Circle of Competence Issue #69

QUOTE OF THE WEEK

"Graham's wonderful sentence is an investor needs only two things: cash and courage. Having only one of them is not enough." –​ Seth Klarman

FOOD FOR THOUGHT

Energy misconceptions - Absolute Return Partners' July Letter (Niels Jensen)

The paradox of rising renewable costs and rising electricity prices (Forbes)

I wanted to juxtapose these two articles because I had no idea that increased penetration of renewables, despite falling production cost per kilowatt hour, could potentially lead to rising consumer prices.

Let's take these one by one. First, according the Niels Jensen (partner of Absolute Return Partners):

In Europe (I do not have corresponding numbers from the US), every 1% increase of wind and solar in the energy mix has raised electricity prices by more than 3% (Exhibit 5).

This is (in economic terms) an absurd misallocation of capital and is one of the key reasons why GDP growth continues to decelerate. According to BP World Energy Statistics, between 2000 and 2016, about $3 trillion was invested in renewables and a further $1 trillion in network upgrades to support the switch to renewables.

Second, the Forbes article states a potential cause of the rising consumer prices despite falling costs of production (emphasis mine):

To cost-effectively scale up renewables, they must be sited where they are most productive – in places with plenty of sun, wind and land. That is typically not close to the population centers where users locate, so more transmission infrastructure is required to connect supply and demand. This may be having an effect on system costs. Between 2012 and 2017, when non-hydro renewables generation grew by 77 percent, transmission costs rose by 50 percent. While not all transmission cost increases nationally can be attributed to renewables expansion – maintaining old lines and modernizing for grid reliability are other reasons – there are notable cases where renewables are driving transmission investments. The Competitive Renewable Energy Zone project in Texas, for example, invested $7 billion to connect wind generation in sparsely populated west Texas to the state’s population centers.

This will be an interesting trend to follow as our power is linked more to renewable energy and less to fossil fuels going forward.

Bill Gurley on tech investing and network effects (Invest like the Best)

I don't always stay this locked into a podcast episode, but this was one of those rare episodes that possessed an incredibly high signal-to-noise ratio. Patrick O'Shaughnessy interviewed Bill Gurley, the famed VC from Benchmark on VC investing, network effects, and the private capital landscape today. Here are my two biggest takeaways:

1. I have never heard a better definition of network effects than the one Bill Gurley gave: network effects can be defined as increasing returns of utility/usefulness (X axis) as the service goes from 1 to 100 to 1,000,000 users (Y axis - e.g. Google, Facebook, Amazon, LinkedIn, Zillow etc.).

2. At 39 minutes, Gurley goes deep into an explanation around what the low cost of capital environment has done for the network effects/marketplace technology landscape. I agree on the cause of current pricing wars for private company valuations and understand that low cost of capital is by and large the key to explaining the absurd valuations in the private markets, however the key question to be asking is "what comes next?" Do rates rise and does the economic tide recede, leaving those dependent on the cover of low cost of capital out to dry? Or do rates stay low for the foreseeable future, allowing more and more historically high valuations in the private investment universe? I won't pretend to know the answer to these questions, but at least at first blush, private market investors seem to be playing a dangerous game with hopes that 1) the growth of highly valued tech startups become profitable growth, 2) there will be another investor willing to buy equity at a higher valuation, and 3) a low cost of capital is here to stay. If any of these legs fails, there will be blood in the streets.

Long term stock exchange founder Eric Ries on corporate governance and incentivizing long term thinking (Recode Decode)

I'm not totally sure how this startup based on new corporate governance will work out. However, I absolutely love that someone is attempting to bring a private, capitalist solution to short term thinking as an alternative to the traditional 'shareholder' model. The way the LTSE would work would be to ensure that boards, executives, and employees are all on the same page around: 1) incentivizing long term shareholder ownership, 2) long term thinking around R&D and business investment, and 3) rewarding management based on performance over longer time horizons. I would much rather support a reorientation around a multi-stakeholder model vs. a shareholder model that comes from a private entrepreneur rather than relying on a regulatory solution that could risk crippling the engines at the heart of our economy. I've cited it many times, but at this point, I can't help but link back to a speech given by Seth Klarman on this very topic of short term thinking vs. long term thinking in business.

WRITTEN WORD

TOP READ: Energy misconceptions - Absolute Return Partners' July Letter (Niels Jensen)

The paradox of rising renewable costs and rising electricity prices (Forbes)

The incredible demise of Knight Oil Tools, a Louisiana family dynasty (The Intelligencer)

Why Strava is getting more social than ever (Outside Online)

Making millions with satellite imagery (Quartz)

Walmart's Jet.com is losing money and the race against Amazon (Vox)

Long Zillow Group, short real estate agents? (Pure Alpha)

The earnings mirage - why earnings and return on equity are overstated due to accounting flaws and inflation (O'Shaughnessy Asset Management Research, Jesse Livermore)

A long profile on Zolgensma, the most expensive drug in the world and the conditions that create its price (The Baffler)

SPOKEN WORD

TOP LISTEN: Bill Gurley on tech investing and network effects (Invest like the Best)

Long term stock exchange founder Eric Ries on corporate governance and incentivizing long term thinking (Recode Decode)

Jesse Livermore on the search for truth in finance and economics (Invest like the best)

Lessons from luminaries - Bill Gates on Microsoft, mistakes, and advice for founders (Village Global)