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Musings From the Oil Patch, February 14, 2012

Musings From the Oil Patch
Februaru 14, 2012

Allen Brooks
Managing Director

Note: Musings from the Oil Patch reflects an eclectic collection of stories and analyses dealing with issues and developments within the energy industry that I feel have potentially significant implications for executives operating oilfield service companies.  The newsletter currently anticipates a semi-monthly publishing schedule, but periodically the event and news flow may dictate a more frequent schedule. As always, I welcome your comments and observations.   Allen Brooks

State Department IG Report Clears Keystone Consultant Hire (Top)

Late last week the Department of State’s Inspector General (IG) issued his report on the possible conflict of interest in the selection of the environmental consulting firm that reviewed TransCanada’s Keystone XL environmental impact statement that was part of its application for a permit to construct the pipeline.  The IG ruled there was no conflict.  The IG’s investigation was conducted at the behest of several members of Congress in an October 26, 2011, letter.  The Congressmen wrote requesting the IG to “launch an investigation in the State Department’s handling of the Environmental Impact Statement (EIS) and National Interest Determination (NID) for TransCanada Corporation’s proposed Keystone XL pipeline.” 

In the IG’s review, it asked seven questions that it believed could be factually researched and determined as to whether the State Department met or failed the standards established.  The central question to the entire investigation was the following:

“To what extent and in what manner did TransCanada improperly influence the Department in the selection of a contractor for the EIS?” 

The answer was clear and a resounding endorsement of what TransCanada had said at the time the potential conflict was raised as a reason why the permit should be rejected.  Opponents of the Keystone pipeline claimed that TransCanada had hand-picked the environmental consultant and as such had tainted the State Department’s review process.  The company claimed it had nothing to do with the selection of the consultant and that it had no meaningful business relationship with the firm.  They said that the consultant was the best qualified and, having reviewed other projects TransCanada was involved in, was up to speed with the process and the best able to complete the review in an expeditious time frame, a position the State Department agreed with.

The IG’ report stated:  “OIG [Office of the Inspector General] found no evidence that TransCanada (the applicant) had improperly influenced the Department’s selection of Cardno Entrix as the Keystone XL EIS third-party contractor.  The Department followed the Federal Energy Regulatory Commission’s third-party contracting process, from reviewing, editing, and approving the draft request for proposal to independently reviewing proposals and selecting a contractor.  This process allows the applicant to influence the selection of the EIS contractor by (1) deciding which contractors will receive the request for proposal, (2) reviewing all proposals received in response to the request for proposal, and (3) forwarding to the Department the three ranked proposals to review. However, TransCanada’s influence was minimal, given the Department’s (1) control of the language in the request for proposal, (2) general familiarity with the environmental contractor community, and (3) independent review of proposals and selection of the contractor. A prime factor in the Department’s selection of Cardno Entrix was the Department’s previous experiences using the company as a third-party contractor for other EISs.” 

That statement clearly exonerates TransCanada and makes clear that the environmental review process was proper.  Opponents of Keystone have seized on a statement by the IG that there should be a review of and changes made to the entire process for selecting contractors to review these applications.  The problem in seizing on that statement is that it implies there is something wrong with the selection process of the Federal Energy Regulatory Commission (FERC) that oversees all the pipelines and new pipelines constructed in this country other than those few that cross international borders.  We thought it interesting that the IG is recommending changes in the State Department’s review division and the hiring of additional staff to oversee the process.  We wonder how many more trans-national pipeline projects we will be dealing with in the future that would justify establishing additional jobs in the State Department, or maybe this is the IG’s job creation contribution. 

Fossil Fuel Industry Should Prepare For Next Attack (Top)

We were intrigued by a recent column in The New York Times written by the paper’s health expert, Jane E. Brody, setting forth what we believe will be the next intellectual attack on the future of the fossil fuel industry.  The column, the first in a series of three planned, was titled, Communities Learn the Good Life Can Be a Killer.  The thrust of the article is an attack on suburbia and how it is contributing to unhealthful conditions, not the least of which is the need for greater personal transportation options.  Backhandedly, Ms. Brody’s article trumpets the benefits of urban living where high population densities can support lifestyles that emphasize greater use of mass transit and local food along with more walking and biking that will improve people’s health.  Implicit in the lifestyle changes will be reduced demand for fossil fuels.

Ms. Brody summed up a report and a television documentary series that she based her article on in this way: “...an alarmed cadre of public health experts says these expanded metropolitan areas have had a far more serious impact on the people who live there by creating vehicle-dependent environments that foster obesity, poor health, social isolation, excessive stress and depression.”  She goes on to characterize these “built environments” (as they are referred to) as “a leading cause of disability and death in the 21st century.”  They have become so because physical activity in them has disappeared and many communities are “’food deserts’ serviced only by convenience stores stocking nutrient-poor prepared foods and drinks.”  She cites the following statistic to support her thesis: “In 1974, 66 percent of all children walked or biked to school. By 2000, that number has dropped to 13 percent.” 

Ms. Brody quotes one of her prime sources, Dr. Richard J. Jackson, professor and chairman of environmental health sciences at the University of California, Los Angeles about healthy lifestyles versus what he sees as unhealthy communities.  As Ms. Brody wrote, “In a healthy environment, he said, ‘people who are young, elderly, sick or poor can meet their life needs without getting in a car,’ which means creating places where it is safe and enjoyable to walk, bike, take in nature and socialize.”  We sure wonder how Dr. Jackson gets around Los Angeles.

Just as the soft drink industry has been attacked for too much sugar in some of its drinks, and trans-fats have been outlawed from fast food menus, we see this healthy living case becoming the next socially-accepted basis for attacking and restricting the use of fossil fuels.  Obviously, we could write pages on this subject, but let this brief article be your warning that a new battleground over energy consumption currently is being established.  We will be revisiting this topic in future Musings.

Is Punxsutawney Phil A Weather Forecaster Or Charlatan? (Top)

On February 2nd, thousands of people, including Governor Tom Corbett, gathered at Gobbler’s Knob in Punxsutawney, Pennsylvania to see what a hibernating groundhog would tell them about the weather for the next six weeks.  The infamous Punxsutawney Phil, as the groundhog is known as, after being rudely extracted from his dark and warm den, was blinded by the clear weather and promptly sought to retreat.  By tradition, having seen his shadow, Phil was predicting another six weeks of winter, something the crowd was not happy to learn. 

 

Exhibit 1.  Sleepy Phil Performing Annual Task
Sleepy Phil Performing Annual Task
Source:  Associated Press

The National Climatic Data Center, a part of the National Oceanic and Atmospheric Administration (NOAA), issued an analysis of Phil’s winter weather forecasting record.  The agency’s release stated, “The table [a comparison of Phil’s prediction to departures in average temperatures for February and March] shows no predictive skill for the groundhog during the most recent years of this analysis.”  So there you have it folks – Punxsutawney Phil is no better than your local television weatherman.  Phil also has another problem; he is not as good looking as most of the weather people, especially the female ones! 

According to Phil’s forecasting record for 1887 to 2011 produced by the Punxsutawney Groundhog Club, he saw his shadow 99 times meaning six more weeks of winter while not seeing it merely 16 times.  There was no record of what Phil predicted in nine of the years during that span.  In assessing the record, the National Climatic Data Center went to great lengths to show how Phil’s predictions compared with the departure in average temperature for the subsequent two months during the period 1988-2011.  In the Center’s discussion of the results, however, it only reported on the results since 1993, but it produced a table showing individual year results beginning with 1988.  According to the release, the U.S. national temperature since 1993 has been above normal 10 (13 since 1988) times in February, 11 (16) times in March, below normal six (eight) times in February, three times in March and near normal three times in February and five times in March. 

With a forecasting record such as that, why would anyone believe in Phil’s predictions?  The reality is that we don’t know how accurate Phil really has been since his predictions are “incapable of error” according to his handler because he is never site-specific in his prognostications.  As Phil’s handler put it, “I guarantee you someone’s going to have six more weeks of winter.” 

The release also focused on the history of this groundhog in light of the tradition of forecasting the duration of winter.  Groundhog Day has its roots in the ancient celebration of the mid-way point between the Winter Solstice and the Spring Equinox.  The belief was that fair weather at that point was a precursor of a stormy and cold second half of the winter.  The early Christians in Europe celebrated Candlemas Day, when the clergy would bless candles people would place in their home’s windows to ward of the darkness of the winter.  This celebration was captured in the old English saying:

If Candlemas be fair and bright,
Winter has another flight.
If Candlemas brings clouds and rain,
Winter will not come again.

In 1887, the city editor of the Punxsutawney Spirit newspaper, Clymer H. Freas, wrote about a group of local hunters who went after groundhogs around this time of the year and then celebrated with a barbecue after their hunt.  Guess what was on the menu.  Mr. Freas dubbed them the Punxsutawney Groundhog Club and he promoted the local groundhog as the official weather forecaster.  Over time the legend grew and was continually embellished.  The Climatic Center went on to demonstrate how Phil’s prediction last year wasn’t very accurate using Exhibit 2 and 3 charts that show 2011 temperature departures by state for February and March. 

Exhibit 2.  Slightly Cooler National Temps
Slightly Cooler National Temps
Source:  NOAA

We were struck by the amount of effort NOAA gave to demonstrating the poor weather forecasting record for Phil.  The same can be said about your local meteorologist employed by television stations.  Then it dawned on us why the attack on weather forecasters by NOAA.  It is part of a broad effort by supporters of climate change within the agency to help the effort of a new website, Forecast the Facts, which went live on the Sunday in January that

Exhibit 3.  Slightly Warmer National Temps
Slightly Warmer National Temps
Source:  NOAA

the American Meteorological Society (AMS) began its annual meeting, to call out 55 television meteorologists for their denial of climate change.  The web site was also pushing to get the AMS to change its stated position on climate change.  Based on research into the backing for the web site, the belief is that it has sprung up from groups supported by investor George Soros, who is an enthusiastic backer of organizations pushing for the adoption of governmental policies to regulate carbon emissions, among other global social and economic regulations.  The web site and its supporters are targeting television meteorologists based on the results of a 2010 survey conducted by George Mason University’s Center for Climate Change Communications.  Its survey found that 82% of broadcast meteorologists believe that global warming is happening, but the two largest groups of believers do not believe that man is the primary cause of global warming.  Because of this

Exhibit 4.  Weathermen Are Skeptical Of AGW
Weathermen Are Skeptical Of AGW
Source:  George Mason University

skepticism of anthropological global warming (AGW), climate change supporters believe broadcast weathermen are preventing the “global warming truth” from being correctly presented to the public. 

Since NOAA believes in global warming and provides a substantial amount of the data and information utilized by weathermen in preparing their daily forecasts, by not supporting and spreading the mantra, these messengers are hurting the cause and should be made to “toe the line” or get out of the way.  Tim Heller, KTRK Channel 13 chief meteorologist told The Houston Chronicle, when queried about the issue, “You wouldn’t ask your dentist about your gallbladder and you shouldn’t ask your local TV weatherman about climate change.  Operational meteorologists and forecasters are not climatologists. The background education is somewhat similar, but our area of expertise is different.  Unfortunately, that doesn’t stop some TV weather forecasters from spouting off on the subject.”

Our sense is that the debate about global warming is far from over, contrary to Al Gore’s belief.  The initial shift in focus by environmentalists from global warming to climate change and now to extreme weather events suggests the movement is grasping for any sensational issue to rally their supporters, and in particular, to keep the government funding flowing.  That is becoming harder to accomplish, unless it is helped by the mainstream media.  A couple of weeks ago, ABC evening news anchor, Diane Sawyer, presented blatantly false information about whether the government issued tornado warnings in Alabama before 25 funnel clouds touched down.  Her report helps motivate the public and politicians to clamor for more spending on climate change research and greater regulations on traditional energy sources in order to mitigate these deadly storms.  Unfortunately, NOAA had issued numerous warnings well in advance of the storms.  Fear, however, is a prime motivator to get people to change their behavior, witness our willingness to proceed zombie-like through TSA screening lines at airports since 9-11.  But when the motivation is based on faulty science and incorrect information, the truth will ultimately win out.

Can’t People Find A New Way To Regulate O&G Industry? (Top)

On January 18th, Representative Denis Kucinich (D-Ohio), along with five liberal Democrats in the House of Representatives, introduced a bill that displays not only a lack of understanding about the basics of business, but also champions some of the most failed government economic policies of the past 40 years.  The bill, H.R. 3784, otherwise known as the “Gas Price Spike Act of 2012,” would, as its preamble sets forth: “…amend the Internal Revenue Code of 1986 to impose a windfall profit tax on oil and natural gas (and products thereof) and to allow an income tax credit for purchases of fuel-efficient passenger vehicles, and to allow grants for mass transit.”  For this group of politicians, profits are as dirty as the crude oil they are derived from.  While the preamble sets forth the premise of regulating energy industry profitability, the proposed mechanisms in the bill demonstrate the worst of a social engineering mandate. 

The premise of the bill is the mantra that fossil fuels are bad and the “excess” profits they produce should be confiscated by the government and handed over to the buyers of politically-correct, fuel-efficient vehicles and the operators of mass transit systems.  What’s worse about the policy is that not all fuel-efficient vehicles would benefit, only those assembled in this country by union labor. 

So just what are “excess” profits, or for that matter “reasonable” profits?  To answer those questions, we would have to await the determination by the Reasonable Profits Board, which would be a three-member board appointed by the president for three-year terms.  (Sounds like Rep. Nancy Pelosi and Obamacare.)  Once they figure out what is an acceptable profit for the oil and gas industry, the law would levy an excise tax of 50% of the excess profits between 100% and 102% of that reasonable profit measure.  For excess profits between 102% and 105%, the excise tax would be 75%, and anything above 105% would be taxed at 100%. 

One of the requirements to serve on this board is that you don’t work in the industry.  We would hope, however, that the members would at least understand business and the respective measures of profitability.  That might stand in contrast with many of President Obama’s economic and cabinet appointees.  What should be the test of “reasonable” profits?  Should it be the absolute dollars?  Or maybe it should be the company’s profit margin percentage.  There is also a case to be made that profitability should be measured based on return on equity.  Whichever measure is used, there will be problems in determining what’s reasonable, since reasonableness should be based on the capital needs of the industry. 

Exxon Mobil Corp. (XOM-NYSE) generated a 9.1% profit margin last year, but that was over two percentage points below the margin of Chevron (CVX-NYSE).  More importantly, while those oil company profit margins exceeded those of GM (GM-NYSE) and Ford (F-NYSE) at 6.6% and 5.1%, respectively, Apple (AAPL-NYSE) had a 25.8% margin, Microsoft’s (MSFT-NYSE) was 32.6%, and Google’s (GOOG-NYSE) was 25.7%.  So why should oil companies be punished given their low profit margins?  Just because ExxonMobil earned $41.1 billion last year and Chevron $26.9 billion, admittedly very large numbers, they were nowhere near as profitable as some of our high tech powerhouses.  If you look at return on equity, Apple (45.6%) and Microsoft (41.7%) were way more profitable than ExxonMobil (26.8%) or Chevron (11.4%). 

We know, we’ll devise a new “Buffett rule.”  Berkshire Hathaway (BRK.B-NYSE) for the twelve months ended September 30, 2011, earned $11.6 billion in net income.  The problem is that its profit margin was only 8.2%, only besting the beaten up auto companies.  On a return on equity measure, Berkshire Hathaway only mustered a 7.6% performance, coming in last among all these companies.  No Buffett rule here.  Even GM had a 26.2% performance through September, but then again it had all its debt stripped away by the Obama administration’s restructuring (we won’t use the term bankruptcy).  A recent article in The Wall Street Journal pointed out how GM hopes to report profits of $8 billion for 2011, a nice recovery, but then again the article pointed out that the company is not paying any taxes as a result of its bailout.  (Above figures from Yahoo Finance.) 

Exhibit 5.  GM Is Making Strong Profit Recovery
GM Is Making Strong Profit Recovery
Source:  The Wall Street Journal

What gets lost in this populist assault on the oil and gas industry is its size and capital-intensive nature.  Last year, ExxonMobil generated $453 billion in revenues while its major U.S. competitor, Chevron, earned $236 billion.  These numbers compare to Apple’s $127 billion, Microsoft’s $72 billion and Google’s $38 billion.  The two auto companies – GM and Ford – were similar in size to Apple at $149 billion and $134 billion, respectively, but more importantly, they are comparable to Berkshire Hathaway’s $142 billion in revenue.  Because the oil companies are so large, their profit numbers are going to be large even with modest profit margins.  To punish them due to their absolute size would be akin to requiring all National Basketball Association players over 6-feet 10-inches tall to have to wear 10-pound ankle weights during games to counter their height and ability to jump. 

Assuming there are excess profits to tax, where would the funds go?  First, they would go to buyers of fuel-efficient passenger vehicles.  Buyers would get a $3,000 tax credit for a vehicle with a fuel-efficiency rating within 10% of the most fuel-efficient vehicle.  Buy a car with a rating within 5% of the most fuel-efficient and you would get $4,500.  But if you buy a car that gets at least 65 miles per gallon, you get a $6,000 tax credit.  This latter category would include all the electric vehicles, some hybrids and a select number of very small cars, many of which have been arbitrarily assigned very high mileage ratings. 

The most interesting point in this section of the legislation is the definition of what is a Qualified Passenger Vehicle.  While that classification includes measures such as having been purchased after the effective date of the legislation, being first used by the owner and only for personal and not business use, the car has to be American-made.  Moreover, as subparagraph B of the section states, a qualified car is one “which is assembled in the United States by individuals employed under a collective bargaining agreement.”  Assuming you want this tax credit, your vehicle shopping list will be limited to models from Chrysler, Dodge, Jeep, Ford (F-NYSE) and General Motors (GM-NYSE).  You also could choose from Mazda Motors’s (MZDAF.PK) Mazda 6 and Tribute models and Mitsubishi’s Eclipse.  Otherwise, you’re out of luck. 

Any left over money collected can be given out by the Secretary of Transportation to operators of mass transit systems to help them reduce fares during gas price spikes.  Mass transit means rail and bus systems, but the grants are made on a fiscal year basis and remain in effect until funds are expended.  Nowhere in this bill is there a definition of a gas price spike – so we guess it has already happened.  Without a definition, we wonder what happens if oil and gas prices decline? 

The Lima News in Lima, Ohio editorialized that Rep. Kucinich’s bill would do little but guarantee the return of gasoline lines such as the nation experienced in the 1970s.  Those lines came partly as a result of the shocks to the petroleum system from the quadrupling of crude oil prices following the Arab oil embargo after the Six Day War in 1973, and the Iranian Revolution and capture of American hostages in 1978.  The reactions to these events prompted politicians to become involved in directing how the flow of oil and gasoline moved in this country and controlling product prices to protect consumers.  That meddling in the business produced little more than long lines of cars at gasoline stations and restrictions on the amount one could purchase on a visit. 

The reason for the gasoline lines was that the government relied on population statistics to allocate gasoline volumes.  As these statistics were notoriously late, and especially before the widespread use of computers, gasoline volumes were always allocated based on historical population measures that were out of date.  The only question was just how out of date they were.  The statistics failed to capture the mass population migration from the Rust Belt states to the jobs Mecca of the oil producing states.  As a result, states like Ohio and Michigan had areas swimming in gasoline and no lines while Dallas, Houston and Tulsa, to name a few oil-centric cities, had horrendous gasoline lines and rationing.  The experiments of regulating the industry proved that bureaucrats didn’t have the ability to anticipate demand changes and their regulations masked the price signals that appropriate allocate petroleum products. 

A different situation occurred in the 1980s after the Iranian Revolution when President Jimmy Carter signed into law the Crude Oil Windfall Profits Tax Act.  That law imposed a 70% excise tax on the amount of an oil sale price exceeding $12.81 per barrel.  According to the Congressional Research Service, domestic oil output declined by 3%-6% and oil imports rose by 8%-16%.  Due to the recession’s impact on the economy, oil demand fell, bringing oil prices down and causing the tax to generate very little revenue. 

With this bill, Rep. Kucinich and his band of followers have committed the folly of planning to repeat history because they haven’t taken the time to know their history.  As a result, they will prove Albert Einstein’s definition of insanity correct – repeating the same thing over and over and expecting a different result.  We are not sure which is the worse criticism - the claim of insanity or of ignorance?  These politicians clearly don’t understand anything about business, only about politics, and for that Americans will suffer. 

Democrats To Alter Decades Of Regulation For Keystone (Top)

After the latest rejection of the construction permit for the Keystone XL pipeline by President Obama, he has come under blistering attacks not only from Republicans, but also from many liberal Democrats who see the rejection as a slap at a job creation opportunity.  As Congressional Republicans mount efforts to attach riders mandating approval of the permit to new legislation, Democrats have begun to attack the proposition that the oil, once it reaches the Gulf Coast, will all be exported, thereby doing little for the energy security of the United States. 

Democrats want to pass legislation restricting the export of this oil hoping that will kill the justification for the pipeline.  It would be nicer if the objective of the Democrats’ legislation was to force Gulf Coast refiners to use oil sands output to displace the heavy oil currently imported from Venezuela and Mexico.  The Democrats’ idea to bar exporting the oil would challenge the history of common carrier regulation of pipelines in that it would force the owner of the pipeline, TransCanada Inc. (TRP-NYSE) to restrict the oil’s export.  As the owner and operator of a common carrier pipeline, TransCanada never takes ownership of the oil, but rather just transports it for oil producers from the point of origin to a distribution point near their customers’ refineries along the Gulf Coast.  For providing this transportation service, the pipeline owner is paid a fee, which is regulated by the government based on an approved return on the investment needed to construct the pipeline. 

The rationale for building the Keystone XL pipeline is demand by Gulf Coast refiners who want to obtain greater volumes of oil sands oil to fuel their expanded plants.  The Democratic effort to stop the pipeline is based on the view that the country needs to have this export restriction in place before they would consider allowing the line’s construction.  Representative Markey (D-Mass), who sponsored the bill to halt the export of Keystone’s transported oil said, “You can’t sneak a 1,700 mile pipeline past the American people, and you shouldn’t be able to sneak the oil out of the United States either.  Other countries shouldn’t be allowed to bisect our country with a pipeline and then bypass our citizens to send the oil abroad.” 

To bolster their case that this is exactly what the oil industry will do with the output, the Democrats have seized on a response by Alex Pourbaix, President, Energy and Oil Pipelines for TransCanada, when he testified before the House Energy and Commerce Committee last December.  In that exchange, Rep. Markey tried to get a commitment from Mr. Pourbaix that TransCanada would include a clause in its transportation contracts to prevent the export of the oil.  Mr. Pourbaix responded, “No, I can’t do that.  We’ve already agreed to our shipping arrangements.” 

A spokesman for TransCanada, Shawn Howard, amplified on Mr. Pourbaix’s statement.  “We have been very clear: Keystone XL is not an export pipeline.  Our customers approached us to build Keystone XL because they need the oil to maintain operations at their refineries.  TransCanada does not own the oil that is produced and delivered to our customers.  Rather, we are simply hired to safely move the oil from one point to its final destination.”  This is no different than if the oil were transported by railroad tank cars.  Thereto, the customers would be contracting with a regulated transportation company (a railroad) and would pay a regulated fee.  Railroad transportation is less safe than a pipeline, but neither regulated business can restrict their users from disposing of the oil any way they want.  Because certain influential Democratic supporters are anti-fossil fuels, is it right for the government to try to selectively overturn the century-old common carrier regulation of this industry in order to foster their anti-oil agenda?  Oh yes, I forgot, these are the same people who dismissed the nation’s bankruptcy law precedents in order to restructure General Motors the way they wanted to while rewarding their union supporters. 

Societal Pressures Put Economies And Recovery At Risk (Top)

A year ago at this time, the world was mesmerized by the events then unfolding in North Africa and the Middle East now referred to as the Arab Spring.  In Sidi Bouzid, Tunisia, 26-year old Mohamed Bouazizi, struggling to feed his family and frustrated by the lack of jobs available and harassed by the police as he tried to earn a living selling merchandise from his street cart, gave up.  In desperation he set himself on fire, suffering burns over 90% of his body before the flames were extinguished.  Amazingly he did not die in the fire, instead he spent the next 18 days in various hospitals fighting to live before succumbing to his burns.  While in the hospital, he was visited by Tunisia’s then-President Zine El Abidine Ben Ali who promised to send him to France for special burn treatment, but that never happened. 

Mr. Bouazizi’s self-immolation immediately sparked protests in Sidi Bouzid.  Those protests became increasingly violent over the next two weeks.  The protests grew and spread to Tunis, the capital city.  The demonstrations and international political pressure ultimately forced the president to escape the country and flee to France.  Pictures of the demonstrations and the government’s military response, captured by cell phones, spread globally triggering copycat self-immolations and demonstrations in other Middle East and North African countries.  The wave of protests throughout the region ultimately led to regime changes in Tunisia, Egypt and Libya, and political and social concessions in several Middle East countries.  The Arab Spring ushered in by Mr. Bouazizi’s death, brought hope for more democratic governments, improved social conditions and better economic conditions for the populace throughout the region.  A year later, however, only a minor portion of these improvements have been accomplished.

One of the forces that held back economic progress in the MENA (Middle East and North Africa) region has been high unemployment, especially among the youth of those countries.  Economists and politicians are now focusing more intently on how to stimulate job growth in an effort to ease this problem.  Twelve months after the Arab Spring, the mainstream media has begun to pay attention to the issue.  In fact, Lucy Kellaway who writes the weekly Business Life column in the Financial Times penned an article based on an item about young people and job prospects she discovered on the World Economic Forum (WEF) web site.  That item was related to a contest for people to write an essay on the topic of youth unemployment.  The topic was prefaced with the following statistic: “In the next 10 years there will be 1.2 billion young people looking for work and only 300 million jobs available.” 

What Ms. Kellaway found as she reached for her pen was the essay contest was for the Young Global Shapers Community, which happens to be “extraordinary individuals” in their 20s and 30s.  She went on to write in her column, “Yet however extraordinary these people are, I guarantee their essays will be no good.  The young shapers have been given the title: ‘What can I and the global community do to create jobs for my generation?’, but there is nothing much any of them can do – because we old shapers are in the way.”

Ms. Kellaway summed up her solution to the problem in one word – resign.  She pointed out that “The youth can’t advance because everywhere they find my complacent generation is in situ.  Thus the only way of solving the problem is to make everyone of a certain age, say over 50, walk the plank.”  Part of her argument is that the older generation has had it good financially for many years so now they should stand aside.  She argues that by making this move, economies would benefit because not only would more jobs be opened up for these youths but there would be a decline in wages, which amazingly could also solve the executive pay problem. 

The arguments against Ms. Kellaway’s plan rest on the loss of experience for companies and their need to retain those “good” people who have risen to the top of the job pile.  To that she responds, “…experience can be overrated; in any case, I’m not advocating giving huge jobs to children, but to those in the 40s, who have 15 or 20 years’ experience, which is surely just as good as 30 or even 40.”  For those star employees at the top of the totem pole, she is willing to “bend the rules to let some ageing superstars – of whom there are very, very few – stay on.” 

While the Davos-based WEF essay competition is an interesting exercise, and certainly Ms. Kellaway’s column an intriguing proposition, just how bad is the youth unemployment situation and what could it mean for economic growth and energy demand?  Unemployment is a drain on economic growth.  Coupled with population growth these represent the two primary forces driving global energy consumption.  That relationship is shown in Exhibit 6.

Exhibit 6  1965 to 2003 Energy, GDP and Population
Energy, GDP and Population
Source:  http://www.paulchefurka.ca/WEAP/WEAP.html

A problem with this equation is that global population growth has exploded over the past 31 years having risen from 4.4 billion people in 1980 to 7 billion last year.  According to one population web site, of all the people who are estimated to have ever lived on this planet (110 billion) a little over six percent are alive today.  The United Nations population division projects that by 2100 there may be upwards of 10 billion people living on the planet.  Other interesting population trends presented by the UN are that the poorest countries are growing the fastest and that due to increases projected in life expectancy, from 68 years now to 81 by 2100, the global population is rapidly ageing.  In low-fertility countries, 11% of the population is now 65 years or older, and that figure is expected to rise to 26% by 2050.  On the other hand, in high-fertility countries, that older population represents only 3% and will only climb to 6% in 2050. 

Exhibit 7.  World Population Growth Through History
World Population Growth Through History
Source:  www.vaughns-1-pagers.com

In a very recent report, World Youth Report, issued by the UN Department of Economic and Social Affairs (DESA), comments and observations from youths were included.  These youths expressed concern over the lack of job opportunities, inadequate education, vulnerable working conditions and inefficient government investment.  As DESA points out in its press release on the report, since the start of the global economic crisis, young people have faced particularly difficult times moving from schools to jobs.  In 2010, following the financial crisis and recession, the world experienced the largest increase on record in youth unemployment as 75.8 million were identified as unemployed.  The youth unemployment rate that year was 12.6% compared to 4.8% for adults.  The swelling of the unemployment rolls with global youth creates not only economic challenges for countries but also increases the risk from societal problems.  One impact highlighted by a 2011 International Labor Organization report was the growing number of youths who have dropped out of the labor force because they cannot get or hold jobs.  The frustration about their employment prospects has led to unrest among the youth.  Numerous countries have experienced riots fomented largely by these frustrated and unemployed youths seeking revenge against the system, i.e., the government.  These youths were often photographed looting stores for goods they couldn’t afford but felt entitled to.

Exhibit 8.  Unemployed Youths Are Dropping Out
Unemployed Youths Are Dropping Out
Source:  International Labor Organization

To appreciate the issue of youth unemployment and its negative implication for economic growth and increased social unrest, one need only look at the historical trends in Western Europe and the United States.  Unemployment rates late last year among youths in the various countries composing the European Union ranged from slight under 8% to nearly 49%.  The countries possessing the lowest youth unemployment rates were Denmark, Austria and the Netherlands.  At the other end of the spectrum are several of the countries in the worst financial shape including Spain, Greece, Portugal and Italy, along with several smaller countries such as Slovakia, Lithuania and Latvia. 

Exhibit 9.  Youth Unemployment Rates In EU
Youth Unemployment Rates In EU
Source:  Eurostat

A significant problem for these unemployed youths is that in many cases the overall unemployment rate for their country is also high suggesting a structural employment problem.  The countries with the highest youth unemployment rates – Spain and Greece – had rates about twice their country averages.  Surprisingly, even those with the best youth unemployment rates reported similar ratios.  Austria, for example, had a youth unemployment rate of 8.3% while nationally the country’s unemployment rate was 4.1%.  This merely demonstrates the difficulty all economies in Europe have had in creating jobs, not merely for their youth.  The impact of declining participation in the labor force by youths is shown in Exhibit 10.  The reported unemployment rate is often well below the actual rate when the labor force data is adjusted for discouraged youths who have quit looking for jobs and instead spend their time in the underground economy or engaged in illegal activities.

Exhibit 10.  Bad Times Drive Youths Out Of Labor Force
Bad Times Drive Youths Out Of Labor Force
Source:  International Labor Organization

The United States is experiencing a similar youth unemployment problem, especially given the weak economic recovery.  The positive employment report for January announced a week ago still leaves nearly 3.5 million Americans between the ages of 16 and 24 unemployed, or 19.9% of that population segment.  That is more than twice the overall unemployment rate, and remains stubbornly high.  We know that the January unemployment rate was helped by 1.2 million fewer workers in the labor force, but we don’t know how many of them were in the youth category and the impact that may have had on its unemployment rate.  What we do know is that the youth unemployment situation today is the worst it has been since the end of World War II.

Exhibit 11.  U.S. Youth Unemployment At Record Peak
U.S. Youth Unemployment At Record Peak
Source:  Bureau of Labor Statistics

The high unemployment rate is both a result of and a contributor to the slow economic growth being experienced globally.  The latest economic growth projections from the International Monetary Fund (IMF) are lower than their prior ones.  As Exhibit 12 shows, the world’s economy, including the emerging and developing economies that are experiencing the highest rates of growth, are all growing slower than before the financial crisis and during the immediate rebound.  The IMF now is estimating global GDP growth to average 3.3% in 2012 and 3.9% in 2013.  These estimates are -0.7% and -0.6% below the prior forecasts made in the fall of 2011.  Advanced economies that include the Eurozone, the United States and Japan are projected to grow by only 2.1% this year and 1.9% next.  While the U.S. growth forecast was not reduced for this year, it was cut by 0.3 percentage points to 2.2% for 2013.  The largest advanced economies reduction was for the Eurozone, which is now projected to be in recession this year with a negative 0.5% growth, to be followed by only 0.8% growth in 2013, which was cut by 0.7%. 

In the emerging and developing economies group, growth is forecast to be much stronger than the rest of the world.  In 2012, this sector is projected to experience 5.4% growth followed by 5.9% growth in 2013.  However, even these growth rates were reduced by 0.7% and 0.6%, respectively.  China, the global economic growth star, is forecast to have only 8.2% annual growth this year, a full percentage point below its growth in 2011.  In 2013, China is expected to grow by 8.8%, but that is still below the 9.2% of 2011 and the 10.4% of 2010.  The 2013 economic rebound for China is in keeping with the IMF’s view of overall economic trends that call for meaningfully higher growth for all the major economies and economic blocks in the world.  Even though there would be healthy growth in 2013, the levels are still below those posted in the pre-financial crisis period.

Exhibit 12.  Economic Growth Estimates Reduced
Economic Growth Estimates Reduced
Source:  International Monetary Fund

The weak global economic growth in the fourth quarter of 2011 contributed to oil consumption falling by 300,000 barrels per day, the first quarterly year-on-year demand reduction since the tail-end of the financial crisis.  Due to both a lower starting point for 2012 and factoring in the reduced economic growth projections, the International Energy Agency (IEA) has cut its global oil demand growth forecast to 1.1 million barrels per day (mmb/d) from the prior projection of a 1.3 mmb/d increase. 

While Ms. Kellaway may believe that the solution to the global youth unemployment situation is for the older generation to merely step aside, it is hard to imagine how that would work and more importantly, whether the theoretical boost to economic growth that should follow a lowering of wages would actually occur.  This is especially important when one looks at youth unemployment rates by region of the world. 

Exhibit 13.  Africa Is Home To Most Unemployed Youths
Africa Is Home To Most Unemployed Youths
Source:  International Labor Organization

Given the history of global population growth by age category and the projections for the future, relief for our youth anytime soon doesn’t appear likely.  The risk to the system is that without some radical action to improve the outlook for these youths, they will become a huge and permanently disaffected group that may be prone to seek relief in the streets. 

What our youth unemployment picture suggests is an economic future that will be tested by the needs to find ways to employ this disaffected group or run the risk of an era of global unrest and violence directed against governments.  The Arab Spring may have only been chapter one in what may be a long saga of government overthrows and demands by the populace for economic help.  Finding a path to gainfully employ the unemployed youth of the world could produce significant economic growth with a growing demand for energy.  The alternative scenario means slow economic growth with a minimal increase in energy consumption.  For

Exhibit 14.  Youth Not Helped By Population Growth
Youth Not Helped By Population Growth
Source:  UN DESA

everyone’s benefit, the former outlook is preferable to the latter.  Achieving that growth, however, will be neither easy nor simple, but it is critical for the future of the world that it happens.

Despite Mild Winter Gasoline Demand Continues Lower (Top)

The latest Energy Information Agency (EIA) Short Term Energy Outlook has begun to incorporate crude oil and refined product pricing intelligence derived from the futures markets into its projections.  This information is particularly interesting in light of rising gasoline pump prices and the market hype that $5 or even $7 per gallon pump prices merely months away.  The EIA forecast calls for regular-grade motor gasoline retail prices to average $3.55 per gallon in 2012, up marginally from the $3.53 per gallon average of last year.  Gasoline prices are projected to average only four cents higher at $3.59 per gallon in 2013.  The EIA did stress that as a result of refinery maintenance and elevated global crude oil prices due to political events, average monthly gasoline pump prices during April through September (the peak driving season) could average seven cents per gallon above the annual average.  Importantly, the EIA said that the futures market is suggesting that gasoline prices have a one-in-four chance of exceeding $4 per gallon in June.  Just as important is the flip side saying that there is a three-in-four chance pump prices won’t hit that $4 target.

What’s going on with gasoline demand given the general conclusion from the latest economic data that the U.S. economy is recovering?  According to the MasterCard Advisors’ SpendingPulse survey during the week ending February 3rd, gasoline demand in the U.S. fell another 2.8% to 8.269 million barrels per day, which marks a 5.3% decline from a year ago.  If you focus on the four-week moving average of demand, it fell year-over-year for the 46th consecutive time.  For that period, demand was 4.9% lower than a year ago. 

Exhibit 15.  Fall In Miles Driven Continues
Fall In Miles Driven    Continues
Source:  Jim Halloran, National Highway Transportation Department

The easiest explanation for lower gasoline demand is that people are driving less because of the recession and high pump prices, and when they have to drive they are using more fuel-efficient vehicles.  The data for vehicle miles driven support those points.  The big question, however, is whether the weak demand is due primarily to the weak economy and continued high unemployment, or whether there might be other factors at work.  We believe this topic merits greater analysis and we will be revisiting it, but in the interim one has to conclude that there may be structural shifts underway in the vehicle fuels market.  While economic conditions have to be one cause, changes in consumer spending and entertainment habits are other forces that could be negatively impacting miles driven.  A comment in a letter to the editor of The Economist on British retailing highlighted these cultural changes.  The writer wrote, “And if I need to buy books I’ll click on Amazon, where parking availability is not an issue.”  Cultural habit changes are obvious factors, but preliminary data also shows the possible end to the growth in American licensed drivers.  Could this be a stealth factor?  There is plenty of data to study, but we suspect it will substantiate a permanent decline in the U.S. gasoline market.  If correct, there are negative implications for fuel tax receipts, highway spending and new car sales – all of which will limit economic growth. 

Controversial Ad And The Future of Electric Vehicles (Top)

A commercial by auto manufacturer Chrysler during the recent Super Bowl has generated substantial controversy in the media.  The ad was narrated by iconic actor Clint Eastwood and was interpreted by some as a positive political ad endorsing President Obama on the basis of his bailout of the auto industry, while others viewed it as an advertisement showcasing the rejuvenation of the industry.  The reason for the ad’s ambiguity was the text, which was read by Mr. Eastwood, who has recently been acknowledged to have helped shape the message although he was publically opposed to the bailout back in 2009.  The text, spoken by Mr. Eastwood went, "its halftime. Both teams are in their locker room discussing what they can do to win this game in the second half.  It's halftime in America, too. People are out of work and they're hurting and they're all wondering what they're going to do to make a comeback and we're all scared because this isn't a game. The people of Detroit know a little something about this.”  At this point Mr. Eastwood begins touting Detroit’s comeback, which has been marked by home buyouts, bulldozing empty neighborhoods and shrinking the city and its services. 

As the debate over the message of the ad rages, Fisker Automotive, a builder of plug-in electric vehicles (EVs) and recipient of government loans announced it was laying off 66 employees including 26 at a former GM plant in Delaware.  Fisker said the layoffs were due to it being unable to access funds from its $529 million loan from the Department of Energy under its program to sponsor the development of advanced technology vehicles.  This DOE loan program is the same one that funded Solyndra LLC, the solar panel company, Beacon Power Corporation, an energy storage company, and Ener1, Inc., a manufacturer of batteries for EVs, all of which have filed for bankruptcy protection in recent months. 

Exhibit 16.  Fisker’s Karma EV Sports Car
Fisker’s Karma EV    Sports Car
Source:  Fisker Automotive

Fisker was allocated $169 million for engineering its Karma model, a plug-in hybrid sports car costing $102,000 and being built in Finland by a contract manufacturer.  So far, Fisker has sold 225 Karmas but has 1,200 in its pipeline.  The company was also granted $359 million for the production of its Nina model, a midsize plug-in sedan.  The Nina was to be built at an abandoned General Motors (GM-NYDCE) plant for which the state of Delaware gave Fisker $21 million in grants and loans.  EVs remain a central focus of the Obama administration’s green energy agenda and as a result, companies building EVs and components have been showered with taxpayer money. 

The Chrysler ad has caused some business reporters to re-examine the auto bailouts, the subsequent green auto agenda, and the new fuel efficiency standards.  For the first time, we have seen several mainstream newspapers pick up on the connection of these three events and how green companies and favored auto companies are being given preferential treatment at the expense of other, profitable and technologically innovative auto manufacturers.  Holman Jenkins of The Wall Street Journal is the latest business reporter to pick up on this story.  He termed the auto bailout as “the most egregious aspect of the Obama …annexation of the auto sector to the administration’s green energy schemes.”  This move is being done to fulfill Mr. Obama’s call for one million electric vehicles on the road by 2015. 

Mr. Jenkins uncovered the key to the Obama plan.  It involves the new 54.5 miles per gallon fleet fuel-efficiency standard to be met by 2025.  What Mr. Jenkins discovered was how EVs are being conscripted to ensure profitability for Detroit’s auto makers and their union employees at the expense of the car-buying public and competing auto manufacturers.  As Mr. Jenkins put it in his column, “…the most important are very large mileage credits awarded to electric cars (thought they basically run on coal), and then doubling of these credits as an “incentive multiplier.”  In effect, auto makers have been virtually required to build electric cars and dump them on the public at a loss in order to create headroom for the cars that actually earn a profit.”  Those profitable cars are pickups, for which Detroit has a powerful franchise.  In order to protect this franchise while at the same time satisfying Mr. Obama’s one million green car promise, his administration has devised a fuel-efficiency mandate that will actually create a fleet with a 40 mpg record but will be lauded as having met the mythical 54.5 mpg standard.  Maybe more quizzical reporters will explore this manipulation of the auto industry to meet the Obama administration’s political agenda. 

 

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Parks Paton Hoepfl & Brown is an independent investment banking firm providing financial advisory services, including merger and acquisition and capital raising assistance, exclusively to clients in the energy service industry.

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