Talk Your Book: The Electrification of America

0:00Today's Animal Spirits Talk Your Book is brought to you by CNIC funds. Welcome to Animal Spirits, a show about markets, life, and investing. Join Michael Batnick and Ben Carlson as they talk about what they're reading, writing, and watching. All opinions expressed by Michael and Ben are solely their own opinion and do not reflect the opinion of Ritholtz Wealth Management. This podcast is for informational purposes only and should not be relied upon for any investment decisions. Clients of Ritholtz Wealth Management may maintain positions in the securities discussed in this podcast.

0:37A couple of weeks ago, Ben and I were in Hollywood, Florida, outside, joined the sunshine. Our friend Devon Drew from DFD Partners brings over a gentleman that he wanted to introduce us to, and it was the guy who's on the show today, Tim Kramer. I just showed up in Florida. He was one of the first people I met. Oh, really? Yeah, I just sat down and then, hey, here's Tim. Did he say, oh, that's right. That's right. That's right. Okay. So we spoke about the fund that he launched, which it's like two or three weeks old at this point. And we've spoken to a lot of ETF providers on the show. Obviously, we've spoken to, I don't know, hundreds, thousands over the years probably.

1:20This is a new category. Yes. It's kind of hard to surprise you at this point in terms of strategies and fund types. And this was a new one for us. It's essentially betting on the price of electricity, which I mentioned on the podcast. It's one of those things you never, those commodities you just don't think about. No, this is definitely a huh moment for me. Yes. And it makes sense. The narrative I was building in my head was, okay, electric cars, power grid, all this stuff. And Tim shares that it's much more than that. But it's an interesting idea that it had never been, it had really never been done before.

1:54Just hedgers had been betting on the price of this stuff, but it was not investable at all. Here's a dumb question for Tim that I, Ben, let's see if you know the answer to this. So when I left my barbecue on overnight, is that strictly gas or is there electricity fueling that as well? Are you using a propane tank? No. What do you, how do you power your grill then? Natural gas. I've got a line to the house, not the brake. Okay. I think you were propping up natural gas prices that night then, not electricity.

2:24Anyway, yeah, this was a totally new market for us. and I think it's because, I mean, people pay their utility bills and stuff and maybe they see them when they spike it, but again, it's sort of one of those out-of-sight, out-of-mind things. You don't think of electricity as an investable commodity? At least I don't. Because it hasn't been, I guess. That was his whole point. So they created an index for this. They created an ETF. I think this is a really interesting conversation because immediately when he talked about building out the power grid for all the electric cars, that to me was kind of like, oh, ding, ding, ding, that this makes sense.

2:58Yeah. Cars, electricity. And the other one you mentioned was cloud computing. All the new warehouses they're building to store all this cloud computing stuff. I mean, this is another sort of thing you don't think about much anymore, but I have an Apple Watch and I have a Mac on my desktop and I have an iPhone. Whoa, whoa, whoa. Save some electricity for the rest of us. But the thing that you don't think about with the cloud is that I can seamlessly go from listening to a podcast on one device right to the next device, and it'll pick up where you left off. And you kind of take that for granted when back in the day we had to plug our phone in and manually move all the stuff over.

3:34Now it just happens behind the scenes in the cloud. Kids these days don't appreciate it. How great is the scene in Swingers? I guess I know we're far afield here, but what, the voicemail? The voice machine? Remember voice machines? Yeah, they don't have that anymore. I don't think anyone ever called it a voice machine, but... What was it called? Answering machine. Oh my God, voice machine. See? We're too far away. Okay, so here's our talk with Tim Kramer, the CEO of CNIC Funds.

4:02We are joined today by Tim Kramer. Tim is the CEO of CNIC Funds. Tim, welcome to the show. Thank you for having me. I appreciate being on here. All right, we're going to talk about carbon neutral investing today. Before we do that, just a quick background. How did you get to where you are today? You don't need to start at 11 years old. But why did you launch an ETF around carbon neutral trading? Sure. So before this, I ran commodity hedging for a couple of private equity shops and infrastructure shops. And then before that, I was the chief commercial officer at a number of energy merchants. And so what happened is it just kind of was scratching my head because the most consumed commodity in the US on a retail notional basis is electricity.

4:48But it's not in any mutual fund. It's not in any ETF. It's not an ND index, nothing. And that just didn't make any sense. And so it just seemed like with the ESG tailwinds that were going on and some other factors, it seemed like a good time to give it a shot. I never really thought about the ability to invest in electricity. It's one of those things that is so important to our lives, what you never really think about. So you were looking at it from a hedging capacity for different corporations or funds. Why is it that this was never an investable commodity for people? So what happens is if you think about like the first commodity indexes that came out, and there's some well-known indexes out there, they were developed like back in the late 70s, but you didn't get investable products benchmarked to those indexes until about the 90s.

5:31And so electricity really wasn't traded until, you know, we'll say the end of the 90s, early 2000s. And then the market started to build up and you now have futures, just like you have futures in crude oil and corn, wheat, gold, et cetera. You've got futures like that. But what kind of kicked this thing into gear was the importance on renewables. So every time you pick up the paper now, you're reading something. Like today in the Wall Street Journal, there was an article about the grid and all these renewables that we're going to put on and the grid can't hold it. And last week, there was an article in the Wall Street Journal that talked about no new gas stoves in New York.

6:07You've got to hook up to the electric grid. And the week before that, there was a New York Times article that said, oh, Colorado River is running dry. You got to ration the water because there's 7 million homes that depend upon this for hydroelectricity. So you just kind of had the incubation period in the beginning like you did with other commodities and indexes. And then you just kind of got the tailwind right now. Man, I have so many questions. I never really thought about it that way. Electricity is the largest commodity that we consume in this country. Yet it's never really been investable inside of an ETF wrapper.

6:35So I guess the first place to start is, is electricity, is the price of electricity biased to go up over time? So interesting question. If you take a look, you know, right now where the prices are, you've got the ability for this to go, you know, almost parabolic. So a good reference point would be when you had the cold snap in Texas a few years ago. The prices before that were trading, you know, we'll say 50 or 100 bucks for the units, which are megawatt hours. and they spiked up to the cap of$9 ,000 for a two-week period. So it's not a symmetric risk-reward profile on that. But then you've got other people that ask the question and they say, listen, the U.S.

7:16has a stated goal to be 85 % renewable generation by 2030 and 100 % renewable at 2035. And they're going to say, well, look, wind and solar is free. So why isn't this going to zero? And the answer to that piece about the zero is, well, you know, guys that build this stuff, they want to make money. and you still have to price to the marginal molecule and there's other factors like that. So you've kind of got two schools of thought. I would say the direct answer to your question, though, is because of the asymmetric pricing profile, it's not going to go to zero. I think you've got more upside potential than downside.

7:50Who actually sets the price in this market? Is it done mostly by hedgers and corporations or how is it set? I was also just to add, just to piggyback on that, Tim, who sells the electricity? So what happens is that's kind of the same question. You guys are just hitting right on the good touch points here. And that is the people that hedge this stuff in the wholesale market. So the generators will do that. So they don't want to be exposed to price earnings volatility. So they'll tend to hedge forward. And then you've got natural buyers like the retail providers. So the guys that hit you up with billboards or send you mailings or whatever, they tend to sell to the retail guys.

8:27And they'll go out in the wholesale market and hedge that like in a 12 to a 36-month strip. And then you've got the guys that are developing new power plants. So we talked about all of this new renewable, 85 % by 2030, 100 % by 2035. In order to build that stuff, those guys need to get financing so they can apply the leverage and get their returns. In order to lever it up, the banks make them hedge in a forward basis. So they're the guys that are selling. You've got long-dated commercial and industrial buyers. There's arbitragers in the market. There's liquidity providers. There's a whole lot of people that are actively trading this right now.

9:00Interesting. Okay. Right. So this isn't giving you access to like spot electricity. What is actually inside of this index that you're tracking? Right. So what happens is the spot electricity is the most volatile. So what we're doing is we're going on to the exchange, the intercontinental exchange, ICE. And what we're doing is we're buying a 12-month strip of futures. And then as that front month becomes the prompt month, gets close to spot, we'll roll that back to month 13. So it's a continuous 12-month forward strip on this. And so what we've done is, if you think about a map of the U.S., what we do for this actual index is we take a representative sample based upon average annual consumption for all the different areas.

9:46So there's an active futures market for New England. So we take a weighted sample of that and for New York and for the Mid-Atlantic and for Texas and for the Chicago area and for California. And then we kind of weight that and then we rebalance that once a year. So what you have is a national kind of like weighted product based upon consumption. And it's the 12-month strip, so we avoid that volatility that you talked about. Another reason we did it this way is because of the seasonality that goes on with this. And it also kind of gives you better liquidity. So it's a little bit of twist on what traditional carbon indexes do, which is usually just the prompt month.

10:19You mentioned the different regions. Is it like gasoline where there's higher and lower prices depending on the region and how hard it is to get there and the consumption patterns? Yep, absolutely. So the underlying supply demand takes over. And so the weather patterns that you may have, like a really, really hot, you know, two, three, four day period in Texas, and you may not see that up in New England. So you're going to see, you know, depending upon the weather patterns, how that differs on each part of the market. And then you've got other constraints in terms of like transmission constraints and unit outages and, you know, the cost of all the different marginal fuels.

10:53and all those things make each one of those regions tend to have different prices that peak at different times. How does something like the government fit into this equation? Because this is something that is, you know, in the past not as many people had. Now it's obviously a necessity for a lot of people. How does like the rules and regulations fit into this equation? So the short answer for what I think you're getting to is once the genie is out of the bottle, once a market is deregulated, I don't think there are very many examples of it going back in the bottle and becoming re-regulated. So I don't think that's kind of a concern here at this point in time.

11:28The government, from what we're seeing, is the impact is the rules that they're stating. So the targets for being carbon neutral and the targets that the government has for electric vehicles. So, you know, you're talking about 2030 to 2035. You're talking about no new combustion engines. The government put their guidelines out for just new electric vehicles, et cetera. So we see them kind of accelerating the electrification of America. And we think that kind of helps what you're looking at in terms of what the index is doing. Can you talk about the index itself? Is this something that CNIC created or are you tracking an index that was created by somebody else previously?

12:04We created the index. And what happens is once we created it, we got in some conversations with ICE, Intercontinental Exchange. And so we partnered with them and they published the actual index. And then we co-branded an ETF that launched about two weeks ago. Got it. Does it make sense to, I know this, I assume I know your answer, but why invest in an index versus like something that's actively managed? And does, would that vehicle, does that even exist? If somebody wanted to invest in an actively managed strategy, what would that even look like? So if you want to invest in an actively managed strategy, the first question you get is, well, let me see your track record.

12:43Right. And so nobody's got a track record for actively managing these futures that they can point to. If they do, they usually do it in like a separately managed vehicle, a hedge fund, something like that. Right. So what we did is we created the index. So it's hard and fast rules. And there's data. It's available now. You can find it all the way back to like January 1 of 2014. And so that is there to kind of jumpstart the credibility of the index in the products. Was this something where you had the idea and then you looked at historical data and you said, wow, this makes sense? Or how did the thought process of developing this, what did that look like?

13:18Yeah, I had the idea and I made this and I've been working on this for three years maybe. And it's just a matter of creating it wasn't that difficult, but then finding people that kind of understood the commercial viability of this because it's new. And so there was an education process that took place with potential investors, potential partners. ICE got the joke right away when we talked to them about like, wow, yeah, we totally get this. We've been looking and trying to do something. We like the way you've approached this. And they were really easy to work with and very commercial. It seems like the commodity space has been mostly commoditized, pun intended.

13:50Is that a pun? That's not a pun. Why do you think this was available? Why do you think nobody else had come along and put this into the ETF wrapper? Because people just don't really understand electricity. It's not a storable commodity. And so people haven't spent a whole lot of time on it. And it's also just generally new. And so once you've got the liquidity in the general commodity markets, and so like for the existing commodity indexes and the famous ones out there, there's probably$800 billion. What are we talking about? The Goldman Sachs one and then the Bloomberg one? Those are the two biggies.

14:28Yeah, the BCom, the Bloomberg Commodity Index, and the GSCI, the Goldman Sachs Commodity Index, are the biggest. There's other ones. There's a Credit Suisse Commodity Index, Merrill Lynch Commodity Index that ICE owns, et cetera. So if you take all those, what's directly tied to those, and then over-the-counter and all the other products, there's over a trillion dollars tied to these things. So those things are up. They're established. If you want commodity exposure, it's there. But just because power is so much more nuanced than those other commodities are, the education process takes a little bit of time to get people up and running with it.

14:59Is electricity in the basket at all? In the basket on those existing commodity indexes? Yeah. Not now, but it will be. So, yeah, well, you mentioned that those commodity indexes were formed back in the 1970s. You know, we're more familiar with the process of index reclassification for like the S &P 500 or the Russell 1000 or whatever. How does it work for commodities? So generally, the commodity index is the ones you talk about. They'll do a rebalancing at the end of every year. And they'll do it on like, you know, weighted consumption, things like that. Occasionally, they'll put new commodities in it.

15:29When we did this product with ICE, we actually have a two-year exclusivity on the data and the index because we're the ones that helped them come up with the thing. And so we think that there's a really interesting fit to include this index in a hybrid commodity product or a hybrid commodity index. Yes. So you think that electricity will be in these indexes in the future? Yeah. So if you look at CPI, right, month after month after month, electricity is 2.5 % of CPI. Varies, you know, plus or minus, you know, 0.1. It's in there. So if you want to have inflation protection, you probably want to have that in that amount.

16:11Also, if you're going to have a commodity index and the BCOM is 30-some percent energy and the GSCI is 60-some percent energy, it's kind of a head-scratcher why you're not going to have the most consumed energy commodity and it's not in the index. So we think that there's a couple of interesting things that you can do to make this product and do a hybrid on that, yes. What other commodities is electricity most highly correlated with in terms of price movements? So right now, the only thing that's correlated to for any substance is going to be natural gas. And we see that correlation breaking down as you go through the future right now.

16:49So what we've done is, you know, natural gas in the commodity indexes now is just a prompt month. But we're doing the 12-month strip. So the correlation isn't quite that strong. And then as you go towards a more and more renewable grid and you have all battery, all solar, all wind, and pretty much no natural gas, we think that correlation continues to break down. And that's why you want the exposure to this directly. Can you talk about the volatility of a strategy like this? So I'm looking at, and we'll link to this in the show notes, I'm looking at the index and it had a crazy run like pretty much every other asset in the world during the pandemic.

17:25And then like a lot of assets, it crashed. Can you talk about the dynamics of what caused the rise in the fall, specifically from 20 to today? Sure. So the rise that you saw was due to what you were looking at in terms of like a post-pandemic pop in demand. And then you had just a big demand for any kind of fuel and looked at what the fuel prices were over in Europe. And so just a general uptick on that. And then the big collapse was the January, February timeframe that you had was like the second or third warmest winter in the past 50 years. And so just, you know, absolutely no demand because of that.

18:03You know, pick a number three standard of the Asia move downward in terms of what the temperatures were. I would imagine there would be plenty of different types of investors who would be attracted to a fund like this. the first one that comes to mind would be a trend following strategy that uses different types of commodities and rates and bonds and stocks and all those different things. Another one would be hedge funds and especially hedge funds that focus on the energy space. And then I would think another segment of investors would be anyone who wants some sort of broad commodity exposure.

18:35So who do you think would be the perfect investors for a fund like this and who are you targeting? So pretty much all of the above. So to kind of take them down an order. So you talk about the trend followers. It's interesting. If you look at like AUM flows into natural gas ETFs, the lower the price, the more money goes in there. So we think that's kind of an interesting phenomenon. That's kind of counter to what I would have thought, but it's there. It's observable. With respect to other investors, we think - So people in commodities are counter cyclical in some of these? It looks like they're trying to pick a bottom on some of these things.

19:08Yeah. At least the natural gas, when we took a look at that, yeah. Interesting. We think this makes sense for sticky money, like for pensions and endowments. And so, you know, we just a little bit of discretion, but people say somewhere between five to 15 percent of the AUM should be allocated to commodities. And that's for inflation protection or portfolio diversification. If you take a look at the actual holdings, like the top 25 endowments and the top 25 pensions, they're around three to five percent right now for what they've got for commodity exposure. So we would say, look, this is, you know, like we've talked about with CPI, this is two and a half percent of month after month CPI.

19:42So if you'd like some inflation protection, we think this index fits that really well. If you've got overall commodity exposure, then we think that you're just kind of missing the boat if you don't have the most consumed commodity on a retail notional basis in your portfolio. So we think pensions and endowments should have an allocation of this and that should stick. Family offices have kind of been some of the first movers here, and that's because they tend to be just kind of independent thinkers and like to have new, unique things. We think that there's an interesting angle for some of the arbitrageurs.

20:13So they'll look at the ICE futures on one screen and they'll look at the ETF on the other screen and kind of arb that away. Speculators, like you said, kind of the whole host. We think it's, we've just created the vehicle for them to express their view. I think I know the answer to this question, but do you see retail investors using this? Because to me, this does not really fit in any bucket. I guess you could say it fits in the commodity bucket, but in which case I would probably throw to you that I would assume most retail investors are not building a basket of commodities. They're using one basket.

20:48They're using one ETF if they have commodity exposure. So is this a segment of the market that you are going to pay less attention to? Or how do you think about the retail investor here? So the retail investor tends to express a commodity of you in terms of a model portfolio. So you'll have, you know, pick one of the big mutual funds. They'll say, look, instead of 60-40 equity and debt, go 60-35-5 and put five in commodities. And so the retail investor tends to get that commodity exposure via that model portfolio. We think that if you took this and included this as one of those hybrid products, as a hybrid into a general commodity fund, and put that into a model portfolio, that would probably be a nice for the retail investor.

21:29Is there any way, just spitballing here, I'm an ideas guy. Is there any way for this to generate income? Would there be a potential down the road where you could sell carbon credits or is that not what you're trying to do here? So the index is kind of hard and fast rules. So in terms of the carbon credit piece, we take that portfolio of electricity futures, and then we go to a publicly available website, the EPA, and it says what the carbon footprint is for that portfolio. And then we buy the correct amount of exchange traded carbon offsets so that the whole thing is net carbon neutral. And then we just adhere to the rules, just like a regular commodity index adheres to the rules in terms of what the composition is and when to roll.

22:06So we don't really take discretion in terms of like when to sell this out and try to, you know, time different pieces of the market. It's just purely rule-based, purely exposure to this as a new commodity asset class. Michael said, oh, sorry, go ahead, Michael. No, what did I say? Let's hear it. No, I said, you said that you were, I think both of us are ideas guys. So I'm just thinking through when a new ETF like this comes out there, there's really two ways that it becomes really successful. One is just it, it rides a wave and the performance is great right out of the bat and people pile in. The other, I think is a narrative.

22:38So if I'm thinking through narrative as an ideas guy here, the narrative for me here would be that you're riding the electric electrification of hardware to say of cars, right? Would that be kind of the, the one narrative you're thinking of is if we're going to have all these, all this big build out of the grid for electric cars, this is a way to play it. Is that a good narrative if I'm thinking of that? Yeah, but it's a lot more detailed than that, right? So we think that just the narrative is the electrification of America. And so when you look at the cars, right? So 2030 is when they're talking about all cars are supposed to new cars be electric and no combustion engine ones.

23:12And you look at, like we talked about, the gas stoves versus electric stoves, et cetera. But there's so much more demand that you're seeing that we don't think has been picked up yet. So for instance, some of the data centers. So if you take a look at Texas, right now, if you take a look at what the peak electricity load is in Texas and take a look at what the demand is from data centers, it's small. It's like maybe 2 % or 3%. But the projections are that grows to like 30 % to 40 % by 2030. So what does that mean in terms of how would that impact prices? So we see the higher demand. And then we also see impacts and prices going up, but we also think supply is actually overstated.