It s no secret that Texas is currently enjoying a dramatic resurgence in the oil industry, propelled by high

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1 NOVEMBER/DECEMBER 2013 IN THIS ISSUE Comparing the Current Oil Surge in Texas to the Oil Boom of the 1970s and Early 1980s Texas is in the midst of an oil boom. In this issue, we look at how the current situation compares to that of the 1970s and 1980s. Perryman s Perspective: Rainy Day Water Texas voters recently took an important step toward ensuring the adequacy of the state s water supply, but more needs to be done. Economic Development News Around the State Read about the state s most recent economic development happenings in this section. Communities throughout Texas are seeing the impact of new businesses, expansions, and job creation. Focus On: Wage and Salary Employment A breakdown of historical wage and salary employment by metropolitan statistical area provides a quick look at population for 2001 to See page 7 to get a snapshot of the historical growth for the state as well as for an MSA near you. Comparing the Current Oil Surge in Texas to the Oil Boom of the 1970s and Early 1980s It s no secret that Texas is currently enjoying a dramatic resurgence in the oil industry, propelled by high prices, new discoveries, and technological advances. The industry is notoriously cyclical, and a common question is whether today s prices and rig counts are here to stay. Texas has seen booms in the past, and the dramatic cycle of the 1970s and 1980s caused major dislocations. However, the current situation varies notably from the prior cycle in fundamental ways, with a more stable supply and demand relationship driving activity. This issue of The Perryman Report & Texas Letter highlights key aspects of these periods in the industry. OIL PRICE DRIVERS As with any product or service, the price of oil is ultimately driven by demand and supply. The demand for oil has been expanding with the emergence and development of economies around the world, which contributes to increasing per capita consumption and industrial requirements. Economic conditions also affect the need for fuels. The ability to add to the supply of oil or natural gas depends on geology, exploration and production techniques, and other variables. In addition, the OPEC (Organization of the Petroleum Exporting Countries) cartel exerts notable (though diminishing) influence on the available supply (and, hence, pricing). OPEC was founded in 1960 when five countries (Iran, Iraq, Kuwait, Saudi Arabia, and Venezuela) signed the initial agreement. Since that time, other countries have joined (including Qatar, Libya, the United Arab Emirates, Algeria, Nigeria, Ecuador, and Angola). The OPEC members try to hold down production (as a group) so they can keep global prices elevated. The actual process is quite complex, but that s the essential framework. OPEC estimates that its members control about 81% of global proven reserves of oil, while the US Energy Information Administration (EIA) notes that OPEC member countries produce about 40% of the world s crude oil and 60% of the total petroleum traded internationally. Clearly, OPEC can and does exert some influence on price. However, the degree of price influence depends on the willingness of member countries to maintain production quotas and targeted price levels. Member countries do not always comply, and if the cartel attempts to force down production too far, the incentive to exceed quotas rises (and, hence, the likelihood of cheating). It is a basic property THE PERRYMAN GROUP Page 1

2 $120 $100 $80 $60 $40 $20 $ Nominal and Real Oil Prices*: Nominal prices Real prices *Nominal prices are refiners acquisition costs in dollars per barrel. Real prices are inflation adjusted and expressed in current (2013) dollars. Source: U.S. Energy Information Administration and The Perryman Group of cartels that they are mathematically unstable, in that any individual country (in the absence of actions by others) can benefit from cheating. Thus, their sustainability depends of the ability to exert discipline on individual members regain territory lost to Israel during the third Arab-Israeli war several years prior. On October 17, OPEC declared that it would refuse to sell oil to any nation that had supported Israel in the Yom Kippur War, which included the United States. dramatic spike in prices for imported oil, which essentially tripled in a matter of months. In reality, the embargo received the publicity, but the production cuts had the real effects. Then, in 1979, the Iranian Revolution again caused a drop in supply, and prices were pushed up even further, with refiner acquisition costs averaging almost $87 per barrel in These oil price shocks of the 1970s caused major problems for the global economy, and the United States was one of many nations plagued by both a stagnant economy and inflation ( stagflation ). Fortunately, the embargo didn t last forever and the OPEC cartel was unable to hold together completely. Production quotas were regularly exceeded by some nations, bringing relief as supplies rose and prices fell. Prices fell further with a rift in the cartel, whereby Saudi Arabia no longer tolerated (and at least partially offset) the cheating of its partners on their quotas. By 1986, prices had dropped to just over $31 per barrel in today s dollars. OPEC AND OIL PRICES IN THE 1970s AND 1980s In order to compare oil price levels over time, it is necessary to adjust for inflation. The Perryman Group utilized a series of US crude oil prices paid by refiners (maintained by the EIA) and adjusted it for inflation. Using such a series accounts for inflation over the past four decades and allows for comparisons of costs that make sense. During the early 1970s, the price of oil was moving in a range of approximately $20 per barrel (on an inflation-adjusted basis). In October 1973, Egyptian and Syrian forces attacked Israel on Yom Kippur, the holiest day in the Jewish calendar, in an effort to The current situation varies notably from the prior cycle in fundamental ways, with a more stable supply and demand relationship driving activity. Taking this huge block of the supply off the table (even though it still made its way into the market) coupled with near simultaneous overall OPEC production cuts caused a THE TEXAS PERSPECTIVE As a large oil producing state, Texas benefitted enormously from the oil price shocks of the 1970s. The nation s shock was, in fact, a boom in the Lone Star State. Rig counts more than doubled in the five years between 1970 and 1975 (from an annual average of 302 to 638). By 1980, the average count was 989, and in 1981 the count stood at 1,318. In the Permian Basin and other oil-producing areas, the boom resulted in a huge inflow of money and jobs, as companies sought to take advantage of the price environment. The mid-1980s price collapse brought a sigh of relief to most of the nation, but a bust and real estate crisis (exacerbated by Page 2 THE PERRYMAN GROUP

3 changes in tax laws and financial regulation) for Texas. Rig counts dropped precipitously, reaching 311 in 1986 and just 206 in The state economy took a similar nosedive, with major job losses, bankruptcies, foreclosures, bank and thrift failures, and other problems. The level of activity remained relatively subdued until the mid-1990s, when it began trending upward again. With advances in recovery techniques (including hydraulic fracturing), unconventional plays became economically viable to produce. Natural gas price levels encouraged notable gas well activity, particularly in areas such as the Barnett Shale. Natural gas well completions in the state peaked in 2008 at 10,361, before dropping off as rising supplies led to falling prices. Currently, pricing strongly favors drilling for oil. 1,400 1,200 Texas Rig Counts: * Counterbalancing effects are keeping prices at relatively elevated levels, where they are projected to remain for at least the next several years. RECENT PRICE PATTERNS In the early 2000s, with economic growth around the world, prices trended upward, peaking in 2008 at over $105/barrel (using the inflation-adjusted series of refiner acquisition costs previously described). Demand fell markedly during the recent recession, resulting in a fairly sharp drop in prices to less than $64 in 2009 (with even much more volatile day-to-day peaks than these annual averages indicate). However, prices jumped back up in a fairly short amount of time and were over $102 in 2011 and are now in the $95-$100 per barrel range. At the moment, there is some upward pressure on price from unplanned supply disruptions in Libya and Iraq. The situation with Iran also has the potential to derail and cause some tension in the region (and, thus, some upward movement), although recent accords have stabilized the situation to some extent. On the other side of the equation, production in the United States is rising, thereby working to dampen these upward price pressures. Also, global demand has been somewhat weaker thanks to slower economic growth, further contributing to lower prices (a situation that is reversing itself as the less-developed countries become more industrialized in the coming years). These counterbalancing effects are keeping prices at relatively elevated levels, where they are projected to remain for at least the next several years. 1,000 DIFFERENCES BETWEEN THE 1980s AND CURRENT CYCLE *Annual average rig counts for 1980 through Source: Railroad Commission of Texas The key question, then, is whether the current price picture has the potential to turn into a mid-1980s freefall over an extended period (or, alternatively, an extreme escalation). Without a doubt, the energy industry is cyclical and price reactions in response to global events are to be expected. However, the situation has changed in important ways since the 1970s. In particular, today s prices are stemming from a far more stable supply-demand relationship. continued on page 6 THE PERRYMAN GROUP Page 3

4 The November decision by Texas voters to allow money from the Rainy Day Fund to be used to help meet the state s future water needs is a win for the Texas economy. If PERRYMAN S we run short PERSPECTIVE on water, the effects on quality of life are obvious. In addition, without enough fresh water at affordable prices, sustaining the state s business complex is impossible. By voting yes to Proposition 6, Texans approved an important first step in the long journey to ensure we have enough of this vital resource. It s no secret that water is in short supply in most parts of the state. The 2011 drought conditions were severe virtually everywhere, and the recovery has been slow in coming. While there has been some spotty relief from short-term problems and the grass is greener in many areas, the long-term effects continue to worsen through much of the state. Statewide, water reservoirs stood at about 60% of capacity at the end of August. More alarming is the sharp divide between the eastern portion of Texas, where conditions are normal or close to it, and the western and panhandle regions. Some very large lakes are completely dry; Lake Meredith north of Amarillo, for example, is designed to hold 500,000 acre feet and is now totally empty. What was once an important source of drinking water is gone, and it s a story repeated time and again across the state. One hard-hit river basin (the San Rainy Day Water Antonio) is nestled between others that are faring much better, which illustrates how spotty the rainfall has been. Equally alarming, the Texas Water Development Board s monitor wells show that some aquifers are simply being sucked dry. You can see recharge through the bumpy pattern of some well-level graphs, but others simply show an all-too-steep downward trend. Water restrictions are in place in many areas, with little relief in sight. To compound these supply challenges, demand for water is growing. The Texas population is likely to nearly double over the next 50 years. Economic expansion will also generate a need for more water. It makes little sense to rely on the vagaries of rainfall and existing infrastructure to fill this need, and fortunately, Texas voters were willing to invest in a solution. Proposition 6, on the recent statewide ballot, created and constitutionally dedicated two new funds: the State Water Implementation Fund for Texas (SWIFT) and the State Water Implementation Revenue Fund for Texas (SWIRFT). The measure passed, with more than 836,400 people voting for it (303,500 against). This 73% to 27% win is a clear statement. Looking at a county-level list of results, I found less than 20 of the state s 254 where the measure failed. By passing Proposition 6, voters authorized pulling $2 billion from the Rainy Day Fund to help set up funding methods to get going on some much-needed projects to deal with shortfalls almost certain to occur in the future if we don t take action. The funds will be used to help communities develop and optimize water supplies through low-cost financing options. With this financial help, communities can begin water projects which are already outlined in the State Water Plan (which addresses the needs of about 3,000 water user groups). At least 10% of the funds will go to projects in rural areas (including Texas farmers), and at least 20% of the funds will be used for water conservation and reuse projects. Even with this much-needed boost to funding for these essential projects, there is still work to be done. While a notable sum, $2 billion will not be enough to solve the long-term supply shortfall. Moreover, it is a one-time infusion from a savings account, not an ongoing source of funds. Needs are estimated at well over $50 billion, and, while the $2 billion can be leveraged to some extent, it doesn t come close to solving the problem. The economic and quality-of-life consequences of not having enough fresh water at reasonable prices can hardly be overstated. Voters have spoken, and Texas legislators, who lacked the political will to provide even this modest funding level without punting the decision to the electorate, should take note. The water supply is a crucial issue to Texans, and fully addressing the problem should be a top policy priority. M. Ray Perryman, PhD Page 4 THE PERRYMAN GROUP

5 Economic Development News from Around the State Corpus Christi: Transit authority starts work on $29 mln Staples Street Center. Project to include new building, renovation of bus station. Expected to create 233 jobs. Houston: William P. Hobby Airport getting $156 million international terminal. City, Southwest Airlines recently broke ground. Could bring an extra 1 mln passengers/yr. $3 mln from TX Emerging Tech Fund to create cell & organ biotechnology center. For Texas Heart Institute, A&M College of Veterinary Medicine & Biomedical Sciences. Bay City: 250 jobs being created for a products manufacturer for oil industry. Texas Enterprise Fund recipient Fritz Industries Inc. to invest $37.5 mln in new facility. Lubbock: Two upcoming local business expansions will lead to positive impact. Incentives to help bring 81 jobs to Tyco Fire Protection Products & 14 to Shearer s Food. New Braunfels: IBEX Global unveiled its new call center here in November. Company starting out with about employees and should eventually reach 600. Coppell: Retailer Anna s Linens Inc. locating regional distribution center to city. The 263,625 square foot space will serve as a hub for 100 stores throughout the US. Beaumont: Expansion is in the works for American Electric Technologies, Inc. Its primary power delivery manufacturing plant to add 11,000 sq. ft. & some new hires. Plano: Insurance giant USAA creating 680 jobs at its info technology operations. Expansion will represent a $31 mln investment with $5 mln from Texas Enterprise Fund. Irving: Provider of supply chain solutions moving headquarters here from Illinois. Neovia Logistics relocation to 45,000+ sq. ft. space to create about 225 jobs for the area. San Antonio: Carbon capture & mineralization plant going up at cement factory. Skyonic Corporation s facility to begin operations in 2014 and should employ about 35. Cuero: Two new hotel options to help meet demand for oilfield worker lodging. A 51-room America s Best Value Inn and a 77-room Holiday Inn Express being built. Want to include a business announcement for your community? Let our editors know what s taking place in your neck of the woods. Share the details of recent economic development happenings in your area. The Perryman Report & Texas Letter is read monthly by the state s most notable leaders. submissions to info@perrymangroup.com or send fax to THE PERRYMAN GROUP Page 5

6 continued from page 3 The global economy (particularly the advanced segments) has developed many industries that aren t quite as reliant on crude to generate value (such as technology). Also, after the era of cheap oil and gasoline ended in such dramatic fashion in the 1970s, concerted efforts were made to try to become less vulnerable to similar events. These efforts (which are still ongoing today) included encouraging energy conservation, developing domestic production capacity, and improving access to sources of supply in nations whose interests more closely align with our own (such as Canada). In addition, the current surge in drilling activity is not as highly leveraged, thus making it able to withstand a greater degree of price movement without dramatic swings in the industry. 20,000 18,000 16,000 14,000 12,000 10,000 8,000 6,000 4,000 2, Annual Oil and Gas Well Completions: Oil Wells Completed Gas Wells Completed In the past five years, production has surged as a result of the new plays and the new technologies and has made up about 30 years of losses. Finally, despite the robustness of the boom from 1973 to 1981, production in Texas fell every year (in fact, it fell steadily from 1973 through 2008, irrespective of prices. No matter how many rigs were running, they couldn t offset what geology took away in declining fields. In the past five years, however, production has surged as a result of the new plays and the new technologies and has made up about 30 years of losses. This is a marked and critical difference. NATURAL GAS ACTIVITY Beginning in 1996, the number of natural gas wells completed in Source: Railroad Commission of Texas Texas essentially equaled the number of oil wells completed for the first time. As mentioned, natural gas drilling activity was brisk through much of the 2000s, and completions exceeded 8,000 per year from 2006 through 2009, peaking (as noted) in 2008 at 10,361. In addition to the opening up of shale plays noted above, natural gas prices had risen and were holding steady at levels that encouraged further drilling. When the US economy entered the recent recession, however, demand fell and an oversupply led to a sharp drop in prices. Unlike oil, the natural gas market has historically been largely domestic, with relatively small levels of imports due to transportation constraints. Without the ability to readily sell excess gas on world markets, prices have fallen. However, several firms are currently in the process of obtaining permits and constructing facilities to convert natural gas into liquefied natural gas (LNG), which can be loaded onto tankers and exported. This capability will help decrease natural gas price volatility, and will likely lead to additional drilling and production activity. CONCLUSION A perfect storm could lead to drastic changes in energy markets. If demand drops off, things calm down in the Middle East, US production keeps rising, and deals for supply from our allies (such as the Keystone Pipeline) are cemented, prices could fall sharply. On the other hand, if OPEC decreases production or war breaks out in the region, prices could jump. The most likely scenario (based on information available at this time) is for various forces to continue to work in opposition, keeping prices fluctuating in a relatively narrow range. Some upward and downward movement in the level of activity will doubtless occur, as companies ramp up or scale back in response to price shifts. Even so, a 1980s-style bust cycle is (fortunately) unlikely. Page 6 THE PERRYMAN GROUP

7 FOCUS ON: Historical Wage and Salary Employment Growth Wage and Wage and Wage and Salary Compound Salary Salary Employment Annual Major Metropolitan Employment Employment Gain Growth Rate Statistical Areas Austin-Round Rock- San Marcos MSA 700, , , % Dallas-Plano-Irving MD* 2,048,887 2,208, , % Fort Worth- Arlington MD* 818, , , % El Paso MSA 274, ,009 47, % Houston-Sugar Land- Baytown MSA 2,374,708 2,782, , % San Antonio- New Braunfels MSA 817, , , % STATE OF TEXAS 9,927,841 11,292,408 1,364, % Wage and Wage and Wage and Salary Compound Salary Salary Employment Annual Other Metropolitan Statistical Areas Employment 2001 Employment 2012 Gain Growth Rate Abilene MSA 68,827 74,816 5, % Amarillo MSA 105, ,432 13, % Beaumont- Port Arthur MSA 163, ,014 6, % Brownsville- Harlingen MSA 119, ,375 19, % College Station- Bryan MSA 86, ,238 14, % Corpus Christi MSA 180, ,737 17, % Killeen-Temple- Fort Hood MSA 153, ,129 29, % Laredo MSA 76,093 95,345 19, % Longview MSA 91, ,801 14, % Lubbock MSA 126, ,911 9, % McAllen-Edinburg- Mission MSA 178, ,623 67, % Midland MSA 56,031 77,469 21, % Odessa MSA 53,308 67,220 13, % San Angelo MSA 51,022 52,552 1, % Sherman-Denison MSA 45,588 46, % Texarkana MSA 40,448 46,066 5, % Tyler MSA 87, ,813 13, % Victoria MSA 51,671 53,392 1, % Waco MSA 102, ,052 9, % Wichita Falls MSA 72,929 69,088-3, % *Metropolitan Division (Part of the Dallas-Fort Worth-Arlington MSA) Source: The Perryman Group THE PERRYMAN GROUP Page 7

8 ADDRESS SERVICE REQUESTED First-Class Mail U.S. Postage Paid Waco, TX Permit # N. Valley Mills Drive, Suite 300 Waco, TX A B O U T O U R S E R V I C E S The Perryman Group assists clients in analyzing and communicating complex information in commonsense terms through comprehensive and objective analyses and presentations. Whether in litigation, regulatory hearings, public finance or legislative assemblies, The Perryman Group brings the power of economic analysis in easily understood and persuasive language. Services provided by The Perryman Group include: Litigation Support and Expert Testimony Antitrust, Patent Infringement, Economic Damages Economic Impact Assessment Industry, Infrastructure, Utilities, Legislative Issues Economic Forecasting and Modeling Demand, Commodities, Interest Rates, Utilities Economic Development Analysis Target Industry, Strategic Planning, Surveys Public Policy and Regulatory Analysis Proposed State or Federal Legislation and Regulatory Issues Survey Research and Analysis Product Demand, Policy Effects, Attitudes Business Valuation Acquisitions, Tax Planning, Financial Reporting Presentations and Speeches Associations, Corporations, Organizations General Economic and Industry Research For more information, contact Ray Perryman by ing info@perrymangroup.com or calling on Twitter. M. RAY PERRYMAN, PhD President and Chief Executive Officer, The Perryman Group Institute Distinguished Professor of Economic Theory and Method at the International Institute for Advanced Studies Dr. Perryman is a consummate economist, bringing a unique combination of credibility, creativity, energy, enthusiasm, excellence, and effective communication to every project. His experience and expertise run the gamut of academia, public policy, economic forecasting, popular writing, speaking engagements around the globe, and an active and diverse consulting practice. As President and CEO of The Perryman Group, he leads a team of skilled professionals specializing in all aspects of the strategic use of economic analysis. Dr. Perryman and his colleagues at The Perryman Group serve the information and analysis needs of hundreds of clients, including Fortune 500 corporations, government agencies, public utilities, financial institutions, investment bankers, economic development groups, trade associations, insurance companies, real estate developers, and numerous other public and private entities. Author: M. Ray Perryman Contributors: Virginia Gleghorn and Nancy Risinger Graphics & Layout Director: Shelia W. Smith Research/Editing Assistants: Karen Amos, Elodia Cavazos, and D Lee Garza, For subscription information, call For information about our corporate services, economic forecasts, and other reports, call Fax: info@perrymangroup.com Texas Economic Publishers, Inc. is a division of The Perryman Group 510 N. Valley Mills Dr., STE 300, Waco, TX Page 8 THE PERRYMAN GROUP