A PetroCity’s Battle Cry

It is Victory or Death!

My family moved to Texas in 1821 to settle the promised land granted to them by the Mexican government. They were ranchers that knew the land would be filled with promise and danger. There were 297 families in all that ended up leaving good lives in search for building great ones. To settle Texas and make it worthwhile, all of them needed to work their own lands from dawn to dusk and then spend time managing the needs of the community. My family served as the first Texas Rangers for the common defense and even as the local Sheriff. And when external powers moved to disrupt their livelihoods, they were willing to fight for it.

Not all battles were won. When there is a shared purpose, even the lost battles serve as a rallying cry. 180 years ago today, The Battle of the Alamo ended in a loss for my ancestors. However, the Alamo became the cornerstone that led to the state’s ultimate destiny. After being surrounded by thousands of men, William B. Travis wrote his famous letter that is still inspires today: “The enemy has demanded a surrender at discretion, otherwise, the garrison are to be put to the sword, if the fort is taken – I have answered the demand with a cannon shot, & our flag still waves proudly from the walls – I shall never surrender or retreat…Victory or Death.”

This spirit of calling, destiny, entrepreneurship, promise, and duty to this city and state runs through my blood and why I feel called to lead us forward.

The state and our largest city has changed dramatically throughout the generations. When the Lucas No. 1 oil well hit in 1901 outside of Beaumont, it changed Houston, Texas, and the entire industry forever. “That first well produced at a greater rate than all other American oil wells in existence—combined. In a matter of days, in fact, the pastures around Spindletop would be producing more than the rest of the world’s oil wells—combined. Of those first six Texas oil wells, three produced at a higher rate than the entire country of Russia, then the world’s top producer.” Oil was a blessing for Houston. It also put Houston on a path to be controlled by the highs and lows of black gold. We have a great opportunity ahead of us if we make a course correction. But first, we must learn from the past.

If you have lived here long-enough, it is accepted that Houston will rise and fall with the price of oil. Houston and the oil patriarch benefactors have done an amazing job building other thriving industries here; however, we are still dependent upon the price of one commodity. As defined by Daniel Yergin, a petro-state refers to nations that may be different on many levels but all rely upon and are driven by their exportation of oil and natural gas. This pushed me to research and determine if Houston was really a PetroState or in our case, a PetroCity.

Houston’s Fate is Controlled by OPEC

In 1960, Iran, Iraq, Kuwait, Saudi Arabia and Venezuela joined together to create OPEC (The Organization of the Petroleum Exporting Countries). The cartel was formed ultimately to control oil prices. In the early 1970’s, 90% of the world’s oil reserves were nationalized. In other words, the countries sitting on the largest reserves of oil and gas took control of their domestic petroleum industries away from the large independent oil companies (IOC’s) like BP, Chevron, ExxonMobil, and Shell. Not all of the National Oil Companies (NOC’s) are in OPEC including Russia, Norway, and Mexico; however, as of 2014, OPEC controls roughly 80% of the world’s reserves. When OPEC talks, the world listens.

The Jakarta Syndrome Driven by Houston

In 1997 during the end of the Asian boom and on the eve of the 1st financial crisis (driven by the tech bubble), OPEC met in Jakarta and agreed to raise production levels to meet the assumed increase in demand coming out of the region. This became known as “the Jakarta Syndrome—the danger of increasing production when demand was weakening or even just uncertain. The price collapse did something else as well. It set off the most far-reaching reshaping of the structure of the petroleum industry since the breakup of the Standard Oil Trust by the U.S. Supreme Court in 1911.” (Yergin, The Quest page 171). After the nationalization in the 1970’s, less than 10% of the world’s oil & gas reserves were available for exploration and production by independent firms. After the price collapse of oil and the growing expertise and self-sufficiency of the national oil companies, the industry players believed that they had no other choice. Between 1998 – 2002, the industry saw the mega-merger as the only path forward. As a result, the majors became even larger:  Amoco was acquired by BP (1998), Mobil by Exxon (1999), Elf by Total (1999), Texaco by Chevron (2000), Phillips by Conoco (2002). In this case, OPEC setoff a massive industry restructuring.

When oil prices exceeded $90 in 2011, this fueled the boom and rise of the unconventional land grab setting off the 2nd Jakarta Syndrome. Instead of OPEC agreeing to raise production, numerous independent operators based here began to produce to take advantage of $90 oil. And Houston became the capital of this revolution. Unfortunately, it did not sustain itself. And once again, OPEC stepped in to quell the insurgents.

$20 per Barrel is the New Hurdle

Houston hosted IHS’s annual CERA week a few weeks ago whereby the who’s who of energy attended. There were a few key stories that came out of CERA week and most of them from the Saudi Oil Minister and largest member of OPEC Ali Al-Naimi. He made a few powerful statements:

• The current oil price environment in the short-term is here to stay (and the IEA forecast edifies this out to 2020)
• His sovereign nation can exist at $20 per barrel
• Solar is the answer to energy’s future (more on this later)

Saudi Arabia controls the knob. With the largest reservoirs and the alignment of OPEC, more expensive producers, like unconventional operators, cannot compete head to head. There is an interesting analysis and pushback from one of leaders of shale claiming that they can make $30 work. “Oil price volatility will be the death of the American oil industry and it is up to companies like EOG to control production spikes and help keep oil prices stable.” And while the industry in Houston is trying to survive, others are continuing to produce to gain global market share.

I am not an expert on predicting oil prices…but I am a student of finance and economics and have spent years buying commodities. Ultimately over the long term, the price of oil comes down to supply and demand. The perfect storm was being setup before our eyes. Oil prices remained high, which fueled the massive growth of exploration and production of tight oil, which led to supply exceeding demand. There have been times that oil prices have not correlated completely with the supply-demand equation including the early 2000’s. This may have led to the belief that $90+ oil was here to stay. There were two periods in this century that the oil price hovered above $90 including 13 months between 2008 – 2009 that led to the 1st Jakarta Syndrome and for 33 months between 2010 – 2014 which led to our 2nd. “Over the last 16 months, about 60 oil and gas companies have filed for bankruptcy as commodity prices slide, and that figure is expected to double in the coming months if prices remain low. All told, analysts say as much as a third of the sprawling oil and gas industry in the United States could be consolidated as a result of the downturn.” This should be a wake up call Houston.

The Problems of the PetroState

Despite the obvious, PetroState’s are burdened with a concept known as a resource curse. “The resource curse, is a theory describing how countries with abundant natural resources sometimes do worse than countries without them. The idea is that the money from commodity sales can lead to overvalued currencies and shortsighted policy-making, leaving such countries badly exposed when the resource boom finally ends…Using data going back to 1800, commodity-dependent economies typically grow for a decade, then spend as long as two decades wallowing or slipping back.” This short-term irrational exuberance leads an industry to ignore the need to preserve and invest into infrastructure that will buffer itself from wild swings in commodity prices. When you read about Brazil’s fall from grace, does the pattern not remind you of the last few years? What infrastructure? In Houston’s case, we need to invest further into rebuilding our lost technology infrastructure and recruit the best entrepreneurs to build the new energy companies of tomorrow. I will dedicate a blog to Houston’s future. Stay tuned.

There are two characteristics that define the resource curse as described by Yergin’s book, the Quest: The Dutch Disease and the Reversed Midas Touch.

• The first ailment is the Dutch Disease. This term was originally used to describe the economic failure of the Netherlands. The country was a natural gas exporter. As it began to export a lot of gas, the country was naturally benefitting from the inflowing wealth from the commodity sales. This new and large inflow of cash into the economy put pressure on its currency leading to an overvaluation. The overvalued currency naturally made exports more expensive. The result was that local businesses became less competitive than cheaper imports. Combined with embedded inflation, the economy in the Netherlands fell, jobs were lost, and businesses closed. The Netherlands is apropos considering that Houston is roughly the same size.
• The second ailment is the Reversed Midas Touch. When commodity prices go up, so do the expectations of society. The government spends more money in the form of subsidies, new programs, and big projects. The oil & gas industry generates a lot of revenue during high commodity prices. However, it does not create as many jobs as expected since most of the money to fund the industry goes to large capital spending (equipment), not to people. This puts further pressure on the government to spend money. When commodity prices fall and the industry revenues slow down, the government has already set the wheels in motion with funded budgets, projects, and programs. The government is locked into ever-increasing spending while also facing fear from political backlash and social protests.

Houston acts like a PetroCity

Does Houston have the same fundamentals as other petrostates? I think the evidence supports that there is both a dutch disease and reverse midas touch happening here. As the unconventional oil & gas industry took off, so did Houston’s inflation as seen most dramatically in real estate. From 2011 – 2014, Houston real-estate prices grew 2x faster than the economy itself. Unfortunately, as oil prices collapsed, the once booming housing market in Houston has come to a slow crawl and may only get worse as we continue to see massive layoffs.

And this is not a good time for the city to be caught in a downturn. Houston already has a major debt problem and surpassed Detroit. Besides Chicago and Jacksonville, Houston’s pension debt alone is the 3rd worst in the nation being 710 percent larger than its annual revenue. Much of Houston’s debt burden is due to pensions…however, our great city has billions in debt from outstanding bonds (big projects and programs). Since the city of Houston makes a majority of its revenue from property and sales taxes, the recent layoffs and declining property values will only exacerbate the problem. Despite these issues, Houston mirrors other petro-states in how it is responding to the downturn. For example our recent mayoral race was won on a platform that stated: “to stay on top, we have to make the big investments.”

I think the data is directionally accurate and in some ways common sense. Despite the external complicated factors, Houston is dependent upon a commodity that is controlled by someone else. At one time, we controlled the commodity, today, we do not. And this city is too great to be under the rule of someone else. Like the brave souls that fought for independence 180 years ago, we find ourselves in an important fight. This time, it is for the sun and owning energy’s future. Victory or Death!

Houston Next

Being a PetroCity is not good enough. Houston has numerous impressive traits outside of energy; however, it has an opportunity to redefine itself and the energy industry overall for the rest of this century and beyond.

Houston is not alone. Saudi Arabia is a petrostate. 90% of the country’s revenues come from oil. Ultimately, the country has its own challenges driven by a growing population of Millennials. 70% of the country is under 30 years old and the government can no longer hire all of them. And despite its ability to exist at $20 oil, it cannot sustain itself in the long-term. For the first time, Saudi Arabia is considering taxing its constituency and even taking Saudi Aramco public.

However, they also see the problem and are moving to solve it. During his talk at CERA, Saudi Oil Minister said that solar is the answer to energy’s future. “We have a solar center, and I recently gave the director of the center a challenge.” That challenge? Currently Saudi is exporting 7 million bbls of oil every day – the minister would like to convert solar into BTUs and generate enough solar as an equivalent to 7 million bbls of oil. “So we can export power and not oil. Solar is definitely going to be the answer to energy’s future.” In other words, Ali Al-Naimi not only read my blog, he also made a powerful statement that his country will lead in the production of all energy sources and is focused on making the sustainable transition.

I am working on the plan and vision for Houston 2050 and will post it soon. In the meantime, I believe that Houston should lead the world in the sustainable production and consumption of energy. We need to be bolder than Ali Al-Naimi and set a purpose that inspires our future leaders. We do not need to invent the technologies that change the world, but rather create and support a technology-driven, millennial inspired ecosystem that allows entrepreneurs with big dreams and high hopes to thrive here.

There is a movement taking place in Houston now…and I hope you will join us. Houston is good. It is time to return to our roots and leave the good to build the great. We shall never surrender or retreat.