Dollars per Barrel: Oil Prices & Louisiana

Watch
                                                                                         “Dollars per Barrel:
                                                                                        Oil Prices & Louisiana”
                                                                                       Wednesday, February 25,
                                                                                       2015 at 7 p.m. on WLPB.

Dollars per Barrel: Oil Prices & Louisiana
        Crude oil prices have dropped from close to $110 per
barrel last summer to around $50 per barrel in January. What
is the reason for the reduction in oil prices? How big a role
does oil play in the state’s economy? Who are the winners
and losers in Louisiana when oil prices drop? And how will
the decrease in oil and gas revenues affect the state’s budget?
Louisiana Public Square looks for answers on “Dollars per
Barrel: Oil Prices & Louisiana.”
Oil And Gas Economy In Louisiana
(Includes excerpts from “The Louisiana Outlook 2015 & 2016” by economist Loren Scott, Ph.D.)
         “Louisiana is an unusual state in many respects. Because of its relatively low
concentration of employment in the durable goods industry (4.6% employment versus 6.4%
nationally) Louisiana tends to (1) get hammered less by national recessions than other states and
(2) respond less vigorously to national recoveries than its sister states. The state is often further
buttressed from the harm of a national downturn by its huge energy sector.
                          Louisiana is the nation’s #2 producer of oil and natural gas (if production
                       from the federal waters in the Gulf is included), has the nation’s 2nd largest
                       concentration of refinery capacity, and has enough miles of pipelines under
                       it to circle the globe 4 ½ times. That same huge concentration of energy
                       firms can also send the state into a steep downturn (when other states are
                       prospering) if oil and natural gas prices fall significantly.
Tremendous Investments
         The excitement along and below I-10 in Louisiana is palpable. Connie Fabre, Executive
Director of the Greater Baton Rouge Industrial Alliance (GBRIA), has tabulated the number of
industrial announcements recently. In a really good year in the past, we would have reported
possibly $5 billion in announcements. GBRIA’s latest list contains a remarkable $103.8 billion
in announcements. These announcements are highly concentrated by industry and by geography.
         From an industrial standpoint, over 92% of the value of announcements is in the chemical
industry. Geographically, the announcements are clustered in the Lake Charles area and along
the Mississippi River from Baton Rouge to New Orleans. These two regions have the three key
ingredients that chemical firms covet: (1) an ample supply of natural gas, (2) an ample supply of
water (the Mississippi River, the Gulf, and the Calcasieu Ship Channel), and (3) viable
waterways for moving their bulk products by barge or ship. Over a third of these projects are
either finished or are under construction. We estimate that about $64 billion worth of the projects
are at the FEED (Front End Engineering & Design) or permitting stage. There may be some
initial ground preparation at the sites, but nothing has gone ―vertical‖ at the site as yet.

Factors behind the Boom: Lower Natural Gas Prices
         What is behind this huge industrial boom? There are basically three factors. First, is the
very large decline in the price of natural gas. Chemical plants are prodigious consumers of
natural gas, using the fuel either as a clean-burning boiler fuel or as a raw material (ammonia
                  fertilizers and ethylene, for example, are made from natural gas). Forfive years
                  in the mid-2000sthe price of natural gas ranged between $6 to $9 per million btu
                  (mmbtu). There were several months when the price exceeded $10 per mmbtu.
                  Beginning in 2009,the price began to plummet and has settled in the $4-$5
range. Our forecast is for this price to stay just below $5 per mmbtu over 2015-16.A key
ingredient in a chemical firm’s production process has dropped significantly.
Factors Behind the Boom: Higher Natural Gas Prices in Europe
         A second and very important factor in the industrial boom (an explanation for its
concentration in the chemical industry)is that while the price of natural gas has fallen in
the U.S., it has not fallen in Europe. While U.S. prices hover between $4-$5 per mmbtu,
in Germany it is closer to $12. Germany and othercountries in Europe are huge chemical
producers. With this natural gas price differential, European chemical firms simply cannot
compete in the world chemical market with U.S. producers. The prospect of eating into Europe’s
chemical market share has fueled much of the industrial expansion in Louisiana.
Factors Behind the Boom: Oil/Natural Gas Price Differential
         A third factor behind this industrial boom has to do with the price differential between oil
and natural gas. When oil and natural gas prices differ by a factor of about seven, they are equal
in btu content. So, if the price of natural gas is $4 per mmbtu and the price of oil is $28 per
barrel, they are about equal in btu content. Early last year the price of oil was $100 a barrel. The
differential was so wide that it created at least two key incentives. One was to switch vehicles
and vessels from running on gasoline/diesel to operating with compressed natural gas (CNG) or
liquefied natural gas (LNG). The second incentive was to attract the building gas-to-liquids
(GTL) plants. These plants would be built to convert natural gas into gasoline. One of the largest
of the announcements in Louisiana was made by Sasol in Lake Charles to construct a $12-$14
billion GTL plant. G2X Energy has proposed a $1.5 billion GTL plant and Southern California
Telephone & Energy has proposed building a $2.4 billion GTL facility.
Three Massive Bets
         There are three massive bets fueling this industrial boom in Louisiana. The first is the bet
that natural gas prices will remain low. We believe this is a very good bet. The second major bet
is that European natural gas prices will remain relatively high. This is a little more risky bet.
                  There are plenty of shale plays under Europe but the green community has
                  managed to pass a EU-wide ban on fracking to harvest those plays. Even if the
                  ban is lifted, it would take time to crack the code‖ on how to frack the EU’s plays
                  and to build the pipeline infrastructure to get the new gas to market.
         The third bet is the riskiest of them all. That is that the price differential between oil and
natural gas will remain wide. The problem is not that the price of natural gas might go up, thus
closing the gap. Because of the huge supplies of the fuel available in the U.S., we believe natural
gas prices will stay low. The trickier issue is the price of oil. It just takes a glance back to realize
that oil prices can fall, and fall quickly as it did in 2009. If fracking for oil migrates to other
countries, the world could find itself awash in oil, putting downward pressure on the oil price. In
fact, Shell backed out on its decision to invest $12.5 billion in a new GTL plant south of Baton
Rouge over concerns about this price differential.”

Repercussions Of Dropping Oil Prices
(Includes excerpts from Louisiana Rattled by Oil Shock That Idles Tugboats from Bloomberg.)
        Earlier this month, Sasol announced it was delaying its high-dollar, gas-to-liquids facility
in Calcasieu Parish due to low oil prices. Sasol in a prepared statement said it would shelve the
proposed $11 to 14 billion project as it tries to conserve cash over the next 30 months. Plans
were approved last fall.
        The Southwest Economic Development Alliance said Calcasieu Parish political and
business leaders, meeting Wednesday, said they remained confident that Sasol’s plans are
deferred, not derailed. “Their $8.9 billion ethane cracker construction project is already
underway, which is a huge investment on its own,” Calcasieu Parish Police Juror Hal McMillin
said in an issued statement. “The announcement is a delay only, so we remain confident about
our economic future.”
Oil Service Provider Layoffs
         In Metairie, outside New Orleans, a recruiter who places oil and exploration workers says
his phones have stopped ringing. In Buras, near the mouth of the Mississippi, a family-run
tugboat company may let workers go for the first time in decades. And in Baton Rouge,
Louisiana’s treasurer says the state’s credit rating is at risk as lawmakers face a $1.6 billion
budget gap.
         Throughout Louisiana, where proceeds from oil and gas extraction account for 13 percent
of revenue, the shock waves from the seven-month plunge in crude prices are hitting home. A 28
percent decline since the start of December threatens to extend an eight-month streak of
increases in Louisiana’s jobless rate, the longest since the recession.
         “Oil is huge, it touches everything,” Norby Chabert, a 39-year-old
Republican state senator, said while reclining on a couch in Bar Roussell, a
lounge he owns in the Cajun country oil town of Houma. “Everyone in the oil
industry knows the price of oil is going to rise and fall. The question is the
duration.”
         As the price of the commodity hovers above six-year lows, companies
that help find and produce it are suffering. Halliburton Co., the world’s
second-largest oilfield services provider, said this week it’s cutting as much as 8 percent of its
global workforce of more than 80,000. Service company Schlumberger Ltd. said last month it
will drop 9,000 jobs, while Baker Hughes Inc. plans to cut 7,000 positions. The reductions
include positions in Houma and Lafayette.
         Louisiana’s jobless rate jumped to 6.7 percent in December, from 5.4 percent a year
earlier, Labor Department data show. North Dakota, a center of the shale-oil boom, was the only
other state where the rate rose, to 2.8 percent, still the nation’s lowest. The U.S. figure of 5.6
percent that month was the lowest since June 2008.
Job Seekers
         The state’s jobless rate rose last year partly because of an influx of people looking for
work. Employment reached a record 2.05 million in December, up 3.25 percent from a year
earlier, Labor Department data show. Business services, as well as leisure and hospitality led the
gains, according to Fitch Ratings, which gives Louisiana its third-highest credit rank.
         Nationwide, energy companies are reducing workers. The industry made up 38 percent of
53,041 job losses in January among U.S.-based employers, according to a report from
outplacement firm Challenger, Gray & Christmas.

While Texas led the reductions, it’s just as tough in Louisiana, said Toby Toups, a
recruiter for oil and exploration jobs at Personnel Consulting Group in Metairie. Sitting in his
office just west of New Orleans, he talks of boom times as recently as last year, when he could
make five calls about a prospect and receive three responses within days. The issue wasn’t
finding the jobs; it was getting enough candidates to fill them. Even in October, he had 12 jobs to
fill and was confident about prospects in 2015. Now, hiring has stopped and dismissals have
begun, and Toups says he has three leads to work.
Capital Concern
                         “Six months ago, everyone wanted to get into oil and gas, because when
                         it’s good, it’s really good, and it pays more than anything,” Toups said.
                         “But when it’s bad, it’s really bad.”
                                 The situation is also precarious in Baton Rouge, the capital.
                         Republican Governor Bobby Jindal this month released a plan to close a
                         $103.5 million budget deficit that opened up for this fiscal year as oil
                         slid. His proposal involves freezing hiring, cutting library hours and
buying less public-safety equipment.
       Moody’s Investors Service said in a Feb. 2 report that the mid-year adjustment
undermines the state’s rating, which is stable at Aa2, the third-highest rank. Louisiana also has to
contend with a $1.6 billion shortfall for the year that begins July 1, and has used up one-time
methods to boost revenue, according to Moody’s.
Borrowing Ahead
        “We were in trouble before the oil price change -- we’ve had seven years of midyear
budget cuts,” John Neely Kennedy, Louisiana’s treasurer, said in a telephone interview. “I don’t
think a rating decrease is inevitable, but if the Legislature doesn’t get our fiscal house in order,
we will have a rating decrease.”
        David Jacobson, a Moody’s spokesman in New York, said the company doesn’t comment
on communication with issuers. A one-step cut to Aa3 would tie Louisiana with California,
Connecticut and Pennsylvania for the third-lowest general-obligation rating among states.
Investors will have their say this month: The state plans to sell about $228 million of bonds in
February, according to Fitch.
‘Strategic Decisions’
        Jindal’s plan highlights that cuts would spare higher education, and he says the state
would be better positioned to address the budget for next fiscal year. “The declining price of oil
required tough, strategic decisions about our spending,” according to the budget report. “We
worked carefully with each agency to prioritize programs and services for the people of the
state.”
        Jindal’s office referred questions to Kristy Nichols, the commissioner of administration.
“We’re going to be prepared for a sustained decline,” Nichols said in a telephone interview.
“We’re maintaining a conservative position on oil prices, and that’s how we’re building our
budget.”
        The state plans to factor a price of $59 a barrel into its next budget, after starting this
fiscal period expecting $93. The price of West Texas Intermediate, the U.S. benchmark, shows
signs of bottoming out. After falling below $45 a barrel last month from about $107 a barrel in
June, WTI for March delivery climbed 3.5 percent to $50.54 a barrel at 9:24 a.m. on the New
York Mercantile Exchange.

‘Ugly Time’
         In Houma, down the street from Senator Chabert’s bar, oil workers say they knew what
they signed up for: a volatile industry that depends on a market-driven commodity. “This is the
ugly time right now,” said John O’Brien, 33, who lives in Abu Dhabi and was in Houma for
training. Smoking Marlboros and drinking beer at Mahony’s bar on Main Street, he said most
people try to save and plan ahead for times like these. Down the bar, Brady Bischof, 46, a sales
manager at an oil and natural-gas company, said Houma residents are concerned that the
economy will shrivel once Mardi Gras festivities subside. He said he knows of machinists whose
workload has dropped to 40 hours a week from 60. “It affects everyone –- people count on the
oilfield,” Bischof said. “People across the country think paying $1.99 a gallon for gas is great.
It’s not great for anyone in this town.”
State Budget (Includes excerpts from NOLA.com )
         On Friday, February 28, the Louisiana Legislature’s Joint Budget Committee will hear
Jindal's plan to close a projected $1.6 billion financial shortfall in next year's state budget. The
Jindal administration has sought to blame most of Louisiana's budget woes -- the current midyear
cuts and next year's deficit -- on dropping oil prices. Still, legislators said this wasn't a proper
framing of the issue.
         Louisiana is facing a continuing, structural budget problem, regardless of what is
happening with the oil market, according to state Sen. Jack Donahue, R-Mandeville, who
heads the Senate finance committee. The state was dealing with a $900 million hole next
year, prior to oil prices dropping, he said. Donahue said the state must find a way to deal
with its budget problems that provides long term solutions. He said the Jindal
administration and legislators have relied too heavily on short-term money that doesn't replenish
itself -- like building sales and trust funds -- to cover ongoing costs. "We're not fixing the
[budget] problem," he said.
         Nichols said Jindal's budget proposal for next year -- the one that will close the $1.6
billion projected shortfall -- will rely less on moving money from dedicated funds -- like the
transportation trust fund -- to other areas of government spending. The Jindal budget proposal
that comes out next week will include longer-term budget solutions. "I assure you, next Friday,
you will see structural solutions," Nichols said.
TAX EXEMPTION DEBATE
        With dropping oil prices, some have suggested now is the time for the Legislature to
raise the state sales tax on gasoline. Louisiana motorists pay a total of 38.4-cents in state and
federal taxes on every gallon of gasoline purchased. The national average is 48.7 cents-per-
gallon. Of the 38.4 cents, 20 cents goes towards financing Louisiana’s transportation projects.
But a broader discussion is taking place about the tax incentives and rebates provided to industry
and whether they should be scaled back or eliminated. Below is an excerpt from a guest commentary
in The Advocate by Steve Spires with the Louisiana Budget Project on that topic followed by a response
from Stephen Moret with Louisiana Economic Development.
Stephen Spires / Policy Analyst with the Louisiana Budget Project
         “The recent announcement by Sasol that it was delaying construction of its $14 billion gas-to-
liquids plant should serve as a teaching moment for state policymakers. In a year when Louisiana is
facing its worst budget crisis in recent memory, it serves as a reminder of the pitfalls of using scarce
taxpayer dollars to chase economic development “wins” instead of focusing on the fundamental building
blocks of economic success — an educated workforce, affordable health care, safe streets and reliable
infrastructure.

For those who missed the news, Sasol is a South African petrochemical giant, and its factory
planned for Lake Charles was set to be the biggest industrial project in state history. But when oil prices
tanked, the economics of the project no longer made sense. So it’s been mothballed indefinitely, and with
it the 750 permanent jobs that were slated to come online once construction was finished.
          The company’s change of heart is merely the most visible evidence that while falling gas prices
are good for most consumers, Louisiana’s economy — and the state’s ability to pay for basic services —
remain vulnerable to swings in the energy sector. But it also tells us something about the limits of
corporate tax incentives. Louisiana offered Sasol $257 million in state subsidies — $115 million of it in
cash — and as much as $3 billion in property tax breaks to build its factory. The subsidies are so lucrative
that some economists question if the state will ever recoup its upfront investment.
                               But the state’s generosity wasn’t enough to overcome the market
                            fundamentals that dictate business decisions. In this case, the falling price of oil
                            affected Sasol’s plans. No tax giveaway will change that. It is all about supply
                            and demand, just like Economics 101 taught us.
                                     Policymakers should stop asking themselves how much tax money it
will take to lure the next factory to Louisiana and start asking how they can make Louisiana more
attractive to investment by modernizing our infrastructure, improving training programs and making sure
everyone has access to great schools and hospitals.”
Louisiana Economic Development director, Stephen Moret replies:
          “This column includes a few serious inaccuracies. For example, Mr. Spires characterizes the
state's incentive offer to Sasol as billions of dollars in "upfront" incentives from the state. That is false. In
fact, to date the only thing the state has provided for the project is training support and a state investment
in a local SOWELA training center that also will benefit other companies. The vast majority of the
proposed incentives for the project will only be received if the company completes both phases of the
project, and the only "upfront" incentive to the company is training support.
           Mr. Spires suggests that the project economics are no longer attractive. That is not the case.
Rather, the parent company's cash flow currently is constrained due to lower oil prices, which means the
company currently is unable to support the huge capital investment that will be required to get the second
phase project off the ground.
          Mr. Spires states, "[S]ome economists question if the state will ever recoup its upfront
investment." LSU economists developed an independent economic impact analysis of the project for the
state, which showed that, during the project's incentive agreement with the state, the project will generate
approximately $616 million in new state tax revenue in excess of the incentives provided. The LSU
analysis also shows that, based on the timing of the proposed incentive payments to the company (which
decidedly are not "upfront" as Mr. Spires incorrectly stated), the state never has to recoup its investment
because the project will generate more new state tax revenue than the state provides in incentives, before
the state incentives are provided.
          Mr. Spires suggests a false choice -- that the state must choose between economic development
and investment in other areas. In fact, the Sasol project is a good example of a project that will generate
vastly more tax revenue than the incentives provided, helping to fund other important state priorities, such
as higher education, healthcare, and transportation infrastructure.
          …I agree with Mr. Spires that tax reform in Louisiana is long overdue. We would be much better
off with far fewer exemptions and lower tax rates for all citizens and businesses in Louisiana. I also agree
that incentives are just one part of a company's decision process, although they often can prove crucial
once a company is selecting between 2-3 finalist states, such as Louisiana and Texas. I also agree that we
should make changes to some of the state's incentive programs -- changes we have proposed for years,
such as tightening up the Enterprise Zone program and the film production tax credit program. Finally, I
agree with the implicit suggestion of Mr. Spires that our economy is overly reliant on energy-related
projects, which is why we have placed so much focus on attracting a more diverse array of economic
development projects to Louisiana, such as Bell Helicopter, Benteler Steel, CSC, EA, GE Capital's
technology center, and IBM.”