Episode #443: Kyle Bass on The Market, Energy Crisis & His New Big Bet For The Next Decade

Episode #443: Kyle Bass on The Market, Energy Crisis & His New Big Bet For The Next Decade

 

Guest: Kyle Bass is the Founder and Chief Investment Officer of Hayman Capital Management, an investment manager of private funds focused on global event-driven opportunities. He is also the Co-Founder and Chief Executive Officer of Conservation Equity Management, an environmental sustainability private equity firm founded in 2021.

Date Recorded: 9/1/2022     |     Run-Time: 48:13

Summary: In today’s episode, Kyle touches on his famous nickel collection, the current macro environment, and why he thinks people need to stop fat shaming oil companies. The second half of the episode touches on Kyle’s newest venture, Conservation Equity Management, an environmental sustainability private equity firm. He walks us through his thesis and explains why he’s buying real assets during a time when people are thinking about the metaverse.

Sponsor: AcreTrader – AcreTrader is an investment platform that makes it simple to own shares of farmland and earn passive income, and you can start investing in just minutes online.  If you’re interested in a deeper understanding, and for more information on how to become a farmland investor through their platform, please visit acretrader.com/meb.

Comments or suggestions? Interested in sponsoring an episode? Email us Feedback@TheMebFaberShow.com

Links from the Episode:

  • 0:39 – Sponsor: AcreTrader
  • 1:36 – Intro
  • 2:11 – Welcome to our guest, Kyle Bass
  • 7:28 – A lack of financial education in the public school system; Tim Ranzetta
  • 9:19 – Kyle’s thoughts on the macro landscape today
  • 13:17 – Why Kyle plans to buy real assets through the coming recession
  • 17:58 – Why we need to stop fat shaming of oil companies will stop
  • 21:04 – Episode #419: Peter Zeihan; Adding nuclear back under the ESG umbrella
  • 22:37 – Episode #343: Dr. Nathan Myhrvold
  • 23:04 – The origin story that lead to Conservation Equity Management
  • 32:34 – The main return drivers for the investments
  • 35:25 – Who the eventual buyers of their projects are
  • 41:28 – Kyle’s most memorable investment

 

Transcript:

Welcome Message: Welcome to the “Meb Faber Show,” where the focus is on helping you grow and preserve your wealth. Join us as we discuss the craft of investing and uncover new and profitable ideas, all to help you grow wealthier and wiser. Better investing starts here.

Disclaimer: Meb Faber is the co-founder and chief investment officer at Cambria Investment Management. Due to industry regulations, he will not discuss any of Cambria’s funds on this podcast. All opinions expressed by podcast participants are solely their own opinions and do not reflect the opinion of Cambria Investment Management or its affiliates. For more information, visit cambriainvestments.com.

Sponsor Message: Today’s episode is sponsored by AcreTrader. You’ve heard us talk about the importance of diversifying beyond just stocks and bonds alone. And if you’re looking for an asset that can help you diversify your portfolio and provide a potential hedge against inflation and rising food prices, look no further than farmland. Now, you may be thinking, “Meb, I don’t want to fly to a rural area, work with a broker I’ve never met before, spend hundreds of thousands of dollars to buy a farm, and then go figure out how to run it myself,” but that’s where AcreTrader comes in. AcreTrader is an investment platform that makes it simple to own shares of farmland and earn passive income. And you can start investing in just minutes online. I personally invested on AcreTrader, and can say it was an easy process.

If you want to learn more about AcreTrader, check out episode 312, when I spoke with founder, Carter Malloy. And if you’re interested in a deeper understanding on how to become a farmland investor through their platform, please visit acretrader.com/meb. That’s acretrader.com/meb.

What is up, my friends? We have a huge show for you today. Our guest is Kyle Bass, founder and chief investment officer of Hayman Capital Management and asset manager of Private Funds focused on global event-driven opportunities. In today’s episode, Kyle touches on his famous nickel collection, the current macro environment, and why he thinks people need to stop fat-shaming oil companies. The second half of the episode touches on Kyle’s newest venture, Conservation Equity Management, an environmental sustainability private equity firm. He walks us through his thesis and explains why he’s buying real assets during a time when people are thinking about the metaverse. Please enjoy this episode with Kyle Bass. Kyle, welcome to the show.

Kyle: Meb, I’m glad to be here.

Meb: I thought about you a few months ago, because we’re both active on Twitter and you like to mix it up. But I saw a phrase trending that made me think of you. It wasn’t about you, but it made me think about you when I saw the word nickel was trending. I think this was back in March, and I said, “Oh, no. What did Kyle do? Did he go buy a hangar full of coins?” But it turned out to be the LME fiasco. You’re not increasing the hoard over there? Do you still have your nickels? Can you tell the audience what I’m referring to?

Kyle: Back when the back of the financial crisis, you know, you had a scenario where the world’s central banks were basically taking bad private assets, putting them on the public balance sheets. If you remember, we had many banking systems. The U.S. banking system was about one times GDP. If you added the non-bank entities that were like Fannie, Freddie, the big financial entities were about 1.7 times GDP. When you looked at places like Iceland and Ireland, they had let their banking systems grow to 10 times GDP.

So, when the assets went bad, it broke the country. So, if you remember back then, the central banks were guaranteeing all of these bad assets made from people that made bad decisions, banks that made bad decisions. They were trying to basically ensure the structural stability of the banking system. And explaining that to my kids at the time, I was explaining to them how the Central Bank expands its balance sheet and prints money, and that that makes money worth a little less.

They were perplexed. And I said, “But, you know, with interest rates at zero, there’s kind of an interesting way to make sure that you don’t suffer from that kind of activity. In fact, you may gain with that activity if you own something like a nickel where you pay a nickel for it. It’s comprised of copper and nickel.” And at the time, those were kind of free call options on copper and nickel. And I was just trying to teach a lesson. Then it became really interesting and fun, you know, the first $100,000-worth of the nickels happened to be sitting at the Central Bank. The next 150,000, 200,000, they said, “Yeah, I guess we’ll order them. It’ll take a little while but we’ll get them in.”

The third couple $100,000-worth of nickels I got a phone call, said, you know, “Hey, we just want to know, why are you taking all these nickels?” And I, of course, gave them a funny answer. I said, “I just love nickels.” Made him think I was crazy. But this is something that will never move, let’s just say my family’s net worth or value but it was a teaching lesson to my kids. And I know the internet went crazy with things like this thinking that, you know, who’s this business guy in Texas, you know, guns and nickels and the goal, whatever. It was really just instructive. We ended up gathering a fair amount of nickels and putting them in a warehouse. And to your point, it literally filled the warehouse.

Meb: I’ve always wondered and I’ve been curious… So, listeners if we have any do-it-yourself maker hackers out there, I’ve always been curious because I have a buddy, and this is more for the adventure than anything, but anytime he sees a Coinstar, he’ll go up to it. And if there’s a 50 cent older half dollar, is it the half dollar, there was largely silver, which are worth, I don’t know, $5, $10 or something, they fall through the machine. And so, they’re often in the coin receptacle. And so, he always checks and often he finds one. But I was always curious, I said, “I wonder what percentage of if you could train a Coinstar machine to recognize coins in circulation that are worth more than their…so whether they’re collectible, whether they’re silver dollars, whatever, what percentage could you actually spend the time, run the coins through and actually come up with a profitable machine?” So, listeners, if we got any hobbyists out there that want to hack a Coinstar, hit me up, always been curious.

Kyle: When you think about the way that Gresham’s Law works, and you go back to that moment, so the last silver dollars and silver half dollars and even quarters were 100% silver back then was 1964. So, when they changed the alloy or the elemental constituency of those coins, in literally eight or nine months, they disappeared from the system. So, Gresham’s Law is bad money runs off the good. Every now and then you may find one of those kind of rare gems. I’d be willing to bet that those are not circulating freely.

Meb: You would assume that markets are efficient. And the last episode we recorded was with David Rubenstein of Carlyle, and we were talking… He had written a chapter about Seth Klarman. And I was talking about Seth Klarman’s book, “Margin of Safety,” which regularly goes for two grand on eBay. And you in particular will like this lead-in because I said… I was Googling Seth for the episode, and I was like, “I’m just curious, are these books still going for 2,000 on eBay,” and they were, but then there was one for sale for $13. And I said, “Huh, I’m going to buy that.” And then I realized it was for sale on Alibaba. I said, “Okay, this is one of four scenarios. One is, it’s just I want to try and scan the barcodes at 13 bucks, and they’re going to send it to me, and I’m going to get it, and it’s $2,000.

Two, I’m somehow going to get all my information stolen and my identity and I’m going to have an apartment in China. Three, they’re going to send me like a terribly redone just copy of the book or, four, it’s going to be like a PDF they like printed out PDF. We’re going to find out in about a week. I don’t know yet.

Kyle: I’ll bet you anything you want to bet that it’s either three or four.

Meb: All right, dinner in Dallas, when it shows up, on you if it’s the actual book, I’ll buy.

Kyle: Dinner in Dallas. Dinner in Dallas.

Meb: Before we get into macro, you know, it’s funny, the comment about your kids, you know, I have a five-year-old. and this is like a white whale topic for me. It drives me nuts. Anytime our politicians are saying really dumb things on social media and Twitter, and this applies to journalists and applies to, you know, just adults in general, I say, “Look, you know, this is frustrating, explain what’s happening.” But, like, you can’t blame them because we don’t teach money in school. We don’t teach personal finance in high school, investing, anything should start in middle or elementary school. And it’s a huge frustration to me. I like you’re at least chatting with your kids about it because most adults don’t. Like, there’s a lot of shame and taboo when it comes to money. That’s unfortunate.

Kyle: I don’t know when you grew up, Meb, but you’re definitely younger than I am, but in my public high school in Arlington, Texas, we did have a class called Home Economics. It was an elective class your junior and senior year. And if you took it, it was an easy A so a lot of the kind of athletes and people that, you know, were not deeply intellectual at the time… And I don’t mean to be stereotypical. Just people looking for an easy A, in that class, for a week, they taught you how to balance a chequebook. That was pretty cool. They should have a home economics class that is actually not an elective. It should be required. And it should be required in like the eighth or the ninth grade. And they should teach you about the compounding of money. And if you start saving 2,000 or 3,000 bucks a year, when you graduate, what that can compound into if you’re vigilant about saving and investing, right?

Meb: We did a podcast with Tim Ranzetta at Next Gen Personal Finance, who’s working on a charity, trying to get it into high schools. And the good news is it’s gone up from like 10% of high schools to this last year, there’s been like four or five states, I think Florida being one, they’re starting to mandate it. And so, it’s up near almost 50%, which is a pretty big shift in the past decade. So, kudos to Tim and others doing that work, because I think it’s a shame.

All right. Let’s talk about the world investing. You’re a longtime macro guy. Macro is always a little bit weird, but I feel like the last few years have been particularly weird. We had a pandemic, we got a war in Europe, and then we have an environment this year that’s probably something that is dissimilar to what most market participants, unless they are really grey hairs, like 70s, 80s, 90-year-olds, have really been accustomed to particularly in the U.S. What are you seeing out there? What’s going on in the world? Any general thoughts on the landscape?

Kyle: I think what’s key is when you think about what the Fed is focusing on, Powell has said and the other board of governors have said that they’re really focused on call it payroll employment. And in inflationary recessions, to be fair, again, you mentioned the ’70s, you think back to ’72. 74, you think back to kind of ’78 to ’81, payroll employment is the lagging indicator. It is the last thing that turns in inflationary recessions. And so, I actually think, just like the Fed went way too big on expanding its balance sheet to almost $8 trillion, I think you’re going to see the Fed go too far because they’re focused on the wrong thing. And raising rates right now is really pushing on a string and just going to make the recession deeper. We’re already in a technical recession.

We typically don’t raise rates 75 basis points a throw into a recession. You typically don’t have central bankers using the word “pain” twice in speeches at Jackson Hole. And you typically don’t have other boards of governors, like we saw yesterday, say, “We don’t want to see the market up 200 points. This is a period in time in which we want to see a contraction. We’re expecting to see a meaningful decline.” And, you know, the real key here is, Meb, they put 40% more money in the system in 18 months. That has never happened before in the history of our country. It is a complete disaster, right? The one institution that’s charged with policing inflation is the one institution that can create it, and they created massive amounts of inflation. And raising rates doesn’t reduce the amount of money in the system. Its mechanism takes a long time to really see the net effects in the economy.

You and I both know housing prices immediately dropped down a bit, you know, call it 6%, 7%. So far, the home sale volumes have plummeted. The number of home closings in June and July were the second least number of new home closings in the history of the numbers being reported only to July of 2007. The numbers that are real economic indicators are telling you that the economy is coming to a grinding halt very fast. And the fact that we want the price level lower, what we should be doing is taking down… I’m sorry, if you hear the leaf blower. Of course, it’s the right time for that to happen.

Meb: Another greatest aside is I like speaking of personal finance mandating. Leaf blowers, one of the biggest menaces of just like day to day, how are all leaf blowers not electric in 2022 is beyond me. But aside, keep going.

Kyle: In our city here, I think they are mandated to be electric by a certain date, which is that’s a great marginal move. I think requiring the entire motor vehicle fleet to be electric by 2035 is like a little bit of an ESG mandate without any science behind it. Back to the money supply, until they meaningfully pull money from the system, not just with rates to actually engage in QT, I think you’re going to see the price levels stay where they are. I do think that just like 2018, remember December 2018, the market dropped by 20%, 22%, that’s the last time they were aggressively raising rates and engaging in QT. The real pull of risk capital from the market is actually only beginning right now, because of the way mortgages rolled off, and the way that there was a netting of the initial QT announcement. But, basically, we’re just starting to pull it. I believe the Fed won’t be able to pull more than roughly a trillion out of the market before the market is materially lower.

Meb: As we look around, you certainly made your name back before the financial crisis looking at housing, and you mentioned housing was starting to come off. Like, is there a trade there, or are there other areas of the market that is more interesting? Or is it one of those scenarios where you’re just like, “Look, just stand back because this is more risk on things coming down?” What’s kind of the lay of the land?

Kyle: I think the banks are really going to suffer a bit with non-performing loans, right? I think you’re going to see… And there’s a stat out there that I haven’t been able to confirm with any official source, but someone’s telling me that one in five consumers is behind on their electric bill. If you look at the Manheim Used Vehicle Index, that has dropped 10%, 12% in just a few months after just being a meteor, a skyrocket over the last five to seven years.

So, the car loans got north of 60 months, and some are much north of 60 month or 120% of LTV, and now, you have car prices really collapsing from their peaks. So, I think auto finance is going to see some NPLs. I think mortgage finance is going to see some non-performing loans. I think housing in general is going to cool off a bit as it should. We all know how much it went up nationwide. But I don’t think there’s a major trade there. I don’t think it’s going to break our financial institutions. I think our leverage levels are appropriate. So, when I think about the opportunity, you need to be buying through the dip, meaning in the next year or two, we’re going to continually buy real assets through that dip because the pattern is set, i.e., the Central Bank. If you look at the shape of the yield curve, right, there are 35 basis points of inversion, I think between 2s and 10s right now. I think the curve’s properly shaped.

I think the Fed is aggressively raising into a recession. They’re going to aggressively have to be cutting rates. Typically, you and I both know in recessions, they actually end up cutting 450 to 500 BIPs. They can’t cut that much because we’re not at 450 or 500 BIPs. So, the next one when they cut will go straight back to zero. The Fed will expand its balance sheet again, and we’ll be back to inflation or some sort of stagflation or some sort of both. I think the opportunity… You asked for the opportunity. The opportunity is by through this recession that we’ll have, I think it’ll be sharp, I think it’ll be short because I think the Fed will be forced to reverse its course here in the next 12 months or so.

Meb: You’re someone who talks a lot about and is familiar with real assets and commodities. You mentioned briefly the amount of consumers that are struggling with electrical bills. You were tweeting recently about electrical bills in Europe, and we’ve had conversations with people over there. And I’m just trying to, like, mentally frame this for the listeners is, like, print out your electrical bill and then just add a zero, and imagine how challenging that is for, not just your house, but businesses and everything else.

Kyle: You say put a zero. Just to be clear, the five-year running average price in euros per megawatt hour in Germany and France is like 48. This winter is trading, so the next call it November, December, January, trade north of 1,000. You said put a zero on it. I would say you’re actually going to have to multiply it by 20 for a brief period of time, but for the year, you’re going to be right, put a zero, maybe multiply it by 1.15 instead of 10. If you had a $400 bill that turns into 4,000 or 6,000, you can’t possibly pay it if you’re an average citizen. The point about this is we’re going to see the social fabric of those societies, I think, tear and the frictions are there, and you’re going to see potentially upheavals that remove leadership in these countries because there’s a lash out as, you know.

Meb: The long arc of history for anything resource-related in more modern times just like a lot of macroeconomics, I mean, going back to the Arab Spring, that one’s fresh in everyone’s memory and crop prices, but also, you know, energy. I mean, my goodness, it’s hard to see how it doesn’t create that sort of environment.

Kyle: I agree. And you mentioned the Arab Spring, which was really about food availability and food pricing, and so, as Tiananmen Square in 1989, these were major events in major economies. I know you’re going to see more of that. But to put it in the numbers, Meb, we can put it in individual numbers, we’re going to put it in the macro numbers. Economies that are typically spending 1% of GDP on energy will be spending 8.5% percent and 9% on energy. That is such a major shift in the macro architecture of these countries, which will invariably cause meaningful recessions. And those aren’t solvable post-winter. These are multi-year problems.

Meb: We’ll just stick on the commodities complex real quick. You had a great phrase, I’m not sure where it came from but I thought it was very accurate, where you were talking about energy complex for the next decade, but was not that long ago when energy as a percent of the S&P, I think, hit like two down from a peak, at one point, of 30%. Energy, oil is trading negative. Energy company is really struggling. But then now, fast forward, we have politicians on Twitter all day long crying about how much the energy companies are making. And you had a quote where he said, “Will the fat shaming of oil companies stop?” So, talk to us a little bit about energy, your outlook, you’re a Texas guy. So, it’s like asking a Canadian about gold or something but come on, let’s hear your thoughts on energy complex.

Kyle: You know, you and I shared offline. Again, I’ll preface the statements I make with I’m actually an environmentalist at heart. I love our planet. I love being outdoors. I love having my family and friends outdoors. I love being a proper steward of our planet and the lands that we own. And I’ve always been that way. So, you can’t take this as someone that lives in Texas only focused on hydrocarbons. That being said, when I was talking about the fat shaming of both the banks and the oil companies, it’s all being driven by shareholders. It’s all being driven by corporate boards being pushed by the shareholders, right? This is not a regulatory crackdown per se. There are no regulators saying, “You can’t do this.” It’s just the preponderance of NGOs, the teenagers they hire to propagate these desires to go immediately alternative.

And the fat shaming of the banks is actually going to come into play by the end of this year. So, about 45% of the globe’s major banks have signed on to what’s called the Net Zero Initiative. And the Net Zero Initiative is the banks revealing their loan books, their assets, and their loan books as a percentage of green and percentage of call it black or hydrocarbon. And they’re all committing to getting to a net zero number in their loan books by a certain date, which further pressures big oil, big hydrocarbons, to get somewhere very quickly, because as you know, there’s a lot of project-level debt at these operations. Fat shaming the banks is the way to additionally turn the screws on big oil. So, you had shareholders doing it from a corporate board and shareholders’ perspective. Now, you have the banks engaged in the second ratchet at a point in time, in which I believe hydrocarbon stability is in almost every country’s national security.

I think energy security is national security. And there are many very energy insecure countries out there. And these policies are actually…they sound good, and you and I would say, “Hey, that’s a great goal to try to get to neutrality by 2040, or 2030, or whatever number you come up with.” The math behind it and the science behind it stipulates that there are decades in front of us where hydrocarbon demand will be inelastic and growing. Those two things don’t mix. They’re mutually exclusive of one another.

Meb: We had Peter Zion on the podcast a few months ago, and he kind of echoed your sentiments where he’s like, “Look, you know, there’ll be stressors throughout the world. The U.S. is in better shape than most but in some places,” and, in particular, he was focused on China, which I know you talk a lot about, he said it’s going to be really a problem. It’s always funny to see if the narrative, nothing like a 10X increase in electricity prices show the narrative changing in Europe of like nuclear going from be anti-ESG to oh, wait, this actually fits under ESG, and this fits clean. It’s just like a, you know, consistent head shaker but who knows?

Kyle: I think when you’re trying to understand in-depth, and you look back at the timeline of things, you know, Putin bought Gerhard Schroder back in 2004. When he was voted out of office in 2005, within days, he was chairman of Nord Stream 1, CEO of Nord Stream 1. Within couple of years after that, he became chairman of Rosneft, the biggest Russian oil company. And then 20 days before the invasion of Ukraine, he was added to the Gazprom board. Europe was sold to Russia back in the early 2000s. And that was Putin’s plan all along. So, Meb, one is being driven by this intense desire to be alternative. And those flames of the alternative energy SGW movement are being fanned by big energy, i.e., Saudi Arabia, Russia, all the players that have, Iran, you’ve talked about the narrative, that narrative was absolutely emphasized and magnified by the big oil players because they knew where it would get us.

Meb: We had Nathan Myhrvold on the podcast last year, and he was talking about their nuclear company and the struggles it has to even get some test production in place. And finally, it’s, I think, in Wyoming getting approvals.

Kyle: It is. It is actually going to open seven years from now, a little over seven years from now. And imagine if we have to wait seven years to actually kind of balance baseload power, those next seven years are not going to be good.

Meb: I wanted to spend some time chatting about new Fincher you’ve been focusing on the last couple of years, conservation equity management. Tell us what it is. Was this just a COVID project, you’re like, “Man, I’m stuck on the ranch looking out, sipping whiskey. Like, this seems like a nice place.” What was the origin for this idea?

Kyle: It’s a derivative of the macro thesis we just talked about. When I think about how to harness and avoid, harness my capital, our capital, my friends, my investor’s capital, my family’s money into an asset class that will stay ahead of the insidious inflation. But if you just look to CPI and the way things are calculated, it makes you feel a little bit better. If you think about in reality, the diminution of our purchasing power has been enormous. So, when I think about the next decade, what’s going to happen, I think the Fed will end up cutting rates in the next year or two. I think the Fed will end up having to expand its balance sheet yet again. I think the pattern is set. They can’t ever reverse that pattern, or we’ll just have years and years of just terrible, terrible deflation and debt-led busts that all the companies. They’re not going to ever let that happen.

So, then I look at the population trends in America. You see the movement from high tax, high-cost jurisdictions like the Northeast, and the West Coast, to pro-business, lower cost, lower or no tax jurisdictions like Florida, Tennessee, and Texas. And I believe that’s a secular movement. And I believe that’s just begun. It accelerated under COVID. And it had already been happening for about 7 to 10 years, population growth in the state of Texas was about twice what it was in the country on average for the last decade. And now, it’s probably going to be even more as a percentage. And, again, pro-business, low or no tax states. Rich people can move to Idaho and Aspen and have great houses but you can’t move whole businesses to those kind of luxury destinations.

So, you’re seeing companies move to more pro-business locations because housing is way more affordable. Growth is twice as good as it is anywhere else. If I think about the extrapolation of that trend, I get to a point where in those jurisdictions I just explained, within two-hour radiuses of major metropolitan areas that are growing at high single or double digits, I think rural land is going to appreciate. I think it’s inevitable, and I think as Elon Musk’s Starlink becomes real, you’re going to have full connectivity and full broadband in places that heretofore you may have been on a huge net satellite for a lot of money for two megabits. So, you’re going to be able to actually function in rural areas that are close to major MSA.

So, that is something where I think you’re going to see a decade or more of a trend of price appreciation, and it’s going to stay ahead of inflation. And on top of that, with that expansion, there becomes a shortage of land for residential expansion, for corporate expansion, and for industrial expansion. When those expansions happen, invariably, they’re expanding into coastal wetlands, people are going to have to build roads over streams, creeks, and rivers, and there’s going to be endangered species habitats that are actually affected. So, there is a way to merge this desire to be a good land steward and conservation with financial investing where you’re actually not giving up returns. That is just something where I saw it all coming together. I was talking with my partner in this business, Terry Anderson, and I said, “You know, why wouldn’t we harness this macro trend and do what we love doing on a daily basis?” Really extrapolating this trend and becoming one of the best call it environmental mitigation firms in the region. And he’s been doing environmental mitigation for 30 years.

Meb: Tell the audience who Terry is, how’d you meet him, his background real quick.

Kyle: He’s a forester and a biologist from Stephen F. Austin University, one of the top forestry colleges in America. Mitigation means, you know, let’s say the Panama Canal expanded a few years ago. That expansion now allows VLCCs, the largest ships in the world, very large container carriers to now navigate the Panama Canal. Heretofore they weren’t able to. Those deep draft ports in America typically are 42 to 45 feet deep to be able to accept those big oil tankers and big ships. The VLCCs need like 57 feet. So, all of the deep draft ports on the coasts are competing with one another to dredge, expand, and not only do you have to expand the depth of the water, you’ll have to expand the landing areas for the ships and the storage areas for the containers, and the rail yards, the services storage areas, all of those ports are expanding into coastal wetlands and endangered species habitats just by nature, they’re on a coast.

And when they do so, whether it’s a port, or whether it’s Elon Musk’s SpaceX down in the tip of Texas, those expansions impact those formerly pristine areas that are protected. And those impacts require you to build additional coastal wetlands in exchange for your ability to really infringe or damage the existing ones. And there’s a multiplier. Terry, my partner’s done that for 30 years.

Meb: Is that sort of a federal regulation? Is that state by state?

Kyle: Yeah, that’s a great question. So, mostly federal, and mostly the U.S. Army Corps of Engineers governs most of that U.S. Fish and Wildlife will govern the coastal wetlands. And then the EPA has a say, and then the states, so Texas Parks and Wildlife, and in California, states like California that have additional regulations, you have to satisfy all of the federal regulations and the state regulations. To your point, state by state in the state of Texas, Texas Parks and Wildlife plays in many of these decisions. But the ultimate arbiter of most of these situations is federal and it’s U.S. Army Corps of Engineers.

Meb: It’s one thing to go from, here’s this idea. It’s happy hour, we’re chatting about it. It’s another thing to actually put this into a real strategy. What was the beginnings of this? I know you guys have actually acquired a few different parcels. Maybe we could walk through Cherokee Ridge or any of these but how did this go from sort of idea to actual implementation?

Kyle: You’ll love this because it actually does involve a ranch and sitting on a porch drinking whiskey. Terry, my partner has done this environmental mitigation again for the last few decades. And he was working with a firm from the Northeast, handling their mitigation projects in Texas, and that’s how they increased their yield on their big timber management organization. This is how he really juiced the yields on just owning forest land, engaging in these mitigation projects. And Terry was doing a stream mitigation project, which is basically rerouting a very large stream, rebuilding, reintroducing the curvature of the city porosity and removing invasive species and replanting endangered species of plants and things like that.

The firm that was doing this did not want to own the land because back in the financial crisis, if you were engaging in this kind of investing, as you know, land prices I dropped a lot. I actually think the reverse. I want to own the land now. I stepped in personally to buy the land and participate in a percentage of that mitigation. And Terry and I were sitting on the porch, and we had just closed buying this particular place it was 1,700 acres roughly, I looked at him and I said, “Why wouldn’t we harness capital, our own capital, and not have Terry be an agent, but be a principal, and I’ll make him as a partner?”

He looked at me and smiled, and he said, “I’d love to do that”. And I said, “Well, I love nothing more than putting on my snake boots, and coming to these kinds of projects, and getting in bulldozers, and moving dirt, and earning returns that are non-correlated, I think, to the stock market,” that sounds like a great deal to me. It was one of those moments in time where all of my macro views and all of the micro activity from Terry’s perspective merged. And in my career when macro and micro mergers, that’s where you make the most money. And, also, it’s a labor of love. It’s a passion project, which from the day I graduated undergrad, I’ve been on Wall Street. That was 1992, waking up each day, and working on a 10-year to 14-year project, knowing that I’ll stay ahead of inflation over that term, and we’ll do things that create more beautiful land, wetlands, streams, creeks, and rivers than we started with. When you think about win-win, I think I’ve developed a win-win strategy. We’ve closed six transactions, we spent about $90 million so far in the first eight or nine months, some of these things are truly remarkable.

So, I’ll give you an example. We just closed on one that you’ll actually see there’s a story coming out on this one on, it’s called Chocolate Bay. It’s 40 miles south of the ship channel in Houston, on the coast. It’s 5,000 acres. We’re going to build almost 3,000 acres of coastal wetland there, probably one of the biggest coastal wetland projects in America. On projects like this, we’re also going to… We’re trying to develop right now a carbon sequestration area where we’re going to pump CO2 into the ground from some of the industrial emitters on the coast. And in the end, what we’re going to have is 5,000 acres of pristine coastal wetland that will be under a conservation easement that we can end up selling to a land steward or someone that wants 5,000 acres of birds and fish to go enjoy. Whether you’re a hunter or whether you’re a bird watcher, there’ll be nothing else built there. So, it appeals to me in so many different ways, and it’s really exciting to engage in projects like this.

Meb: There’s land appreciation, but these sort of what I would consider to be almost like alternative sources of yield. Are these return drivers…? I assume it’s very parcel specific, or are there like two or three you’re like, “Look, these are the main ones we’re targeting. Terry has been doing this, we identify projects that fit these one or two concepts.” What will end up being the main muscle movements? Because you mentioned some sort of potential revenue sources from some of these. Is there one in particular or what’s the main ones?

Kyle: It’s a great question. Each property is idiosyncratic. The one that I discussed, I’m very excited about that project because we are building a giant coastal wetland. We are going to engage in a carbon sequestration operation, either independently or with a major energy company there because it has the geologic structure that can handle that. And then we’re also going to create an endangered species habitat. We’ve got a giant cattle operation where we’re doing regenerative grazing on the property. And we also have recreational leasing. So, when you think about the revenue drivers on that property, those are they. On something like Cherokee Ridge that we bought from ExxonMobil, that is a giant carbon sink, i.e., it’s got upland and lowland, amazing, amazing places to conserve carbon and create carbon credits.

We’re also doing boutique forestry there. It’s one of the pine stands on that piece of property, hasn’t been touched since the 1920s. So, you imagine a piece of property where the trees have kind of grown all the way up and then grown to the ground, where the forest bottom hasn’t seen the light of day in decades. We’ll run controlled burns through there. Our first investor day, we gave investors drip torches, and we literally lit the forest on fire. And we did it in a controlled way. And our head of fire operations are one of the guys that we use is literally, his name’s Rip. He’s 70-plus years old, he wears overalls and all he does is light fires. Meeting characters like that is really exciting. But that type of operation there will be controlled burns. It will be lifting the value of the ecosystem where we plant wildflowers, we limb up the trees, we do some selective forestry, we call it boutique forestry, where we sell some of the lumber.

What that does is open up the forest floor for sunlight and it regenerates the succulents, which bring in the animals, the deer, the raccoons, everything comes back. This is super fun to do. It’s something you would do if you owned this property. And in the end, we buy things kind of broken forest land, and we’re going to sell them many years down the road to a land steward that wants to conserve and preserve that operation. We are not looking to create four houses per acre on every acre that we own. And what we’re looking to do is teach people how to be proper land stewards whenever we sell these things, whenever we’re finished with all the revenue drivers and the value of raising the ecosystems.

Meb: Who is the eventual buyer? Is it like Ted Turner? Is it organizations? Is it just family offices? What’s the spectrum of potential?

Kyle: We are very close to one of the top land brokers and real estate firms in the region, and their name is Republic Ranches. And it’s kind of a 5 partner, 50 person firm. They are the pulse of the market we’re talking about, call it land sales that are 1 to 2 million, 2 to 3, or 2 to 5, and then 5 and up. And so, when you ask who the buyer is, this is fascinating. In the last two years, the buyers had moved from being local to being half foreign or more, foreign meaning other states. Five out of six buyers are all-cash buyers. They’re not buyers that need financing.

So, what I believe is happening, Meb, and this is another reason why I believe it’s worth paying attention to is this type of investment in basic land and hard assets is becoming a real asset class to institutions, not only to family offices but to institutions. And you’re seeing it proliferate across the board. Some have done it for a long time. When you own a team or a timber investment management organization where you just own a forest, you’re hoping for a mid-single digits yield by clear cutting some of the lumber each year, and owning forest land, and taking the long view. What we’re doing is much more active. When you think about the ESG narratives today, we kind of talked about that earlier, you want to put on snake boots or mud boots, and you want to engage in a controlled burn or build a wetland, this is not green washing. We’re actually creating things. This is not putting… You run ETFs, Meb. The number one ESG ETFs largest holding happen to be Alibaba. They literally build the surveillance equipment that is running the genocide in Xinjiang. And you can’t even make that up.

So, a lot of these ESG mandates I know we’re starting to be regulated as they should be but some people are green washing and some people are actually engaging in raising the value of ecosystems and bringing about biodiversity. And, again, people pay for that, meaning, when we finish with something, it will have beautiful dirt roads cut through it. We’ll build lakes and ponds to fish in. We will have the forest floor just rejuvenated with life. And it will be an amazing second home. So, we asked who the buyer is. It’s people that are buying second homes. It’s people that are buying second homes as investments. And these things can range from 10 acres to 1,000s of acres of land. So, it just depends. It can be a small family and a small investment or it can be a very large investment for a majorly wealthy family.

Meb: Why are the current landowners not doing this? We talk about, you know, efficient markets and free markets. Is it a situation where either they don’t have the skill set or the resources or they just stress situation or it’s like a divorce or spin-off? What’s traditional…? I assume there’s not a zillow.com for giant land parcels in Texas. How do you come across these situations to where people aren’t doing this vision that you guys have?

Kyle: You’re asking great questions. This one is vitally important, I think, to our success. I sit on the board of the Texas Wildlife Association Foundation. I sit on the board of Texas Department of Public Safety Foundation. I’ve been here 42 years. I’ve built a lot of goodwill here. Terry, my partner, has been 30 years and dealing with the regulators, both state and federal regulators, has built a great reputation. We find the majority of everything we bought has been off-market.

And let me give you a few examples. There are a few families that still own land that date back to the Spanish land grants before Texas was a state, before we were actually a republic. Those families are incredibly wealthy landholders, but many of them, now that they’ve matriculated through generations, now, they’re lots of holders of land and they’re land rich and cash poor.

And so, what you see happening is you’ve got a scenario where typically beautiful big pieces of land like this only trade, you mentioned a divorce, either in divorce or death. And now, that you have the new generations coming up and many more owners, you’re starting to see some people that might be pliable or amenable to purchase but they actually don’t put things on the market. You have to know them, and you have to know what their family tree looks like, and who might want to be selling something like this. Also, the EMP companies, their boards are telling them that clearly they own the mineral rights because that’s how they pump the hydrocarbons, but many of them actually bought the surface rights, meaning they actually own the land. They’re not just owning the minerals.

Many of these companies, the big oil companies have owned land for 60-plus years, and their boards are now telling them, “Sell your surface land holdings and invest the money in renewable technologies.” A couple of broad mandates have been given to huge landowners in areas where I really want to own some land, and they sell it as just kind of unkempt forest land. Well, I think the highest and best use for what I’ve been sharing with you, the valuation differentials north of 100%, that’s interesting to me.

Meb: There’s a trend which you’ve hit on, which I think is only going to grow in a world of I don’t know if it’s 4, 6, 8, or 10 inflation, but it’s higher than 2, we did a post in the pandemic talking about, like, what is the safest asset. And if you look at 99.99% of people, the assumption is that it’s T-bills and accompanies to Treasury. The post we did looked at assets on a real basis. And it’s interesting, as you make the case, as a quant, which I am, that the numbers say that’s actually not the safest asset but rather, if you invest a portion of your “save assets” in a mixture of stocks and real assets and ends up being safer, and a higher yield to. So, this is obviously something that people wake up to when inflation prints 9%. But is the case when it’s low as well and in repression. Kyle, I’d love to keep you for a couple of hours. We’ll have to do this again sometime. I know you got to run before you leave us, we ask all the listeners what’s been and you got a lot, so you got to pick and choose, good, bad, in-between, but most memorable investment of your lifetime, doesn’t have to be career, it can be your lifetime, good, bad, in-between, what you got?

Kyle: I’m going to talk about the one that got away, memorable in which it was a successful investment, but my God, we missed the big one. At the back end of the financial crisis, we were doing the work. So, this is back end, meaning, late 2008 when everybody was finally figuring out that we were going to have a financial crisis. You know, we had been making those investments since call it July of ’06. For us, that was just something that had played out by then. I was talking about that transference of bad private assets, public balance sheets. And if you remember, the way those dominoes fell, you had Iceland, Ireland, and Greece, basically go right away between 2009, 2011.

The first Greek CDS position that I bought, I bought a billion dollars worth notional of Greek CDS, and I paid 11 basis points for it in 2008. That ended up being worth 80 points, do 800X. In this world of risk management, in this world of institutional investment in your operations, when you start winning on a very asymmetric bet like that, it quickly becomes a very big piece of your portfolio. Even if you believe that you’re going to see Greece default and actually lose 80 points of their 100 points of their bonds, when things went from 11 basis points to 100 basis points and you multiply that by the effective duration, which is call it four, four, and a half years, four, four and a half times the major asymmetric play where we made great money. And it became a large position.

And some of our institutional investors were saying to us, “Hey, that’s a huge risk now that it’s such a large percentage of the portfolio.” So, that’s where if it were your investment in your family, you’d say, “We got this. We think risk going to default, and we don’t need to worry about risk managing it from here.” When you get to institutional investors, they want to risk manage all the time. So, we close that position, at roughly, I think about 300 basis points running. So, we left 77 points on the table. So, when I think about… You asked me the most memorable, it wasn’t the most profitable in dollars. It wasn’t even close. But, for me, I will never forget that. I just wish we had the ability to hang on to that one.

Meb: We live in a world of big asymmetric outcomes and power laws. And we often say on Twitter, we poll investors, we say, “Do you have an investing plan for this trade when you place it,” 99% saying, you know no, or something. And most people assume it’s always going to be the worst-case outcome. What happens if a trade goes bad? But also, you know, when a trade goes great, and I feel like the VC Angel community kind of gets this because they see it more often in their world, but you got to plan for that. Because all of a sudden, like you said, you got this massive success. And when you have other people involved, it gets even more complicated too. So, a good problem to have.

Kyle: In that VC community, right, what they’ve also learned and they become so good at this is ride your winners and cut your losers. If you follow that strategy, you’re going to have some massively concentrated positions that may not be suitable in a public market setting for many investors. In a private market setting where you don’t have liquidity, that’s why it works because you can’t sell it many times. And that’s why those people make the money that they make investing in human innovation, which I think is one of the greatest investments there is. And from our perspective in our firm in the past, we have a great saying, we say, you know, the definition of a long-term trade is, it’s when a short-term trade goes bad. You have to be able to cut those quickly. You can’t just stick with them forever.

Meb: I love it. On that note, Kyle Bass, thanks so much for joining us today.

Kyle: Pleasure to be here, Meb.

Meb: Podcast listeners, we’ll post show notes to today’s conversation at mebfaber.com/podcast. If you love the show, if you hate it, shoot us feedback at the mebfabershow.com. We’d love to read the reviews. Please review us on iTunes and subscribe to the show anywhere good podcasts are found. Thanks for listening friends, and good investing.

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