The Green Futures’ Chernobyl Moment

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Dear fellow investors, 

What has taken place in 2022 is nothing short of a man-made problem. The question is if you looked upriver, could this have been avoided? While it could be argued that Putin invading Ukraine was unexpected, the policy decisions and structure of the global energy markets have been shaped for years. It reads like the lamp in the movie A Christmas Story: Fragile. Besides structural issues, there have been pressures imposed on these structures that were unforeseen when they were built. These were exactly the pressures that caused what we now know as Chernobyl.

I was personally reminded of this while reading Vito Tanzi’s book Fragile Futures. He does an excellent job of retelling the story of what transpired:

The Chernobyl disaster took place on the night of April 26, 1986. It released radiation equivalent to 500 Hiroshima bombs. By any standard, it would be considered an enormous disaster. It was partly the consequence of fault design of the power plant, and partly due to pressures by the Soviet Government in Moscow, specifically conveyed by Gorbachev, then head of the Communist Party.

This is what 2022 feels like. The areas that are the most closely tied to Ukraine are having the effects of radiation. Companies are assessing their risks to see what their exposure is to the crisis and people are fleeing, rather than eventually being evacuated as they were in Chernobyl.

Gorbachev gave a speech on March 6th, 1986, to the Plenary of the Soviet communist party where he laid out his future vision for the Soviet economy.

Gorbachev’s speech had called attention to the poor performance of the Soviet economy in the previous five-year plan…Gorbachev had stressed that to reverse that poor performance, it would be necessary in the next five-year plan to push the technological frontier, in which he assumed the Soviet Union had a comparative advantage. That push would provide a needed jolt to the Soviet Economy.

The sentiment of this story sounds oddly similar to today as we hear about how far behind we are in fighting climate change. Further, the current US administration is using similar language and logic in the recently-passed Build Back Better bill (inflation reduction act of 2022) to use the technological frontier of green energy to unleash the American economy. More importantly, the issue for Gorbachev and the Soviets was putting numbers or quotas into their mandate. This was the real problem.

He specifically mentioned the introduction of new technologies, and especially a shift from using fossil fuels, such as coal, oil, and gas, that were costly to produce and could be exported, earning needed foreign exchange, toward cheap energy, generated by atomic power, in which the Soviet Union was the leader.

The rhymes of these words are ringing in our ears as we see the policy prescription from the western world collide with the realities of the devastation being brought to the economies of the world. When investors hear things like net-zero by 2050, it screams like Soviet-style mandates on market economies. When pressures collide in economics, there is only one way to rectify these forces: price. An example would be European electricity prices. The price being paid by businesses and consumers is being brought by mandates and quotas that aren’t market-based assumptions.

To evidence how far away from the market these policies are, look to the recent news. In the same month that California announced they will not sell gasoline cars beginning in 2035, they also told residents to not charge their electric cars in fear of blackouts. Again, quotas and mandates that are unreasonable for consumers and businesses. This radiates confidence in the economic structure and the decision-makers pushing policy.

The real danger to today’s Gorbachevs seeking to impose their will on the green future is that Chernobyl was a defining moment in the adoption of nuclear energy in Europe. It went from being the answer in energy, led by Russia, to being relegated below coal, oil, gas, wind and solar. This is the real danger for the green agenda tied to these Soviet-style decisions.

We look at these decisions and pressures being brought by today’s Gorbachevs much like Warren Buffett does. “People that are on the extremes of both sides of are a little nuts. I would hate to have all the hydrocarbons banned in three years. You wouldn’t want a world, uh, it wouldn’t work and on the other hand what’s happening will be adapted to over time just as we have adapted to all kinds of things.” He goes on to say, “I think we are going to have a lot of hydrocarbons for a very long time and will be very glad we got them, but I do think the world is moving away from them. That could change.”

Buffett understands how fragile this ultimately is. The most important words he utters are “that could change.” The reverberation and radiation of 2022 may cause a change in the policy prescriptions from today’s Gorbachevs. I don’t expect things to get better in the Soviet-style decision-making of the West as we read about price caps in Europe. If you want economics to stop supply from increasing, use price caps. Or better yet, set mandates and quotas for households of the world after a two-year period where you controlled their face attire and their movement to slow a pandemic. As Tanzi makes the case, Chernobyl was the beginning of the end of the Soviet Union. It was the government folding. It was bad decisions coming home to roost. Alarmists in the green future better take heed. If they take one step too quickly as Gorbachev did, they may prematurely end their cause.

Fear stock market failure,

Cole Smead, CFA

The information contained in this missive represents Smead Capital Management’s opinions, and should not be construed as personalized or individualized investment advice and are subject to change. Past performance is no guarantee of future results. Cole Smead, CFA, President and Portfolio Manager, wrote this article. It should not be assumed that investing in any securities mentioned above will or will not be profitable. Portfolio composition is subject to change at any time and references to specific securities, industries and sectors in this letter are not recommendations to purchase or sell any particular security. Current and future portfolio holdings are subject to risk. In preparing this document, SCM has relied upon and assumed, without independent verification, the accuracy and completeness of all information available from public sources. A list of all recommendations made by Smead Capital Management within the past twelve-month period is available upon request.

©2022 Smead Capital Management, Inc. All rights reserved.

This Missive and others are available at www.smeadcap.com.

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