Economy & Markets
Oct 16, 2025
Economy & Markets
Feb 8, 2021
Hydraulic Spacking
Michael Cembalest
Chairman of Market and Investment Strategy for J.P. Morgan Asset & Wealth Management
In this month’s note, we look first at the SPAC capital raising boom. Our main focus: returns to date for SPAC sponsors and investors, and the large wealth transfers taking place among SPAC participants. Second topic: Biden’s early stage energy policies (ban on new oil & gas leases on Federal lands, Keystone XL pipeline termination and conversion of Federal fleet to EVs) will probably end up increasing US oil & gas imports more than they reduce emissions.
MICHEAL CEMBALEST: Good Afternoon, everybody. This is the early February “Eye on The Market” podcast. This Eye on the Market this week is called “Hydraulic Spacking” because we want to talk about two things. First, the capital raising boom using the SPAC vehicles, and secondly, the reference of hydraulic fracking.
I want to take an early look at some of Biden’s energy policies which so far don’t seem to be in sync because they’re mostly about reducing oil and gas supply and not reducing oil and gas demand, in which case all you get is a rise in oil imports and no real change in emissions.
Anyway, let’s look at this SPAC boom. It’s pretty remarkable. Just to make it simple, a ‘SPAC’ is an alternative way for a private company to go public. Instead of doing a traditional IPO, a ‘SPAC’ is established through an IPO.
There are some sponsors. They hold the proceeds in cash and they have a couple of years to hunt around for a private company that they take public. And then there’s a snowflake-like array of different rules, regulations, disclosure, etc., in terms of how this all works.
The bottom line is that you’ve got a blind pool SPAC. Tons of them have been formed. Around 85 have completed their mergers and brought new companies public. There’s another 300 or so that haven’t completed the process or even found a merger partner yet. And we wanted to take a look at the results so far even though there’s way more SPACs to be completed than the ones that have been completed so far.
The bottom line is that some people are making a lot of money here because there are some wealth transfers and they’re large from some SPAC participants to others. SPACs might be a cheaper way for companies to raise money. We’ll talk about that.
And then my biggest concern is that the SPAC boom may simply end up bringing a lot of earlier stage, lower quality companies to market, and that might be the more lasting legacy of this whole thing. And, you know, every 15 minutes you’re reading about another celebrity that’s raising a SPAC, so I think that does tell you something.
Anyway, so in--on the first page of the piece we have a diagram here. Our piece is not a SPAC primer. You should look elsewhere if you want to see that. There’s plenty of law firms and investment banks that have published detailed SPAC primers, and if you’re going to invest in them you should probably read one of them just so that you know what all the rules are.
Instead, we wanted to focus on the performance and some of the basics that you need to know. So what are some of the basics? The SPAC market kind of revived what was a moribund new issue market in the U.S. and have been around half of all new IPOs by volume and number of deals over the last couple of years.
A lot of them are technology, electric vehicle, and health care companies so there’s a big growth bias there. And they tend to be pretty early-stage and unprofitable of--you know, way around three-quarters, maybe more, of all of the SPACs brought public so far were, you know, had negative free cash flow in their most recent financial statements.
Now, that’s not unique to SPACs. The IPO market last year, 80 percent of those IPOs had negative earnings as well, so risk tolerance for unproven business models is just very high right now. It’s what happens in an environment of low interest rates.
And we’ve actually built this thing called a “YUC model” where “YUC” stands for young unprofitable company. And we showed in 2019 how the share of new high-growth but unprofitable companies as a percentage of market cap had been rising to the highest level since 2000. We’ve updated the chart and it’s still rising and that, you know, obviously the SPACs are part of that.
And so anyway, read the piece if you want to see more about the rules. The bottom line is that there are four major SPAC participants. You know, five if you include the SPAC sponsor, right?
So the SPAC sponsor sets it up. Then you’ve got a group of investors that participate in the SPAC IPO itself. At that point they hunt around for a company. They find one. They sign a Letter of Intent and then they start--typically most of them are going to start talking to institutional money managers to arrange a private placement so they can close the merger.
And in case those up-front SPAC investors decide to redeem for cash, which is their right to do that, you’ve got the institutional money standing by to help you complete the merger and also to do larger deals. And then eventually you have the final retail investors who end up owning the new public company once the merger is complete.
So we went through each one and we computed the returns for the different SPAC investor types that we’ve identified. And we compare--we looked at the returns on an absolute basis and relative to other things people could have bought, such as traditional IPOs and the Russell 2000 Growth Index.
And what you tend to see is a real divergence. So first you’ve got the original investors in the SPAC and they do great. And I have to say, these are some of the most remarkable investments I’ve ever seen because you can sell in the secondary market before the merger if shares go up, or get your cash back if the SPAC prices decline.
So it’s kind of a very low-risk optionality for your money. And then you also get warrants in the new company that you can keep even if you redeem for cash.
In my experience, every time you see one investor class making tons of money relative to the risks that they are taking, that’s because other classes of investors and the issuers are paying for it, right? There’s no free lunch here.
So in my opinion what we have happening here is wealth transfers from all of the other participants in this SPAC universe and from the selling companies to juice up those returns of the original SPAC investor.
So we have a table here that compares all the different returns. For the up-front SPAC investors, who we call the SPAC garb investors, the returns look great. For all the other investors, the SPAC buy-and-hold investor, the pipe investor, the institutional money, the retail holder, the absolute returns have been great, but the relative returns relative to any IPO index they could have bought or the Russell 2000 Growth Index, most of those numbers, those median numbers are negative.
So, you know, and you have to remember in a rising market, rising tides lift all boats. So you’ve gotta take a closer look at the assumptions we’ve made and what we’re saying, but I think a lot of people feel great about the SPACs right now because they’ve made money in them.
If the people who are the buy-and-hold investors took a look at what they bought instead, they might see that they might have made even more money.
So, you know, we’ve got a lot more information here. We take a look at the question of whether or not SPACs are in fact a cheaper means of raising capital for companies going public. The early evidence suggests that they might be which is why the selling companies might be willing to give the SPAC sponsors such a big piece of the deal. Some of them get as much as 20 percent of the shares in the SPAC.
And then we’ve got a whole bunch of charts here that show you the growth in the SPACs and the sectors, redemption rates, and the low level of profitability of the companies that have been brought public so far.
So, yeah, take a look. The bottom line is that this looks like a vehicle for bringing new companies public that will stick around. But after this surge in SPAC activity fades and we get a chance to sit back and look at the actual performance of the companies that are brought public, I wouldn’t be surprised to see if a lot of them under-performed, other investments one could have made in traditional IPOs, and in the broad markets.
The second half of the Eye on The Market this week look at Biden’s early energy agenda. And there’s undoubtedly going to be more to come from the Biden administration. I mean they’ve barely had a month on the job.
That said, just like we looked at a preliminary basis on the SPAC market, let’s take a preliminary real world impact look at Biden’s early energy policies, and so far a lot of the policies are going to reduce oil and gas supply a lot faster than they reduce oil and gas demands.
And what you end up with in that case is a--just a modest rise in exports--I’m sorry, of U.S. oil and gas imports rather than any change in emissions. So let’s take a look just for a second.
The first major policy was a ban on new permits for oil and gas production on federal lands. So this doesn’t cancel any existing leases. It just means that as the existing wells become non-productive and get shuttered, they won’t be replaced.
That’s going to have a bigger impact on onshore production sooner than offshore because the life cycle of the onshore hydraulically fracked wells is, let’s say, 12 to 18 months where the offshore wells can, you know, can last for years if not decades.
So up front I think the impact is fairly small. Onshore production of oil and gas only accounts for around nine percent of total U.S. oil and gas domestic production. That said, if this moratorium were to stay in place forever, the larger amounts produced in offshore federal lands would add to the decline in production.
I think the more important point is what I said earlier. If you shut down oil and gas demand on U.S. federal lands and it’s not met by increased production on U.S. private lands, the gap simply is going to be imported unless you can enact policies that reduce oil and gas consumption just as quickly. And that we’re really not seeing yet.
Kind of a similar situation with the Keystone Pipeline termination. If you take 500,000 barrels a day of oil that were going to be exported by Canada to the U.S. and use standard refining conversions, you’d get about 3.5 billion gallons of gasoline a year that would have come to the U.S. from Canada.
Now if the U.S. were adopting electric vehicles at a sufficiently rapid pace, you wouldn’t care about this pipeline disappearing, and the emissions gains would be immediate but that’s not what’s happening.
If you make some basic assumptions about passenger cars, 3.5 billion gallons of gasoline every year would power almost 6,000,000 internal combustion engine cars. Last year only around 330,000 electric vehicles were sold in the U.S. So based on the current pace of electric vehicle sales, it would take 17 years to offset the loss of the Keystone Pipeline. In the meantime, the U.S. will simply be importing the oil that would have come from Canada from someplace else.
Now, the current pace of vehicle sales, I hope, will start rising more rapidly than it has been. A lot of the auto companies are announcing new models and, you know, and we’ll see what happens.
But EV sales in the U.S. have kind of been flat-ish for the last couple of years. Let’s see whether or not the Biden administration can do things to make those go up faster.
Here’s one thing to think about. In addition to the lost gasoline supply from the Keystone cancellation, you’ve also got around $2.5 billion of distillate fuels and 800,000,000 gallons of jet fuel that we won’t be getting which are, you know, the other components of refining crude oil.
And so those are other fuels that will need to either be produced domestically or imported from some other place other than Canada. And imagine the irony if Biden’s Keystone policy just ended up benefitting Middle East oil exporters and hurting Canada which is America’s, arguably, closest ally that has been reliably selling its oil and gas and hydroelectric and uranium supplies to the United States for decades.
Now, there was one policy we saw of the Biden upfront policies, and again there’s more to come, that does reduce oil and gas demand and that was the electric--the electrification, you know, EVs for the federal government agency fleet of vehicles.
The challenge here is that it’s only about 600,000 cars and immediately electrifying them would reduce U.S. gasoline demand by about 400,000,000 gallons a year. That’s a very, very small number compared to the 5.5 billion gallons a year that you lose from eliminating Keystone XL and eliminating onshore oil production on federal lands.
So, again, just to beat a dead horse here, the federal electric vehicle--the vehicle electrification policy reduces demand by a small amount and is dwarfed by the policies that reduce supply. And all you’re going to end up with is a lot more imports at some point, not a big change in emissions, unless you get some policies that reduce demand.
Now maybe those will come next. And at the end of the Eye on The Market this week we talk through what some of those would have to be. You would certainly have to increase the pace of investment and production tax credits for wind and solar power. You’re going to need, you know, either hundreds of billions, or trillions depending upon whose numbers you believe, to invest in transmission for increased wind and solar power and avoid curtailed renewable energy and remain--and maintain power reliability.
And something we’ve been writing about in the Eye on The Market energy paper for years: the federal government may need to exercise its imminent domain rights to prevent local politics and NIMBY activists from killing projects that are going to make this all work.
There was a Clean Line Plains and Eastern project to bring wind power from Oklahoma to the east coast. Arkansas killed it. There was--the most ridiculous example was the progressive enclave of New Hampshire killed a hydro-electric project from Quebec to the Northeast that’s simply going to result in more combustion of natural gas. And they did that because they thought the transmission lines would be a blight on tourism.
So I don’t know how you get to real demand reduction and displacement of fossil fuels if critical infrastructure and renewable energy projects can be killed by states like this. You know, and you--certainly Biden will probably reinstate the auto mileage standards revoked by Trump.
And so we walk through some of those things, but, you know, it’s very easy for a new administration to come in and do things to reduce supply. Reducing demand is another question entirely and this is something that we’re going to track as we evaluate and understand the Biden energy agenda.
Okay. That’s enough for this week. And thank you for listening and we’ll talk to you again soon.
[END RECORDING]
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