited time.

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CRUDE.

First-thing-first → on oil.

Petroleum & LNG transport challenges are a boon for refining margins.

Just three commodity vessels passed the Strait of Hormuz yesterday, the fewest (daily) since May.

Simultaneously, the Ukrainian drone campaign against Russian shipping is growing - 12 ships were hit, including an LNG transporter & an oil tanker.

Unsurprisingly, the refining market has reacted:

As gas winter gas storage in Europe looks to be challenging, petroleum reserve stocks remain low, and crude/LNG transport disruptions trend in the wrong direction, the expectation should be that US Independents & Refiners have an excellent H2 ‘26 -

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COMPUTE.

Demand continues to outpace supply.

Specifically, for the latest Nvidia GPUs.

Therefore, compute rental prices are going up.

Given the uncertainty surrounding where demand lands, and the certainty of the debt capital required to build currently planned GPU datacenters, the development of a derivatives market for hedging is both natural & necessary.

In practice, similar to the US LNG export market, the hedging function has been absorbed by large, investment grade counterparties in the form of long-term contracts.

On that note, two days ago, Kalshi announced the launch of Compute Forward Curves.

Given the shear volume of project finance debt against the build-out of GPU datacenters (1.5% of US GDP in Q1) - with a highly volatile underlying asset - quickly building a mature derivatives markets is imperative to bridging the gap between the stable cash flows debt financing requires & the volatile spot price of GPUs -

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OTHER.

• Jim Chanos has been posting about NeoClouds; we’ve found it a bit strange, as there’s no shortage of data available to get to the bottom of the economics

  • Wrote a few thoughts on that topic, here

• As it relates to energy, creating a forecast for Frontier Lab demand & GPU supply are likely the leading indicators for marginal electricity & gas buyers over the next two years

  • And it’s never been easier to leverage LLMs - as a tool - to conduct that analysis -

“The energy sector is often viewed as one that should be traded - and isn’t investable - like other sectors” - Toby Loftin

Editor’s Note: I’ll be writing on this topic for a few weeks.

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THE ANALOGY.

It’s been a minute…

Since I last wrote, a new - multi-trillion-dollar - market has emerged at an unprecedented pace.

The token market is on a course to rival the US mortage and oil markets in size.

The most common analogy - and a poor one at that - has been to the Telecom Bubble (and Bust) of 2001.

All the while, the obvious parallels have been to the development of the oil market, at the inflection of the automobile.

As gasoline is to transportation, tokens are to intelligence.

Google is the only vertically integrated player → an Integrated Token Company (ITC), per se.

Amazon & Microsoft are increasingly concentrated in the Midstream Token market.

Meta (fka Facebook) has ambitions to play in the Midstream & Downstream Token markets, while SpaceX has quickly entered both - as a serious player - in a matter of months.

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PRIMERS.

I’ve strangely found myself, as a long term - nearly 10 year - shareholder of Amazon & Microsoft, having personal equity exposure to this generational inflection.

And I could not answer basic questions about “what this inflection means”…

Back in April, Thomas Kurian, the CEO of Google Cloud (not known for hyperbole) made the following statement about Token Demand:

“I think for the next 10 years there will always be more demand than supply.”

Is it tradable, or investible?

And where does that distinction lie, across the vertical?

Kurian’s statement & a combination of self-interest & curiosity were the catalysts for what follows.

I wrote two Primers on the Midstream and Downstream Token Markets, as well as a deep-dive on SpaceX (a firm that - on the AI/token side of things - is operating in both).

Today, I’m sharing the first - a primer on the Downstream Token market, titled Frontier Labs: The Economics of Intelligence Production.

• Later this month, I’ll share a primer on the Midstream Token Market

• And if you’d like, email/DM me for a copy of some work on SpaceX

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OTHER.

• I have money (rather boring) on France to win the World Cup

  • I would love to be talked out of this bet & into another

  • If you have a better World Cup bet, would love to see it

Matt

“This aggression will not stand, man” - The Dude

**If you enjoy this newsletter - do us a favor & forward it to your friends or colleagues**

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**Note: we will be writing sporadically, for the indefinite future; if the note is too “hot”, it will only go out via email (will not be available on the site); the aim, at this point, is for a monthly note**

MACRO.

Over the past few weeks, LNG cargos have been rerouted from South Asia to Europe, depriving the former markets of gas. Many crops in Ukraine - the breadbasket of Europe - will not be planted.

The real-world economic consequences of recent economic warfare has only just begun.

The race to fill up gas storage for next winter will result in political & economic turmoil. And when spring turns to summer, we’ll begin to see the fallout in agricultural markets.

While Russia is the target (and will be the biggest loser) in this unprecedented economic war, other economies will also suffer.

The lowest bidders (the poorest markets) will likely see orders unfilled.

And note that revolutions often follow lesser events of economic unrest.

In thinking about what may transpire, we’ve found ourselves thinking about the 2nd & 3rd order effects of what may come to pass.

The following interviews & research have either been predictive of recent events or - we believe - have the capacity to be predictive going forward (beyond 1st order effects) -

Research / Data / Commentary:

• The artist(s) known as @ViscosityRedux published a comprehensive analysis of the potential energy shortages resulting from recent sanctions

• Alex Turnbull on Sanctions Evading

Podcasts:

• An interview with Julia Friedlander - a former policy advisor for Europe in the U.S. Treasury Department’s Office of Terrorism and Financial Intelligence - on economic warfare & sanctions; previously, her role at the Treasury was executing sanctions

• In an interview from December, Russian-born Dmitri Alperovitch - the former CTO and co-founder of CrowdStrike, the world’s largest cybersecurity company - makes the call that Putin will invade Ukraine

• Last week, following the invasion, Dmitri Alperovitch returns to be interviewed on the topic of Russia & Ukraine - and his correct calling of the matter

We’ve thought a lot about a ~90sec tangent in an interview from 2018 with Fabrice Grinda (a former emerging markets tech entrepreneur & venture capitalist) on emerging market risk.

Roughly a decade ago, he the made the call that specific political choices would lead to negative economic outcomes for investments in many emerging market economies.

It has - unfortunately - been a great call -

OTHER NEWS.

• This event will cause prices to inflate, globally (and monetary policy won’t solve it)

• How a Nickel becomes a Dime

• Doomberg on the LME crisis

• A California VC Narrative Violation

• We warned a Russian friend of this possibility a couple weeks ago; if you have Russian friends, it may be worth reminding them that many countries in the Americas (especially the US & Canada) were built by people leaving bad situations in Europe

That’s it for now - hope y’all enjoy the rest of your week -

“Strikes and gutters, ups and downs” - The Dude

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"So the universe is not quite as you thought it was. You'd better rearrange your beliefs, then. Because you certainly can't rearrange the universe" - Isaac Asimov

**If you enjoy this newsletter - do us a favor, forward it to your friends or colleagues**

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Editor’s Note: Well, we’re back for the 3rd time in 2x weeks. We’re still not promising a regular schedule…

Following-up on Last Week's Note:

• The equities we highlighted w/ Russian exposure were down an avg of 12%

• Excluding IOC's, our list was off 17% on avg

• At the same time, the S&P was ~flat

Going forward, there's 2x major risks that - in our opinion - are not fully priced into the market:

• The partial removal of Russian & Ukrainian commodities (e.g. coal, oil, gas, wheat, metals) from global markets in 2022

• The impact on banks w/ exposure to these markets, and the cascade of counterparties that will have liquidity issues as a result of bank stresses

Expect wheat (and thereby corn & rice) prices to continue to rise - aside from price increases, this will cause geopolitical instability in emerging markets (e.g. the last time there was a spike in wheat prices, the Arab Spring happened).

And - unless the practice of “self-sanctioning” reverses - energy commodities should also continue their rise.

Regarding banks - there’s 2x concerns:

• Direct Russian exposure

• Exposure to Russia-linked collateral

The banks that we highlighted last week had relatively large businesses, physically in Russia.

The comparatively unknown issue of financings - with Russia-linked collateral - will play out by ~end of the month:

• Loans (like RCFs) that financed Russian collateral will face defaults or deficiencies, needing the be restructured or refinanced

• Both the banks & the borrowers will face stresses, causing counterparty issues to arise

• The worst case scenario for non-Russian firms is a full collapse of the Russian Central Bank / Banking System

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Other Notes & Thoughts:

• No one seems to be preparing for a Firebird Round 2…

• #OSINT is Twitter’s opensource intelligence community - we’ve added a few of its most active accounts to our Russia | Ukraine Twitter List; within that community, @Osinttechnical is noteworthy

• An alleged letter from an FSB whistleblower (Russian version; English translation here); take it with a grain of salt, misinformation from both sides is high

• Expect a mass-exodus of Chinese / Russian money from London & Switzerland to Singapore & Dubai (recent sanctions have spooked more people than were actually targeted by those sanctions)

• Will & Robert - our friends who were in Mariupol a few days back - made it out in one piece… by the skin of their teeth -

That’s it for today - catch y’all next time -

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“It is a matter of life and death. So the EU will provide weapons for Ukraine’s armed forces. It is the moment to stand up and to speak out” - Josep Borrell, High Representative of the EU for Foreign Affairs

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Editor’s Notes:

• We have friends w/ family in Kyiv & Lviv; there are a number of ways to support - an easy one is World Central Kitchen

• This piece - like the last one - is a one-off

We may not be back for a while -

SELF-SANCTIONING.

Russian exposures aside (above), there are reports of “self-sanctioning” in the crude & products trade.

While energy exports were excluded from sanctions, some of these commodities are traditionally financed via European bank trade finance desks.

That appears to be disrupted; unsurprisingly, Brent Crude is up 5% tonight.

That trade may run for a while -

BANK RUNS.

The ECB Says Sberbank Europe Is Failing or Likely to Fail. The inverse of this situation - European banks with Russian subsidiaries - will likely play out en masse in the next few hours, when Russian markets open.

RUSSIAN EXPOSURES.

France - Renault in particular - has disproportionately large Russian exposures.

Outside of France, Coca-Cola HBC (listed in London) - the Eastern European / Russia / CIS Coke bottler - faces material volatility going forward.

Non-traditional resources:

• A Twitter account following Russian air-force radio communications

• Flight tracking (unusual flight pattern changes have materialized ahead of official announcements)

• If you have not read The Prize, *read it now*

That’s it for tonight - hoping for a swift end to this chaos -

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“... in moments of crisis our thoughts do not run consecutively but rather sweep over us in waves of intuition and experience...” - John Le Carré

Russia - a few things of note:

• Two weeks ago, we were convinced this would happen

• Last week, we heard a good argument (from a George Friedman interview) on why Russia *would not* do what they just did (and subsequently had less conviction)

• Last night, we set up a Russia-focused Twitter List for the purposes of following coming events

The Friedman interview is still worth listening to, as it contains valid takes on expected Western responses to this event.

For those unfamiliar with George, he’s had - in the past - US / Russian / Asian / Euro Generals (among others) on payroll as sources; he probably (still) does today.

That said, we still think an invasion is imminent.

A final note re/Russia: for those who want photographic updates, Robert Cooper (this guy) - a friend from South Texas - is on assignment as cameraman for journalist Will Cathcart.

They’ll get unreasonably close to the action. Hopefully, not too close…

Re/ our overdue China work: we’ve amassed too much to publish in email form; TBD on how we will publish it, but it will not be coming imminently -

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Q: “What was the single biggest driver of the deal for XEC?”
A: “It makes us a better company”

@NextWaveEFT: ‘Nailed it’ (sarcasm)

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CHANGE OF CONTROL.

Merger arbitrage usually refers to an investment strategy - whereby - an investor simultaneously purchases the stock of merging companies, *exploiting* market *inefficiencies* before a merger.

In the absence of a reasonable explanation for the Cimarex | Cabot merger, investors & analysts are voicing that the tables have been turned.

The merger appears to trigger change of control clauses.

And management appears to be using *the merger to exploit an executive compensation inefficiency*:

“Ryan Lance at COP had notoriously massive change of control of like $120MM at one point. They changed it, but at a glance he would get 2-3x his comp of around $30MM. So (COG) Mr. Dinges $40MM is... modest?” - Paul Sankey

In support of this argument is a history of alleged misalignment of incentives at Cimarex:

Since 2014, there have been 160 insider transactions at Cimarex:

• 152/160 were sales

• Total sold: $85.2MM

• Total bought: $570K - @EnergyCynic

The great thing about public transactions is that the market’s vote is transparent.

*Both* COG & XEC traded down ~7%, on a day when almost all other E&Ps were up -

DEMAND.

• China’s oil demand has already reached pre-pandemic levels

• US mobility recovered to 16% below pre-pandemic levels

• Goldman sees oil hitting $80/bbl

Oil demand appears to be recovering faster than excess supply (Iran, etc.) is hitting the market.

We could go with more details, but - TBH - S&P put together an infographic that visualizes the story better than we can tell it.

Check out the infographic here -

OTHER NEWS.

• Japan & others push back on IEA report

• White House EO on climate

• Bids come in for Shell refinery

• Shell sells separate refinery to Pemex

• LP ESG #s

That’s it for this week - we’re betting on Chelsea & ManU - catch y’all next Tuesday -

“We are masters of the unsaid words, but slaves of those we let slip out” - Winston Churchill

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ECONOMIC SHOCKS.

The world appears to be dead-set on supply, demand, & supply-chain shocks:

• Covid-related trade disruption,

• *Hopeful* energy policy, &

• Helicopter money…

…are leading to:

• Port bottle-necks,

• Higher energy prices, &

• Labor shortages (Uber drivers now make > than some banking analysts)

Right now, the semiconductor shortage is the supply problem in the world.

The shortage is is hitting everywhere…

…from server-farms to *farming* itself:

“The worldwide shortage of computer chips will impact all aspects of agriculture for the next two years and beyond.  Almost every piece of farm equipment, like most everything else in our lives, needs a computer chips to operate.”

“Due in part to the Covid 19 Pandemic, there is a massive worldwide shortage of chips; and the industry is unable to meet the skyrocketing demand. Industry sources say the current shortage will not be resolved until sometime in 2022” - Gary Truitt

Assuming that gets solved, we expect that - in the long term - oil & oil products will take the pole position.

If governments even attempt to follow the IEA’s latest report guidelines, then the outcome would be something on the scale of the 1973 oil price shock (~300% price increases).

The press has even called out the absurdity of the report:

“Finally, the IEA has a credibility problem. The agency was saying the opposite (we need more investment in oil) as recently as 2017. So either it was completely wrong then, or perhaps it's now. But the old messages from the IEA, and the new ones are difficult to square” - Javier Blas, Bloomberg

Unfortunately, the world has been trending towards the absurd…

We’re reminded of the Hunter S. Thompson quote:

“When the going gets weird, the weird turn pro”

Today, there’s no shortage of policy “pros” doing weird things -

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OTHER NEWS.

Michael Burry (of The Big Short fame) is massively short Tesla…

…that trade has functionally stolen the name “widow-maker trade” from those lost souls who’ve bet against Japanese government bonds…

The event has our attention -

• On Montney well economics

• The German / Coal drama continues

• US lender recovery rates drop

• Dutch Nat Gas trading booms

• Gulfport is heading back to the NYSE

• On the SPR drawdown

• Ownership of US equities by age

That’s it for this week - we’re rooting for the Spurs & Golden State on Thursday night - catch y’all next Tuesday -

“Our goal is to make money, and not creating problems for society,” DarkSide [group that attacked Colonial, from the FT]

Editor’s Note: Matt is working w/ the Marshall Society on their digital speaker series.

Tomorrow, the Marshall Society is hosting a panel on the virus / recovery efforts.

Panelists:

• James Sweeney - Chief Economist / Americas CIO at Credit Suisse

• Dr. Claudia Sahm - Former Section Chief at the Federal Reserve

• Jeanna Smialek - Federal Reserve Reporter for the NYT

Y’all are welcome to join (panelists will be taking questions live) - the event kicks off at 6pm London time (1pm NYC / noon Texas) tomorrow.

Event link / details -

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COLONIAL CYBERATTACK.

On Friday, the Colonial Pipeline suffered a ransomware attack. The hacker-group DarkSide is allegedly behind the attack.

Colonial is responsible for delivering 40%+ of the American Southeast’s gasoline supply. Obviously, an outage of this sort can affect gasoline prices.

This event further raises cybersecurity concerns about American infrastructure.

But - putting that aside - the public response from the hackers stole the story…

…it read like a passage from absurdist fiction:

“We are apolitical, we do not participate in geopolitics, do not need to tie us with a defined government and look for other our motives.

“Our goal is to make money, and not creating problems for society.

“From today we introduce moderation and check each company that our partners want to encrypt to avoid social consequences in the future” - DarkSide

Joe Weisenthal (Bloomberg) had a few good takes on the ordeal.

The FT noted:

“In a sign of how ransomware has become a professionalised industry, DarkSide operates its own “press office” and claims to have an ethical approach to choosing its targets” - FT

What’s clear - from this attack (and, well, all recent major hacks) - is that hacking risk is a tail risk that the market (industry) is not appropriately valuing -

OLD WORLD ATTACKS.

Rocket-fire has followed a conflict at Jerusalem’s al-Aqsa mosque.

Israeli police & Muslim protesters clashed over planned home evictions & restrictions at the mosque.

Hundreds of Palestinians were wounded - Hamas responded by firing ~200 rockets.

Israel then responded to Hamas:

“The Israel Defense Force’s spokesman Jonathan Conricus said the military had a ‘green light’ to hit military targets until Hamas ‘gets the message and learns its lesson’” - the FT

Politics aside, history would tell us that Hamas has not quickly gotten “the message”.

We expect to see that Israel will continue to respond with (more) air-strikes.

And - as of today - we don’t expect these events to escalate into a larger conflict -

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OTHER NEWS.

OPEC+ restraint appears to to be faltering…

• Iron ore prices hit records on Monday

• The biggest jobs (data) miss on record

• Check out pg2 of JPM’s annual energy report

That’s it for this week - check out the panel tomorrow - catch y’all next Tuesday -

"It's important not to overreact to this volatility in prices resulting from the unique circumstances of the pandemic" - John Williams [NY Fed President]

Editor’s note: A few weeks ago, we were alerted to the fact that the spot price of bee-tee-cee traded below the CME futures contracts. On the surface, that’s free money.

We’re guessing a few of you were also aware - here’s the best thread we’ve seen on the trade (and its risks).

OK - back to oil -

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Q1.

Diamondback reported Q1 adjusted EPS & EBITDA of $2.30 & $836MM, beating consensus estimates of $1.83 & $740MM.

M&A was the story.

• This is the 1st quarter post the QEP / Guidon acquisitions

• Diamondback also announced two divestures

Oasis (emerged from Ch.11 in Nov) is buying Diamondback’s Williston Basin assets for ~$745MM, financed entirely by debt (via their RBL & a bridge).

Considering recent history, that’s aggressive.

Diamondback also sold a small chunk of non-core Permian assets for $87MM.

Hedging hurt a bit, and will continue to - throughout 2021 - at these oil price levels.

[re/ FANG: we liked the presentation of the tables (above) from BAML]

From the other side of the world, Aramco reported Q1 net income of $21.7BN (also beating consensus estimates).

When you produce numbers like *that*, you get to skip the analyst Q&A call.

And Aramco is doing just that.

Later today, Conoco, CDEV, PVAC, Pioneer, & Devon report, among others -

OTHER NEWS.

Mohamed El-Erian has recently made a few good points about the Fed, bank policy distortions, & global supply chain issues. We think the latter faces structural / policy concerns going forward, even if (or when) short-term issues are addressed.

And we don’t think that’s a good thing.

• Did Munger slip the Berkshire successor?

• Pickering enters EVs (listen on Clubhouse, on Wed)

• A great thread on L/S

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That’s it for this week - hope y’all enjoy Cinco de Mayo w/ a couple Mexican Martinis - catch y’all next week -

“Occasionally people will look at me and do a doubletake and they'll look at me like they're trying to think where they know me from” - Nick Hoult

Editor’s note:  Day late -

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PVAC.

We did a doubletake on PVAC…

Penn Virginia’s wells, and our December look at Magnolia - another oily Eagle Ford E&P - caught our eyes.

PVAC is an Eagle Ford E&P company headquartered in Houston:

• The company focuses on Lavaca & Gonzales Counties

• Juniper Capital now owns ~60% of PVAC

From PVAC’s most recent operational update:

• 16,324 bbl/d

• 20,534 boe/d

• 80% oil cut

• $364MM net debt (the equity is trading at a ~$500MM valuation)

PVAC’s latest reserve report lists 500 future locations:

• They own ~91,000 net acres in the EFS

We built out type curve parameters (using ’19 & ’20 vintage wells) with ShaleProfile‘s state-level data.

A $52.5 WTI break-even is pretty good, in our minds.

On a multiples basis, PVAC looked good, too.

On top of that, their well efficiencies have been improving 15% per year over the last 3yrs (on both a total EUR basis & per 1000ft drilled), which is pretty rare.

So, the plan was to write up another (surprisingly boring) story about an E&P just drilling good wells…

…and then we looked at the capital structure…

And we found senior debt, junior debt, preferred shares, dividend restrictions, and a HoldCo / SubCo structure w/ one shareholder controlling 59%…

OK, not so boring.

At this point, we decided to throw the quick-and-dirty analysis out the window and focus on the assets.

So we ran a production forecast & built out the model.

We sensitized what we found:

• For this analysis, we ran a prod forecast using 3rd party data, covering 500 operated PDP wells owned by PVAC

• The above results represent NAV sensitivities (PDPs + PUDs - $ in MM) of PVAC’s wells

• Inventory is drilled over 8 years

• Our 2021 Oil Production is 18,209k/bbl

Two major take-aways:

• At the current strip, PVAC seems to be overvalued

• PVAC is more sensitive to the price of oil than drilling inventory depth

A 25% increase in WTI - from $60 to $75 - translates to a ~100% increase in value:

• A good way to value an E&P like PVAC is to apply probabilities to the above table, and take the sum (of the each scenario multiplied by the assigned probability)

• Doing so would likely result in a higher valuation than a point-estimate using today’s strip which is in steep backwardation

We expected to see this sensitivity to the price of oil with PVAC.

We did not expect the valuation - at today’s strip - to be so low.

[to be fair, we think Juniper did very well w/ their November investment]

The whiplash from looking at this E&P felt all-too familiar.

US E&Ps are never as simple as they look from the surface (or the screen) -

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OTHER NEWS.

• Doug Lawler is abruptly retiring

• Another Guyana discovery for Hess & Co

• On tax policy - an argument made twice in one week

That’s it for this week - the Ohtani dream has come to life - catch y’all next week -

“…from ESG - tweeting that it is ‘the paper straw of investing’ because it’s ‘symbolic, not substantive’ - to SPACs: ‘There’s so much dog sh*t there,’” - from Michelle Celarier’s profile (in II) of Carson Block / Muddy Waters

Editor’s Notes:

• Last week, we were trigger-happy - the newsletter fired while in-edit…

• Next week - ahead of earnings - we plan to profile a US E&P

• For now, we’ll just say: we like the stock

  ---

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OIL.

A number of variables in the Oil supply / demand equation are in play.

We’ll start with the good:

• The US is recovering faster than expected

• China is recovering faster than expected

• *Excessive* global stimulus

The (potentially) bad:

• An Indian virus variant is of new concern

• Lockdowns have “resumed” in Germany / France

• The Iran-China deal

And, the hard-to-forecast:

• Libya’s NOC declares force majeure

• OPEC(+): meetings re/ Iranian production (& China deal), Russia’s compliance / willingness, &

So far, these variables have netted out to - in the short-term - higher crude prices.

Our take - if the US / China recoveries surprise (further) to the upside, then expect crude prices to continue rise -

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OTHER NEWS.

India is expected to follow China, building new coal plants. As pointed out by Javier Blas, China is now expected to hit a *new* peak in coal consumption this year…

• This time last year, WTI went negative

• A series of interviews worth watching

• The (retired) king of gas stirs the pot

• Gas price earnings surprises may be coming

If you have a few minutes to spare, the II profile of Carson Block is worth the read.

That’s it for this week - for anyone following the European Super League news, we’ll note that it reminds us of the origins of the EuroLeague basketball system - if you’re struggling to grok what European football (soccer) may look like going forward, then check out the EuroLeague (basketball) license format - that’s our best guess as to what may come - catch y’all next week -

“I always thought of economics as a quantitative field and when I hear people talk about why this is the right thing to do, they say things like ‘we really need to go big’, or ‘the ‘09 stimulus was too small’” - Larry Summers

**Editor’s note: we fat-fingered the send button during editing this AM; this one may be rough around the edges**

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IATROGENIC VOLATILITY.

“Iatrogenic illness is when you go into a hospital and you catch an infection there. Iatrogenic volatility is when policymakers, whose role is to stabilise markets, destabilise them with their actions. I think there is a risk of that taking place” - Larry Summers

As part of the FT’s Economists Exchange series, Martin Wolf interviewed Larry Summers (yesterday).

Summers shocked us - he pulled no punches:

“Today’s situation is a bit like the 1960s. It was then hoped that the laws of economic arithmetic could be suspended and that it would all work out. That experiment didn’t work out well for Lyndon Johnson, economically, and it didn’t work out well for the Democratic party” - Summers

Before continuing - we recommend reading the entirety of Martin Wolf’s interview.

OK - back to what Summers said.

It’s not that his words were especially profound.

It’s that they were as directly critical as could be, while remaining - to an extent - polite.

Still, Summers intentionally broke party ranks.

For almost 5yrs, financial speculators have been calling for “financial / asset bubbles” to pop.

Many will read into this interview, seeing another harbinger of such an event.

As we read (and reread) this interview, thoughts of cyclical political-economic concerns surfaced:

• Unproductive government spending

• An increasing welfare state

• Inflation

At a time when the world is now economically competitive w/ the US, can the US (or an economy), really afford this kind of structural slippage?

Hopefully, it doesn’t come to that & the dissent is heeded -

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OTHER NEWS.

BaFin (the German equivalent of the SEC) is facing a criminal probe over its handling of the Wirecard fiasco. It’s refreshing to see prosecutors take allegations of regulatory abuse seriously.

• On inflation & the base effect

• Another excellent Paul Graham essay

• US SPACs raise more than US PE in Q1

• On regional US Base Declines

• Diamondback’s revised guidance

• A little drama for Argentina's Vaca Muerta

• Russia is going for 25% of the hydrogen trade

• Total | Uganda | Kenya (finally) sign key agreements for the Lake Albert project

That’s it for this week - tonight, PSG plays Bayern in the Champions League (this one is too close for us to bet) - catch y’all next week -

“You don’t want to do an extension or fringe, you have to be in the areas with truly low break-evens” - Cody Campbell (DoubleEagle | DoublePoint)

Editor’s Note: **If you enjoy this newsletter - do us a favor, forward it to a colleague** -

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Transaction Notes:

• Pioneer | DoublePoint Presentation

• Pioneer PR | Double Eagle PR 

• @WAR527 commentary

• 8K | Purchase Agreement

A $6.4BN PARLAY.

The long Easter weekend provided cover for one of the larger recent Permian deals - the Pioneer acquisition of DoublePoint.

DoublePoint will receive:

• ~11% of Pioneer’s equity

• $1BN in cash

Pioneer will receive:

• ~100,000 boepd (at close)

• ~1,200 core locations

Relative to recent Permian transactions, the deal looks expensive.

However, those transactions were executed at a lower strip; with higher prices, we could understand a valuation that’s ~double.

That said, this deal was expensive, even on that basis:

HUSTLE & GAMBLE.

There’s a couple noteworthy pieces to this story.

The Campbell & Sellers / DoubleEagle acreage acquisition machine has been incredibly effective at scale (in ‘17, they sold ~71k acres to Parsley for $2.8BN).

It appears that the duo’s operation has been better - at acquiring top Midland basin acreage - than anyone else.

This time around, they had to do more (drilling) to prove out the acreage.

In 2020 of all years…

Scaling production in ‘20 was a gamble that - in the simplest terms - bet on oil prices mean-reverting.

DoublePoint increased rig-count at a time when almost all of their competitors cut rig-counts by half or more.

Doing so, DP committed to drilling wells at a negative NPV.

That’s a leveraged bet on WTI - like buying out-of-the-money calls on oil futures.

On top of that bet, the wells had to work.

And they did:

And - somehow - DoublePoint financed this bet with debt.

They drew-down on commitments to drill these wells, and then they re-fi’d those commitments with a private placement.

• An acreage bet

• A drilling bet

• And a financing bet

All three paid out - for a $6.4BN parlay -

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OTHER NEWS.

• On Iran oil exports

• India’s energy minister on net-zero targets

• An interesting take on Netflix & Europe

• Even the sell-side thinks the PXD/DP deal is expensive

That’s it for this week - congrats to Baylor - catch y’all next Tuesday -

“The only reason oil is higher is because Saudi has defended the price by cutting production. Demand hasn't come back. So the thesis we're putting on the table is if demand does recover as most people are expecting in a post-COVID world” - Doug Leggate, BAML

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BILL HWANG.

There are two new verb phrases on Wall Street:

• “Going-Bill-Hwang”: taking a large, concentrated leverage position

• “Getting Hwang’d”: a lender - unwinding a margin call - that takes a large loss

Bill Hwang’s family office (started with $200MM in capital, 8yrs ago) took >10% of Credit Suisse & Nomura’s market caps.

[Tbh, that’s an achievement]

For years, Bill Hwang apparently ran leveraged positions in Chinese large-cap tech equities.

That was an all-time-great trade.

And leveraging up a great - multi-year - trade is how you turn $200MM into ~$15BN.

But Bill, like many US Oilmen, found himself with a case of Winner’s Tilt.

He was caught long TMT names - with 4x+ leverage - as they crashed, while short the S&P500 (which is somehow up YTD).

And the following margin-call wiped out the run-of-the-decade, as well as a few bank risk managers in the process -

CREDIT.

OK - here’s where things don’t make sense.

[Bill Hwang’s trade fired up a few thought]

• The 10yr is up ~80bps YTD

• High growth tech stocks (EM Cloud Index) are down YTD

• S&P500 is up YTD

Rising rates should imply that the terminal value component of a DCF declines…

…and yet, the S&P isn’t budging.

[At least credit markets are still being rational]

US IG Corp Credit registered the 2nd largest quarterly loss on record, at -4.4%.

Which is *to be expected* when the 10yr rises.

The credit markets are convinced that interest rates will rise.

And equity markets are convinced that they won’t -

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OTHER NEWS.

• When oil workers are under siege (Moz)

• Suez Canal reopens

• Saudi wants to extend cuts

• Indonesia refinery fire

• The artist fka-Encana sells EF assets

• An Equinor discovery

• New global solar PV installations to increase 27%

• Total / Iraq talk $7BN infrastructure deal

That’s it for this week - catch y’all next Tuesday -

“The financial services industry is duping the American public with pro-environment, sustainable investing practices” - Tariq Fancy [former BlackRock CIO of sustainable investing]

Editor’s Note: we’re back, after a work-necessitated break. Thanks for waiting.

**If you enjoy this newsletter - do us a favor, send it to a friend or colleague** -

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GREENWASHING GAS.

Last week, Blackrock’s former head of “Sustainable Investing” - Tariq Fancy - eviscerated the “E” & the “S” in ESG.

***On National TV***

His arguments are well known to the Oil / Gas / Nuclear worlds, as well as to sober investors.

Still, it was surprising to see Tarik as the messenger.

It’s not quite the same as the Pope becoming a Protestant…

…but perhaps a Cardinal - certainly an Archbishop - screaming heresy to his [former] Church.

Given enough time, reality tends to rip away the veils of ignorance.

Tariq being a case in point.

Yesterday, another - similar - veil appears to be falling off a very large face.

The FT reported that the EU is considering labelling gas as “sustainable”.

There’s no doubt that if your goal is less carbon - and you don’t want to use nuclear - then increasing natural gas usage is the only way you get there.

There was a doubt as to if the EU / many Western governments could do math.

Their stated sustainable finance plans didn’t add up to a feasible solution.

With gas, they do.

And we think that at least a couple European IOCs (Total et al.) were the beneficiaries of their regulators tipping their hands.

Years ago.

And they planned accordingly.

It’s not like the European IOCs could (or even try to) hide the cards (like Mozambique) that they played over the past few years.

The deals were too big.

However, the certainty of Total’s language - like calling LNG “an Energy of tomorrow” - specifically in the context of yesterday’s headline out of Brussels, means that - to us - they knew this language was coming.

And front-ran the trade -

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STUPID-CYCLES.

11yrs ago, BAML ran a note (below) on “commodity super-cycles”:

The trade was a bloodbath.

History was rightly cruel to this thesis.

[To be fair, most of the sell-side held this thesis - we bring up BAML bc they gave the best arguments for, albeit incorrect in hindsight]

It’s worth examining why the thesis fell apart.

We’ll start with the idea of persistent, multi-year “insufficient production capacity”.

That played out - for oil & gas - about as accurately as a flat-earther’s description of the universe.

For some commodities (like Helium), prices did appreciate dramatically.

Today, there’s still a shortage of cheap Helium.

But prices of just a few commodities dramatically rising *is not* inflation.

Those *are* cases of “insufficient production capacity”.

Worse still, the inflation argument (from the above report) completely fell apart.

But the ghost of inflation still haunts equity investors….

The late 70's saw the peak of the Misery Index coincide with high oil prices.

And recent fears of inflation (which may come to pass) are causing investors to search for trades that historically performed well in high inflation environments.

Those investors return from their studies with the trade “long-oil”.

Well, oil spiked in the late ‘70s on account of supplies being disrupted by the Iranian Revolution & the start Iran-Iraq War.

*Not inflation*.

But investors don’t do that much homework.

They like themes…

“…humongous ETF inflows into energy past 4 weeks as inflation theme dominates…” - BAML Flow Show, March 18th 2021

Over the same time-period, WTI is down ~3% & XOP is flat.

For an investor, the theme to ride is not ~“inflation causes commodity prices to rise”…

..it’s “insufficient production capacity” causes commodity pries to rise.

Which has been happening to a number of commodities…

…this year:

Chinese environmental regulations have caused Steel & Aluminum prices to go interstellar.

On cue, “insufficient production capacity” strikes again.

We think the blind commodity inflation thesis is baseless.

Don’t buy it.

But - if a commodity has production capacity issues - there’s your trade -

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OTHER NEWS.

• Cheapest shale refinancing conditions in last 7yrs

• More on inflation & data from Macro Hive

• An interesting Guyana Basins Summit note

• Gas bills, post-TX-blackouts

Btw, if you want an inflation hedge - just buy BeeTeeCee; it quite literally can’t be inflated, by design -

That’s it for this week - outside of investing & commodities, we’ve been listening to the neuroscientist Andrew Huberman’s podcast: Huberman Lab - if you’re looking for a non-fiction / non-work / science related podcast, then we strongly recommend it (also strongly recommend for athletes) - catch y’all next Tuesday -