Musings From The Oil Patch, March 18, 2014

• It’s Official – Oil Industry Enters The New Era Of Austerity
• The Euphoria Surrounding Automobile Market Is Faltering
• The Climate Battle Within NASA Makes For Comical Relief
• U.S. Social Trends Have Long-term Impact On Energy Use
• The Challenges Facing Saudi Arabia Include More Than Oil

Musings From the Oil Patch
March 18, 2014

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

Last week, Chevron (CVX-NYSE), the second largest oil company, held its annual analyst meeting at which time the company’s management laid out its plans for the next five years, including projections for capital spending and oil and gas production growth.  The meeting followed on a presentation at the IHS CERA Week conference in Houston by Chevron CEO John Watson in which he proclaimed that today’s $100 a barrel oil is the equivalent of the past’s $20 a barrel oil.  By that he meant that the oil industry must now figure its budget outlooks based on the need for oil prices to stay around the $100 a barrel level in order for the company to generate the necessary cash flow to support spending plans and for projects to offer future returns to meet or exceed required investment hurdles.  Mr. Watson has talked about the impact on his business of rapidly escalating costs for finding and developing new oil reserves, which is why he says the company now needs that $100 a barrel price.  Chevron is the latest major oil company to implicitly declare that the oil industry has entered a new era – one marked by higher costs and more disciplined capital investment programs that will require higher oil prices.  Capital discipline forces companies to sacrifice production growth targets on the altar of increased profitability in order to boost returns to shareholders.  What does this new era mean for the oil and gas business?  Equally important, what does it mean for energy markets?

Chevron now projects it will produce 3.1 million barrels a day of oil equivalent (boe/d) in 2017, down from a target of 3.3 million boe/d that the company established in 2010 and reiterated to the analysts last year.  If Chevron attains its target, it will have increased production in the interim by 19%, a not inconsequential gain.  Mr. Watson attributed the reduction in the company’s output target to lower spending for shale wells due to the fall in North American

Exhibit 1.  Rapid Increase In Cost To Find New Oil

Source:  EIA

natural gas prices, higher volumes of oil going to the host countries where the company operates under production-sharing arrangements, and “project slippage.”  Mr. Watson also indicated that the company would raise $10 billion from the sale of assets, up from its previous target of $7 billion.  The company plans to sell oil and gas fields and acreage to raise the funds. 

The Chevron outlook mirrors that presented earlier by the industry’s largest company, Exxon Mobil (XOM-NYSE), at its annual analyst meeting.  There, not only did ExxonMobil CEO Rex Tillerson announce a reduced production target, but he also said that the company would cut back its capital investment program.  While neither the world’s number one nor number two oil companies signaled that the changes in their targets were the result of the industry entering a new era, their actions and similar ones by several of its smaller sisters do suggest that reality. 

BP Ltd. (BP-NYSE) announced it was going to split off its shale operations into a separate company, still wholly-owned by BP, in an attempt to transform the operation into a more nimble explorer and developer of shale properties.  If mimicking the organizational structure of larger independent oil and gas operators was BP’s goal, one has to wonder what structural impediments necessitated the total separation of the unit.  Maybe the move made it easier for BP’s senior management to highlight the drag of its shale business and establish the entity as a stand-alone business.  It may also be advertising the unit’s potential in order to attract a joint venture partner or another energy company’s investment. 

The strategic moves by ExxonMobil, Chevron and BP fit with the efforts that Shell (RDS.A-NYSE) is making to improve its financial performance.  The company is constraining its capital spending and

reassessing the economic attractiveness of every exploration and development project.  Another large oil company that recently made a strategic move was Occidental Petroleum (OXY-NYSE).  The company is planning to spin off its California oil and gas assets and operations into a new company for its shareholders, while the remaining corporation is picking up stakes and moving its headquarters from Los Angeles to Houston where it maintains significant operations.  While this move may say more about the desire of OXY’s management to exit the unfriendly confines of California’s regulations and costs, it also says something about the future direction of the company’s exploration and development focus. 

We have seen similar statements about revisions to strategic plans by the large, European-based oil and gas companies – ENI (ENI-NYSE), Total (TOT-NYSE) and Statoil (STA-NYSE).  These moves are being undertaken by the management teams in response to flagging performance from their huge shale investments and other challenges similar to those outlined by Mr. Watson. 

We were intrigued by the decision by Chevron to boost its oil price outlook from $79 a barrel for Brent crude oil to $110 per barrel.  This move is designed to help the financial outlook for the company’s earnings and to offset the reduction in the production target.  The oil price assumption is consistent with the average Brent price for the past three years, but it is at odds with the trajectory for prices derived from the futures market, which call for lower levels in the future.  We wonder whether this price-target revision will rank with their statement about the future course for natural gas prices a few years ago when the major oil companies jumped on the shale gas bandwagon.  Their timing essentially marked the top for gas prices as North American gas prices collapsed due to the surge in gas output.  This would not be the first time major oil company planning departments incorrectly projected the course of global oil prices. 

Strategy adjustments by major oil companies are seldom quickly reversed even when near-term industry trends suggest an adjustment should be made.  If the newly defined financial discipline mantra demanded by investors is followed and industry capital spending is restrained, and possibly falls, there will be ramifications in the energy market.  If Mr. Watson’s declaration, as echoed by other oil company CEOs, is true, then the cost of finding and developing new reserves is too high and the pressure to drive down oilfield service costs will grow more intense.  We may now be witnessing the fallout from that discipline in the offshore drilling business where the expansion of the global rig fleet with more sophisticated and expensive rigs, necessitating higher day rates, is leading to near-term “producer indigestion.”  Could the offshore drilling industry be on the precipice of a significant wave of older rig retirements in order to sustain demand for its new, expensive drilling rigs currently being delivered without contracts? 

Another question for the industry is who will supply the risk capital for exploratory drilling, both on and offshore, if the majors pull back their spending?  Onshore, for the past few years, a chunk of that capital has been supplied by private equity investors who have supported exploration and production teams in start-up ventures.  They have also provided additional capital to existing companies allowing them to purchase acreage or companies to improve their prospect inventory.  Unfortunately, the results of the shale revolution have been disappointing, leading to significant asset impairment charges and negative cash flows as the spending to drill new wells in order to gain and hold leases has exceeded production revenues, given the drop in domestic natural gas prices.  Will that capital continue to be available, or will it, too, begin demanding profits rather than reserve additions and production growth? 

The amount of capital flowing into the oil and gas business is extremely important for the future growth of the nation’s oil and gas output since shale wells experience sharp production declines in the early years of their production.  A series of questions flow from that production profile: What will happen to oil and gas prices in the medium-term if drilling slows and production rapidly declines?  Will manufacturers who currently are building billions of dollars-worth of new plants designed to capitalize on cheap American energy find their investment returns not what they anticipated?  How will they react?  Will first-mover advantages in this manufacturing renaissance become a disadvantage?  What about the billions of dollars targeting new liquefied natural gas (LNG) export terminals?  Will we actually have the volumes of natural gas to export, and especially at the low prices projected that are anticipated to give American gas a competitive advantage in European and Pacific gas markets? 

These questions should be raised at the same time the national debate about exporting domestic crude oil is commencing.  There are various subtleties in that debate that are often lost in the broad debate themes.  For example, how quickly can the U.S. refining industry build new refineries or expand existing ones in order to use more of the light, sweet crude oil coming from the tight shale oil formations?  If the refining expansion doesn’t keep pace with the growth of light oil, then there could be a cutback in drilling for shale oil that will certainly result in a sharp reduction in the current bullish outlook for U.S. oil production as shown by the significant increase in future output estimated by the Energy Information Administration in its 2014 outlook versus its 2013 projection.  (Exhibit 2, next page.) 

A cutback in oil drilling would also reduce the volume of associated natural gas being produced, which could result in an unexpected spike in gas prices.  For some time, U.S. oil producers have been able to secure export licenses to send oil out of the country, primarily to Canada, but will that avenue continue to exist and can it be expanded to prevent a shutdown in shale oil drilling?  The political debate over exporting domestic crude oil is being described as 310 million American consumers versus a handful of oil company CEOs with fat pay packages.  We doubt the industry can win that battle.

Exhibit 2.  Rising Oil Output Expectations Could Be At Risk

Source:  EIA

Those are only some of the critical questions that must be asked and answered as the oil and gas industry transitions into the next era of its existence.  Much like the performance of the United States economy, the oil and gas business has internal momentum that will keep it going as managements reassess its future.  We have been watching the industry over the past couple of years with one historical perspective in mind – the generational change underway in the executive suites of energy companies.  While we are not denigrating the experience levels or intellect of the new CEOs, we are merely reflecting on the past periods when industry leadership changes occurred.  Those transitions often resulted in the new leaders having to make their own “learning mistakes” like their predecessors did.  That may be an important aspect of the industry transition currently underway. 

A recent column in autonews.com pointed to an interesting phenomenon occurring in the automotive industry right now suggesting that the euphoria that has existed during the past couple of years is waning.  The article focused on the sales forecasts of the 15 major automobile brands and how collectively they usually are in excess of industry sales forecasts made by analysts.  The assumption is that brand managers are always more optimistic about their particular product line than the predicted growth for the entire industry.  Implicit in that relationship is that brand managers always believe their cars will gain market share.  The outlook for 2014 is pointing to a tempering of industry demand projections.

The autonews.com column contained a table with individual brand forecasts compiled from discussions with or taken from statements by auto industry executives.  (See Exhibit 3.)  The combined forecasts total slightly fewer than 16.4 million units expected to be sold this year, up from 15.9 million units sold in 2013.  Analysts’ forecasts for this year’s sales range as high as 16.5 million units.  Noteworthy forecasts include LMC Automotive at 16.2 million; Kelly Blue Book, 16.3 million; Edmunds, 16.4 million; and Cars.com with 16.5 million.  The sum of the brand managers’ forecast is in the upper end of the range of industry forecasts.

Brand manager forecasts are not wishful thinking and carry important significance for the economy and energy demand.  These forecasts are hard targets set by the automobile manufacturers and they dictate production and inventory planning.  These forecasts impact the amount of raw materials necessary to build the vehicles and in turn influence future gasoline and diesel fuel demand.

Exhibit 3.  Auto Brand Manager Sales Forecasts

Source:  autonews.com, PPHB

This relationship between the collective brand managers’ and analysts’ consensus forecasts was quite different in prior years.  For 2013, the consensus forecast was for 15.1 million to 15.4 million units to be sold while the managers’ expected 15.8 million units.  Actual sales for the year were only 207,000 vehicles short of the brand managers’ forecast.  The year before, brand managers expected sales to hit 14.4 million units compared to the consensus forecast range of 13.6 million to 13.8 million units.  Actual sales exceeded even the optimistic brand managers’ expectations hitting 14.5 million units, a 13% increase over 2011 sales.  Now, however, with the brand managers and analysts expecting essentially the same sales volume for 2014, one must conclude the auto industry senses a tempering in its growth.  Part of the tempering may reflect the weak sales during 2014’s first two months due to weather, although recent reports say that showroom traffic in recent weeks has increased providing hope that the sales rate will accelerate.

Mike Jackson, the CEO of AutoNation (AN-NYSE), suggested, in an interview with CNBC, that if auto sales do not pick up steam quickly it will be very hard for the industry to reach the 16 million unit sales mark.  As he pointed out “We now have six consecutive months of very tepid industry sales increases of only two percent.  We’re either about to have several very big breakout months or the industry is not on track for 16 million units this year.”  There is concern that if the sales rate does not increase, auto manufacturers will resort to boosting sales incentives to move the growing inventory glut.  If one is considering buying a new vehicle this year, watching the near-term monthly sales and inventory figures may be critical for securing an attractive deal.

One auto brand manager concerned about this possibility is Mike Accavitti, American Honda’s senior vice president of automobile operations.  He told autonews.com, “I don’t know any executive wanting to get into an incentive war on purpose.  There needs to be a mindset shift in the industry, where companies are ready and willing to take production down, rather than jam production and incentivize.  I hope we would all operate in a more rational manner, but you never know what’s going to happen.”  As autonews.com commented, American Honda might have a difficult time navigating that desire as it recently opened a new assembly plant in Mexico to produce 200,000 additional subcompact hatchback and crossover vehicles for the U.S. market. 

While auto industry enthusiasm about 2014 sales growth is moderating, there have also been some downward adjustments to long-term forecasts for the global automobile industry.  In early 2013, there were several reputable forecasts projecting global sales would reach between 120 million and 130 million units by 2020.  These forecasts also projected manufacturing capacity for the global auto industry to grow by 35 million to 40 million units taking total annual manufacturing capacity to about 150 million units of output by 2020.  Starting late last year, those sales forecasts began to be tempered and are now settling in around 100 million units for 2020, although there are a number of industry drivers that are difficult to predict, making long-range forecasts less reliable.  While uncertainty is a given for all forecasts, if the auto industry plans to add that much new manufacturing capacity over the next six years, decisions on where to locate new assembly plants and making arrangements for suppliers must be underway now, or starting soon.

Exhibit 4.  Optimistic Global Auto Industry Outlook

Source:  OECD

Last year a detailed study of the issues facing the global automobile industry was prepared by the economics department of the Organization of Economic Cooperation and Development (OECD) and targets 2020 sales at 127.1 million units with industry capacity needing to reach 149.7 million units, suggesting a 22.6 million capacity surplus at full utilization, or about 15% of the projected capacity needed.  That production capacity gap means the automobile industry will need to invest substantial capital in new plants and supply chains to reach the OECD’s suggested target. 

A critical driver for the OECD forecast is the changing global demand for vehicles.  Most forecasts acknowledge the geographic shift in demand from North America, Western Europe and Japan (OECD countries) to developing economies.  The OECD study contained a graph showing how it sees regional growth based on an index of 2000=100.  Sales growth in North America and Europe are projected to be essentially flat to 2020 while South American sales grow and Asian sales soar. 

Exhibit 5.  Auto Sales Growth In Developing Economies

Source:  OECD

The primary reason for this geographical shift is the lower penetration of automobiles into the populations of Asia.  A graph from a presentation by automotive tracking and consulting firm JD Power shows the difference in geographic penetration rates.  Given the huge differential between the numbers of vehicles per 1,000 of population in a group of highly developed economies versus those of large population developing economies, one can see where the global automobile industry needs to focus on locating new assembly plants. 

Exhibit 6.  Where New Auto Assembly Plants Will Go

Source:  JD Power

A less optimistic sales forecast by IHS Automotive shows how they see sales growth evolving between now and 2020 by geographic region.  The IHS forecast also shows stagnant sales growth for North America and Western Europe with virtually all the industry’s growth occurring in developing economies.

Exhibit 7.  Auto Sales Outlook Become Less Euphoric

Source:  IHS Automotive

The IHS forecast contained a slide (Exhibit 8) showing how it foresees the North American light vehicle sales and production outlook to 2020 developing.  The forecast projects that from 2015 through 2020 North American vehicle sales will reach or exceed 20 million units per year, a return to sales rates experienced during the industry’s boom days of the early years of this century.  The forecast also foresees production capacity expanding, but at a slower rate than sales, meaning that auto manufacturers should be able to keep inventories under control, which will be critical for sustaining profitability.  Ballooning inventories force auto companies to resort to sales incentives that lower per-unit profits.  Of course, there is still the risk that market trends that have driven the rapid sales recovery following the 2008-2009 financial crisis and recession could be changing due to demographic, social attitude and lifestyle shifts.  If sales do not reach the 20 million units a year level, then the North American auto companies will be forced to adjust their production plans, and even consider exporting more vehicles to growth markets around the world.

Exhibit 8.  North American Vehicle Sales To Peak Soon

Source:  IHS Automotive

Of particular significance for energy demand is the number of vehicles that will be manufactured and sold and what their average fuel economy will be.  That measure will be impacted by vehicle models and design changes that will shape the fleet of the future.  IHS raised several interesting points about future vehicle design trends – what cars are made from and how they will be powered.  The Detroit Auto Show this year showcased Ford Motor’s (F-NYSE) most popular truck, the F-150 model, built with an aluminum body.  The company reportedly spent a number of years developing the vehicle and getting its suppliers and repair shops ready to handle the new body panels.  The goal from the new design, a risky venture with your most popular and profitable product line (think new Coke), is to reduce the vehicle’s weight in order to boost its fuel-efficiency rating.  This effort mirrors the increased fuel-efficiency trend now widespread throughout the passenger car segment of the light duty vehicle fleet. 

Exhibit 9.  Aluminum Body F-150 Ford Pick-up

Source:  Ford Motor Company

The current material composition of vehicles and their weight by component suggests there is considerable room for improvement in the future.  Aluminum has already established a beachhead in the vehicle market and with Ford’s push into pickup trucks we should expect to see lighter vehicles across the board, along with smaller vehicles, too.  Consumers may be more willing to accept more exotic metals and composite materials in order to reduce vehicle weight so

Exhibit 10.  Components Offering Fuel-saving Opportunities

Source:  IHS Automotive

that passenger room does not have to shrink.  The same can be said about the industry’s potential for reducing weight in various vehicle components.  Stronger metals offer the potential for meaningful weight reduction in components such as the chassis and engine, boosting fuel performance while not sacrificing vehicle durability. 

The other focus of the auto companies is on boosting the fuel-efficiency and performance of smaller engines.  We recently rented a standard size vehicle in Boston and were presented with a choice of four or five models from two different manufacturers – one from Detroit and the other Japan – but all had four cylinders.  The rental car employee told us which models not to select given their terrible fuel-economy.  We drove a Camry with four cylinders and it had acceptable highway pickup, even with four adults in the car.  Since it was winter, we didn’t test the air conditioning so we don’t know what would have happened to fuel-economy and driving performance had the air conditioning been on.  As can be seen from the chart in Exhibit 11, by 2020, four-cylinder engines are projected to power over 60% of the vehicles sold.  Equally important is that eight-cylinder or above engines will decline as a portion of cars sold from 30% in 2005 to 10% in 2020. 

Exhibit 11.  Shifting Trends In Vehicle Powertrains

Source:  IHS Automotive

The other issue with powertrains is the success of non-internal combustion engines (ICE) in taking market share from ICE-powered vehicles.  The JD Power study suggests that electric and hybrid powertrains will still remain a niche segment of the global fleet in 2020, just as they are today.

Exhibit 12. Electrics And Hybrids Remain Niche Markets

Source:  JD Power

The global automobile industry is facing a challenging outlook that will test company managements.  The pressure to boost fuel-efficiency for the global fleet is important for economic and environmental considerations.  In the OECD forecast, its baseline forecast, shown earlier, assumes that Brent oil prices rise to $130 per barrel in real terms by 2020.  The economists prepared an alternative scenario based on $150 per barrel Brent oil price.  The higher oil price sliced 3% off the 2020 sales forecast, or about four million fewer vehicles.  We suspect the full impact of sharply higher oil prices has not truly been factored in since we know that social attitudes and lifestyle changes will accelerate and drive younger people to seek alternative transportation options rather than own their own vehicles.  The conclusion we draw from these recent studies is that the petroleum industry will remain critical in the global energy mix of the future because vehicle sales will continue to grow.  The question is at what rate they grow, and how the design changes will impact vehicle fuel consumption, in addition to the impact from social changes altering the number of vehicle miles driven.  Our best guess is that gasoline demand forecasts are probably too high relative to what will happen in 2020.

We were treated to an interesting discussion of the battle between active employees of the National Aeronautical and Space Administration (NASA) and a group of retired scientists who were instrumental in the success of the American space program.  The retired scientists fired the first shot in the current battle when they published a report disputing the impact of global warming and its predictions for a cataclysmic future for our planet.  Of course, presenting a report that is at odds with the official position of NASA and the federal government meant the scientists needed to be “former” scientists so as to not get caught up in disciplinary sanctions for their actions. 

The NASA retired scientists’ report concluded the following:

“We have concluded that, at most, 0.7 degrees C AGW [Anthropological Global Warming] has occurred since 1850, but that it is possible that some of this observed warming was caused by naturally occurring cycles of global temperature variation.  Other small amounts of global warming since 1850 were caused by an increase in solar irradiance.  The naturally occurring global temperature cycles are clearly evident in the 8,000 years of climate data before the dawn of the Industrial Age.  Earlier, much greater changes in global temperature were exhibited during the ice age cycles, and are destined to occur again as the current Holocene ice age cycle unfolds.

“We have also concluded that increasing levels of GHG in the atmosphere cannot cause more than 1.2 degrees C of additional warming above current global average temperatures, before all economically recoverable fossil fuels on the planet are consumed.  This maximum possible additional AGW should be offset to some extent by a forecast of reduced solar output over the next couple of centuries, and that has already started to occur.”

Following the release of the retired scientists’ report, NASA issued a press release announcing the publication of a new study by a scientist from the Goddard Space branch of the agency with the following, although not surprising, conclusion:

“A new NASA study shows Earth’s climate likely will continue to warm during this century on track with previous estimates, despite the recent slowdown in the rate of global warming.

“This research hinges on a new and more detailed calculation of the sensitivity of Earth’s climate to the factors that cause it to change, such as greenhouse gas emissions.  Drew Shindell, a climatologist at NASA’s Goddard Institute for Space Studies in New York, found Earth is likely to experience roughly 20 percent more warming than estimates that were largely based on surface temperature observations during the past 150 years. 

“Shindell’s climate sensitivity calculation suggests countries around the world need to reduce greenhouse gas emissions at the higher end of proposed emissions reduction ranges to avoid the most damaging consequences of climate change.” 

The battling studies became public about the same time a group of Democrats in the United States Senate conducted an all-night slumber party to discuss global warming.  The event, although hailed by the Democratic Congressional leadership as raising the conscience about a critical issue posing significant harm to our society and economy and that of the rest of the world, was not designed to stimulate a policy debate with those senators who don’t believe in AGW nor lead to the introduction of climate change legislation.  Instead, it was the Democrats fulfilling their part of a deal with former hedge fund manager and avowed environmental activist, Tom Steyer, who has promised to donate $50 million to the Democratic Party and helping to raise another $50 million to support the party’s efforts in the upcoming mid-term elections.  To secure his financial support, the Democrats had to promise to campaign on and lobby for actions to curb climate change.  

Senate Majority Leader Harry Reid (D-NV) announced that he will not introduce any environmental legislation until possibly after the elections since it would likely be voted down by his own party’s members who fear a political backlash at the voting booth.  In fact, a handful of senators engaged in stiff re-election battles did not participate in the slumber party climate discussion to avoid even being tainted by the effort.  Ah, the political reality of campaign funding versus spaghetti-like backbones.  

We were recently rereading a column that appeared in The New York Times in February written by David Brooks (no relation) entitled “The American Precariat.”  If you check for the meaning of “precariat” in various online dictionaries you will not find the word listed.  Mr. Brooks explains the term as he concluded his column, but it seems this word was invented although it may eventually enter our lexicon.  The cull-out in the article’s text was “Hunkering down in an age of anxiety,” which describes the American version of the British phenomenon of precariat that stimulated the column and our focus on its implication for future energy consumption.

According to Mr. Brooks, Americans were often described by foreign visitors in the past as people who “worked frantically, moved more and switched jobs more than just about anybody else on earth.”  Those of us who travel internationally can relate to that as we often visit parts of countries where generations of families still live in the same community.  Those relatives who departed for other locales were the exception, and they either were taking advantage of a job opportunity or were forced to leave by the lack of opportunity in their hometowns.  But as Mr. Brooks points out, this description of Americans has changed over the past 60 years, and we have become a less mobile population. 

Quoting various statistics, Mr. Brooks demonstrates how American mobility has declined and what may be behind that trend.  In 1950, 20% of Americans moved in a given year.  Now, only about 12% of us move in a given year.  In the 1950s and 1960s, people lived in the same house for an average of five years.  The average home tenure now is up to 8.6 years.  Our current mobility statistics put Americans in the same category as the people of Denmark or Finland.  If Americans are becoming less mobile, the question is why?

The most important reason is demographics – we are becoming an older nation, and older people are less likely to move and more likely to stay in their homes for longer time-periods.  The problem is, however, that the decline in mobility is also evident among the nation’s young people.  Between the 1980s and 2000s, mobility among young adults has dropped by 41%. 

A possible explanation for the mobility decline is the financial crisis and the resulting collapse of the real estate market, which trapped people in homes where the balance they owed on their mortgage was substantially above the value they could realize from selling it.  A study reported in the Washington Monthly magazine, according to Mr. Brooks, shows that mobility among renters is down just as sharply as for homeowners, which would seem to belie the “trapped homeowner” theory.

Mr. Brooks believes changes in the labor market partly explain the decline in Americans’ mobility.  As he pointed out, for decades the jobs in Pittsburgh were different from those found in Atlanta, but now they are similar so there is little reason to move from one city to another.  The homogeneity of the labor market has reduced the need to move, as well as has the ability to work remotely. 

His explanation for the mobility decline is that Americans have lost their self-confidence.  He suggests that it took faith to move given the temporary expense and hardship that was to be experienced.  It was faith that in the long-term things would be better that drove people to move.  Mr. Brooks points out that many highly educated people are still moving in large numbers because they do have faith in their long-term improvement.  On the other hand, less-educated people often do not move.  Many of them are trapped and have become quasi-wards of the state, or what has become known in political circles as the “dependent-population.”  It is also interesting where people are moving.  People are not moving to low-employment/high-income areas where presumably the jobs are.  Instead, they are moving to lower-income areas with cheap housing.  They are willing to sacrifice future employment opportunity in order to avoid temporary housing hardship, which would seem to indicate a lack of self-confidence. 

Other signs of the decline in faith include the drop in the birth rate, which reflects young peoples’ concerns about their future security and prosperity.  Americans are also less likely to voluntarily give up their jobs as the latest quit-rate statistics show.  Only 46% of white Americans believe they have a good chance of improving their standard of living, the lowest level in the history of the General Social Survey.  While over 50% of Americans over 65 years old believe America stands above all others as the greatest nation on earth, only 27% of Americans ages 18 to 29 believe it.  Thirty years ago, a vast majority of Americans considered themselves members of the middle class, which is not the case now.  Since 1988, the percentage of Americans who consider themselves members of the “have-nots” has doubled.  At one time, Americans used to have much more faith in capitalism, a classless society, America’s role in the world and organized religion than people from Europe.  Now American attitudes more closely resemble European attitudes. 

After listing these and other pessimistic statistics and beliefs, Mr. Brooks seizes on a concept floating around Europe called the Precariat.  He cites British academic Guy Standing, who says “the Precariat is the growing class of people living with short-term and part-time work with precarious living standards and ‘without a narrative of occupational development.’  They live with multiple forms of insecurity and are liable to join protest movements across the political spectrum.”  Mr. Brooks modifies the definition to declare that “the American Precariat seems more hunkered down, insecure, risk averse, relying on friends and family but without faith in American possibilities.”  He calls this view of fatalism as “uncharacteristic of America” and disturbing. 

Exhibit 13.  Per-capita Energy Use By Select Countries

Source:  economicshelp.org

What could the precariat mean for America’s energy future?  European energy consumption per capita is considerably below that of the United States and Canada.  While there are only four European countries’ per capita energy consumption shown in Exhibit 13, Austria’s consumption is on a par with Germany’s while the Netherlands is higher at about 4700 kilograms of oil equivalent (Kgoe).  Eastern European countries such as Poland and Hungary are around 2400-2500 Kgoe, which is between Spain at 2755 Kgoe and Portugal at 2266 Kgoe.  With many Western European populations consuming between a third and 60% of the per-capita energy use of Americans, the question is whether U.S. consumption could be heading lower? 

We know the popular explanations for the difference in energy consumption, such as European population density being higher than America; Europeans have better mass transit options; they drive smaller, more fuel-efficient vehicles; and they live in more compact homes.  If we stop and consider the social and economic agendas being promoted today by a segment of our elected officials, the European conditions are their ideal for America’s future.  Will our automobile culture remain as it has been?  Will the suburbs be declared anti-social and a disproportionate consumer of resources?  We are on the road to smaller, more fuel-efficient vehicles and reduced living spaces as city-living styles are heavily promoted and regulated.  We doubt we will see the ultimate outcome of this push to go down this path, just as we don’t expect to see the renewal of our United Club membership in 2099. 

The International Energy Agency (IEA) recently issued a call for Saudi Arabia to sustain its current oil output during the upcoming seasonally weak global oil demand period in order to rebuild global crude oil inventories following the harsh winter in the Northern Hemisphere and the uptick in developing country oil needs.  The IEA estimates that Saudi oil production in January was 9.76 million barrels a day (b/d), down about 60,000 b/d from December’s output level.  Saudi’s sales for January, which includes volumes from storage, averaged 9.92 million b/d, down 70,000 b/d from December.  A challenge for the Kingdom may come after March when it shuts down the Shaybah field, currently producing 750,000 b/d of light oil, to hook in new production facilities enabling the field to boost production to 1 million b/d in April 2015. 

The call for Saudi to sustain its nearly 10 million b/d output to ease a potential global price spike reflects the belief that the Kingdom will take direction from its customers about its oil output policy.  As we have found in the past, this belief may not prove accurate, although it has generally been correct.  Saudi is caught in the middle of a rapidly changing Middle East geopolitical environment.  These tensions surfaced with the first Arab Spring, but they often drop off the radar screen due to other geopolitical developments such as the East-West struggle over the Ukraine. 

To appreciate how the geopolitical environment that shapes Saudi Arabia’s reaction, and its oil output policy, please see the following two charts.  It was only five years ago when the entire geopolitical story of the Middle East was centered on the wars waged by the United States and its allies in Iraq and Afghanistan.  The Iraqi conflict had the attention of officials in Saudi Arabia because the battle was perceived as a struggle between the two dominant religious sects – the Sunnis and the Shia.  This struggle, which involves the Al Qaeda terrorist organization along with its numerous affiliated terrorist groups, is reshaping the political landscape of the Middle East and North Africa.  As the map in Exhibit 15 shows, most of the region is now engulfed with this struggle. 

Exhibit 14.  The Middle East In More Peaceful Times

Source:  moneyandmarkets.com

Exhibit 15.  The Middle East Today

Source:  moneyandmarkets.com

As Saudi Arabia contains the most holy sites of the Islamic religion, the Saudi royal family is its custodian and protector.  Recently, a new political struggle erupted when Saudi Arabia listed the Muslim Brotherhood as a terrorist organization and the country withdrawal of its ambassador from Qatar who has been supporting the Brotherhood.  The United Arab Emirates, Bahrain and Egypt have followed suit, also withdrawing their ambassadors.  The spat with Qatar started a couple of weeks ago at a Gulf Cooperation Council foreign ministers’ meeting held in Riyadh.  Saudi Foreign Minister Saud bin Faisal declared that Qatar needed to shut down the television station Al-Jazeera, the Brookings Doha Center and the Rand Qatar Policy Institute if the emirate did not wish to be punished. 

The punishment was not specified, although the media has reported that Saudi Arabia has threatened a sea blockade of Qatar, although shutting down its land border would be considerably more effective.  Qatar has only 40 miles of sea and land borders, with its only land border being with Saudi Arabia.  At present, a substantial amount of fresh food and other goods crosses the border every day to supply the busy city of Doha.  The border between the two countries has been disputed for 35 years.  Qatar and Saudi Arabia skirmished in 1992, when Saudi troops occupied a border post.  A final border agreement was signed in 2001.

At the root of the Qatari dispute is a political clash between the emir of Qatar, Sheikh Tamin bin Hamad, and Saudi Arabia’s King Abdullah bin Abdulaziz over support for Islamist groups perceived to be terrorists by the old, autocratic rulers in the region.  The principal focus is on Qatar’s support for the Muslim Brotherhood that was instrumental in helping to depose Egypt President Hosni Mubarak several years ago and replace him with the organization’s president, Muhammad Morsi.  The Saudi monarchy has been supportive of the military rulers of Egypt who overthrew the Morsi regime late last year.  Saudi Arabia, along with the United Arab Emirates, has sent billions of dollars in order to prop up the military government, with no end in sight to the political and economic chaos in the country. 

The demand for Qatar to shut down the branches of the two American think tanks is intended to embarrass President Barack Obama who is scheduled to visit Riyadh later this month.  The Saudi monarchy has been upset with the U.S. position on Iran and with its lack of involvement in resolving the Syrian civil war, both of which are considered threats to the Sunni-dominated state.  The Saudi monarchy is, and has been, concerned about the 12% of its population that are Shiite and that live over the Kingdom’s petroleum reserves.  The Kingdom is concerned about Shiite Political Islam, the ideology of the Iranian state, which it believes was behind the social unrest in Bahrain during the Arab Spring.  Saudi was so concerned about the stability in Bahrain that it sent troops into the country to support the current ruler. 

The Saudi Royal family was described as both outraged and threatened by the role of Al Jazeera in the first years of the Arab Spring, which saw fellow potentates deposed in Tunisia and Egypt.  They have become increasingly upset with Al Jazeera’s sympathetic television coverage of the secular and Islamist opposition in Egypt.  There has recently been a court hearing in Egypt involving three Al Jazeera reporters who are accused of “joining a terrorist group, aiding a terrorist group, and endangering national security.”  A fourth reporter is being tried in a separate case.  The military-backed Egyptian government has now outlawed the Muslim Brotherhood. 

Exhibit 16.  The Middle East Religious Line-up

Source:  moneyandmarkets.com

Saudi Arabia’s actions have paralyzed the Gulf Cooperation Council, with Oman refusing to expel Qatar and Kuwait uneasy about developments.  This stance is beginning to further crystalize the realignment of countries in the region.  Reportedly, within hours of the Saudi decision to withdraw its ambassador to Doha, Turkish Prime Minister Recep Tayyip Erdoǧan called the emir of Qatar to express his country’s support.  Analysts believe that Saudi’s and its supporters’ actions have moved Qatar closer to Iran.  Another interesting aspect of this split is the perceived generational battle.  Saudi Arabia is ruled by its 89-year old king while the emir of Qatar is only 33 years old.  We have written several articles in the past focusing on the upcoming generational leadership change in Saudi Arabia as the current king and his brothers and half-brothers pass from the scene and the country’s leadership transitions to the younger generations – not necessarily the children of the current leaders but possibly to their grandchildren.  What will be the tolerance of this younger generation to the economic and social changes now demanded by the Saudi population?  While the current Saudi king boosted social expenditures in the aftermath of the Arab Spring to buy peace among his constituents, will those spending decisions be endorsed, expanded or possibly reduced when the younger leaders accede to power?  That decision alone could influence the country’s oil policy as it will dictate just how much revenue the Kingdom needs to sustain its government.  The regional realignment will also dictate the size and sophistication of the Saudi military in the future – another expense to be supported by the Kingdom’s oil output. 

Besides the question of exactly how much oil Saudi Arabia desires to export, there remains the issue of possible constraints on getting its output to market.  Two maps help demonstrate that challenge.  The first map shows the Oil Corridor where at least 25% of the world’s oil supply originates.  The religious aspect for oil output is also shown by that map.  The second map shows the three shipping choke points for Middle East and Saudi Arabian oil output.  The 1960s shutdown of the Suez Canal in Egypt not only drove oil prices higher but also contributed to the development of the supertanker that was able to haul much larger volumes of oil since they were not constrained by the dimensions of the canal for passage.  Closure of any one of these choke points would set off a scramble for oil supplies causing global oil prices to spike and likely setting off the next global recession.  That event could trigger a major shift in the future evolution of global energy markets as the high oil price would force countries to enforce energy conservation and adopt a more rapid program to develop alternative energy sources. 

Exhibit 17.  The Nexus Of Middle East Oil Output

Source:  Energy and Capital

Exhibit 18.  Middle East Oil Shipment Choke Points

Source:  Energy and Capital

To better understand some of the oil market dynamics at work amongst the key Middle East and North African players in this regional realignment, the chart in Exhibit 19 shows monthly oil production since 2009 for Iran, Iraq, Libya and Saudi Arabia.  The chart shows how the civil war in Libya and the impact of the West’s economic sanctions against Iran have limited their oil output.  One can also see the slow but steady rise in Iraqi oil production, another wildcard in the global oil supply picture.  The shifts in oil output from these three countries helps explain why Saudi Arabia has sustained its high oil production for so long despite rather anemic global oil demand growth as it wants to prevent a spike in oil prices. 

Exhibit 19.  Key Middle East Oil Producer Outputs

Source:  EIA

Saudi Arabia faces two major questions, the answers to which will help determine how the country responds to the IEA’s call for sustained output.  Will the easing of the economic and financial sanctions scheduled under the recently negotiated nuclear deal between Iran and the United States result in a surge in Iran’s oil production?  Will the turmoil in Libya end and its oil output be restored to past levels?  If both countries are able to boost their output, then the burden for supporting $100 a barrel global oil prices will fall to Saudi Arabia who can more easily cut back its output.  Once again, however, the Kingdom is presented with an opportunity to possibly teach its fellow Organization of Petroleum Exporting Countries (OPEC) members another lesson about their need to be more deferential to Saudi Arabia’s wishes, which may extend beyond just oil output levels. 

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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.