Texas State Senator Paul Bettencourt, (R-Houston) poked the bear when he filed Senate Bills 1750 and 1751, which would allow the Teachers Retirement System of Texas (TRS) and Employee Retirement System of Texas (ERS) to study, and possibly implement, changes in their public pensions. Change would mean moving – in an as-yet unspecified way – from a traditional “defined benefit” to a more 401K-style “defined contribution” plan. The effect would be to shift the burden of paying for retirement, somewhat, from taxpayers to employees. The bills as written specifically would only affect newly hired employees, not existing employees or retirees.
The bear he poked, of course, is public school teachers.
Public school teachers in Texas face steeper challenges planning their retirement than other professionals, in part because the vast majority cannot participate in Social Security, in part because of modest pay increases throughout a full career of service, and in part due to barriers to good retirement advice.
I don’t blame teachers, their union, and groups like the Texas Public Employees Association and Texas Retired Teachers Association (TRTA) that have come out in opposition to the bills. Tim Lee, Executive Director of TRTA, told me that an estimated 120 thousand text messages had been sent to legislators regarding changes toward a hybrid plan, such as suggested in SB 1751. Lee regards a shift to a hybrid system – even for only new hires – as undermining the strength of the entire TRS. A change caused by these bills would cause his organization to rethink their strategic approach to everything, including whether to advocate for joining the Social Security system. They don’t currently, but might in the future if they thought a hybrid system weakened TRS.
And yet, (and here’s where I become a target for the next 10,000 angry text messages from teachers) Bettencourt has an important point to make, by filing these bills. “Long term, what I hope to do is start a discussion about the real cost of pensions,” Bettencourt told me.
As a finance guy, I want my public officials staying up late worried about public pensions, seeking ways to reduce their systemic risks. TRS has more than 1.5 million members, more than $130 billion in net assets, and represents the ultimate “Too Big To Fail” public pension in Texas.
Reasonable people can disagree on the following, but on the four biggest measurements of a pension plan’s health, the TRS according to its 2016 audit is worse off than we’d wish for, although maybe still within acceptable bounds.
We want at least an 80 percent “Funded Ratio” – the percent of money owed to pensioners that’s covered by money already in the investment portfolio. TRS is now at 79.7 percent. Too low.
We want less than 30 years to “amortize” or pay down, pension debts, and would prefer 15 to 20 years. TRS is at 33 years. Too long.
We would prefer a low, or conservative, annual return assumption, compared to a national average of 7.47 percent annual return assumption in pension plans. The TRS assumes an optimistic 8 percent return. Too high.
Finally, the unfunded liability part of the pension – money owed to retirees but not yet paid for – has grown from zero in the year 2000 to approximately $35 billion this year. Too big.
None is this spells catastrophe today, in my view. It just means the TRS is not, currently, building in room for error. As a teacher, if TRS is my main safety net, these numbers do not make me comfortable.
Actually, let me restate: Were I a young teacher, or a prospective teacher facing a new career, I would be livid about those TRS numbers. Older teachers – those close to retirement or already retired – are probably fine, and realistically won’t get benefits chopped to make up any future shortfalls. Rule changes in pensions always hurt the young ones.
In fact, one of the main flaws of the TRS design is this “generational inequity” in favor of older teachers rather than younger teachers, according to Josh McGee, who is both a pension-plan economist for the John Arnold Foundation and the Chairman of the Texas Pension Review Board. McGee has written extensively about how traditional pensions like TRS strongly favor veterans over younger teachers, especially those who change jobs or leave the system at any point in their career.
Defined benefit plans are most generous to veterans of over 20 years, but McGee cites figures that only 28 percent of teachers nationwide stay for that long. The early-departing teachers lose many of their hard-earned retirement rewards.
A defined contribution plan or hybrid plan theoretically could allow teachers the chance to self-fund part of their retirement, which could accompany them to another career or another location.
Then there’s the issue of pension plan solvency.
“When you look around the state, the Dallas [Police and Fire] Pension is a smoking crater at this point in time. Houston is not far behind,” Senator Bettencourt notes, referencing existing problems in public employee pensions in the state’s largest municipalities.
The following are my words, not Sen. Bettencourt’s, but I regard public pension plans as ticking time bombs. Not because the managers of TRS are bad, or because anyone is doing anything particularly wrong. It’s just that small decisions to underfund a public pension can, over decades, compound into giant problems. Make a few wrong assumptions – the 8 percent return assumption seems way high to me for example – and you end up with a big fiscal hole in the state.
A safer approach for teachers and taxpayers might in fact be to shift, over time, some of the risks away from taxpayers. Currently 13 states have a version of a hybrid system of the type that Bettencourt’s bill would allow, while 38 states continue with a “defined benefit” plan like Texas’ current TRS.
It’s a debate worth having now, before anything bad happens.
A majority of people struggle to prepare financially for their retirement, but public school teachers and employees face a particularly difficult set of circumstances.
I’m enough of a fiscally hard-assed finance guy to think that every public school teacher should self-fund his or her retirement to supplement their pension plan, which for people in my state is the Teachers Retirement System of Texas (TRS). Unfortunately, there’s the grim reality facing many teachers about how hard this is to actually do. I learned a lot recently from my teacher friends about why that’s so.
My friend Dina Toland has worked as a public school teacher in Texas for 23 years and described the typical way she and her colleagues obtain their “retirement advice.”
First, a representative salesperson for an insurance or investment management company gets invited, for some unclear reason, to a faculty and staff meeting, where they have a captive audience from which they can collect email sales leads by offering raffles or some other minor incentive.
The salespeople then attempt to schedule one-on-one teacher meetings using these leads, at which the pitch usually involves scaring teachers about their insecure retirement and the need for certain specific investment products. Thus made anxious, teachers are often urged to invest in variable annuities, which I consider one of the four horsemen of your personal financial apocalypse because of their high fees, illiquidity, low returns, and generous sales commissions for these same salespeople.
Dina was convinced to buy into this mess when she was a young teacher just starting out. Ironically, the salesperson herself was so inexperienced that she convinced Dina and her cohort of similarly clueless young teachers to take out too much money from their paychecks, such that they all had trouble paying their bills in subsequent months. Besides taking too much money, they all bought into these terrible variable annuities. As Dina says, how would they have known any better?
This problem afflicting teacher retirement planning isn’t limited to Texas. The New York Times ran an excellent 6-part series last year with provocative and true headlines like “Think Your Retirement Plan is Bad? Talk To A Teacher” and “An Annuity for the Teacher – And the Broker” about precisely these difficulties, featuring public school teachers in Connecticut who were sold products with this combination of high fees, low returns, illiquidity, and hefty commissions for insurance salespeople.
My friend David Nungaray, in his 6th year of teaching and administration in public schools in Texas, has a similarly discouraging story.
Early in his career, a representative salesperson of an insurance company was invited to speak to new teachers like him, at which he was of course urged to purchase an annuity. He did, to my chagrin when I later learned what had happened. This year he resolved to open up his 403(b) employee-sponsored retirement account, the next big option for self-funding one’s retirement.
Helping my friend David set up his 403b account was anything but easy and straightforward. David is himself extremely competent. But we agree this would never have gotten done without both of us working hard to do it. As a first step, David asked six of his colleagues in the public school system – chosen by David for their seeming prudence and likelihood to have a 403(b) account – if they had any advice for him. Only one of the six had ever signed up for a 403b account. Not an auspicious start. David then contacted his school district to look for help. Could David get any investment advice from his school district? No. The human resources department at his school district referred David to TCG Group, which administers all employees’ 403b plans for his school district, as well as many others in the state. The TCG Group website provides a list of 51 approved annuity and investment firms, with links to contact them.
“Shit Sandwich”
David had no idea which investment firm to pick. Could TCG Group help? No, that’s not their job. They are 403(b) plan administrators only.
As a side note, I tried for three days to have a substantive conversation with folks at TCG Group, for the purposes of this post. Let’s just say they were as helpful and open with me as they were with David.
The next step was to pick an investment firm and to open an account. I helped him do that. Having done that, he returned to TCG Group to give them instructions to have 403b contributions deducted from his paycheck. Of course, then he needed to select an investment, or series of investments, at his chosen investment firm. That’s easy for me to help him with, so I did. But this hand-holding happened over the course of four weeks, with many barriers along the way. The barriers would have deterred a less determined employee, especially one without a friend willing to do it, in a non-conflicted way, for free.
Of course any of the investment firms could have “helped” him too, but he might have ended up with terrible annuity-like products totally inappropriate for the retirement account of a teacher still in his twenties. I’m all for self-funding and self-reliance as a theory, but I’ve become concerned about the reality of doing this well, for most teachers.
The stakes are high because most public school teachers in Texas – like those in many other states – can not count on Social Security in retirement, as 95 percent of school districts opt out of the federal system. So teachers fall back on the TRS and do little else.
If you are one of the over 1.5 million Texans who are members of the TRS, you should ask at least two big questions about your retirement. First, as my main safety net, is TRS financially strong? Second, will payments from TRS be enough to cover my needs in retirement, personally?
If you are not a member of the TRS, then as a citizen and taxpayer you should hope that state leadership is also asking important questions and having a good dialogue around these challenges and solutions. In a subsequent post I’ll talk about the finances of TRS, and that dialogue.
When I think about environmental action, my mind goes to the words we commonly use – particularly “sustainable” and “green.” And like the Princess Bride’s Inigo Montoya, I do not think these words mean what traditional environmentalists think they mean.
Because of my particular definitions, I am oddly excited about my city’s organic compost plan. I’ll explain why in a moment, but first, those words.
To me, an environmental plan is “green” when we make money or save money – cool, paper, greenbacks. A “sustainable” environmental plan is one that continues because everyone sees it as in his or her own personal financial self-interest. A “sustainable” environmental action, therefore, is one not easy stopped by a political change or a slight shift in market prices. If people want to do the right thing environmentally and it’s also in their interest financially, then that action will sustainably continue.
Ok, so why do I get all tingly about my city’s green organic composting barrel that showed up at the end of my driveway a few months ago?
After a little bit of research I found out that a business managing organic waste can make money – in a green, sustainable way. As it turns out, my city, and indirectly taxpayers, can save money from organic composting. The final piece – the specific financial benefit for households – is only weakly established, in my opinion. San Antonio is working on this as well, but that’s probably the part that needs the most strengthening in the years to come.
Figuring out how a private business makes money is why I visited the headquarters of New Earth, the company that has the contract with the City of San Antonio to collect organic household waste.
In theory, I’m enamored of their business model. They get paid to take in raw waste, and they get paid to sell compost. Getting paid both coming and going!
Organic waste dumpers – like landscapers, tree-clearing developers, and now the City of San Antonio – pay New Earth for the privilege of dropping off organic trash, the first source of the company’s revenue. New Earth then applies its processes – the art and science of industrial-scale composting – to that waste over 1 to 3 months. At the end, they produce ground cover, mulch, and compost bags for sale to landscapers, developers, and gardeners.
Of course, I’ve simplified the attractiveness of New Earth’s business model.
Like any real business, profit is not as easy as it at first seems. New Earth takes considerable financial risks.
Here’s just a sample of why it’s risky: Handling trees and brush cleared from a new construction site is relatively easy – you run the trees through a chipper and you have a relatively uniform product at the end. However, properly filtering household organic waste – produced from hundreds of thousands of sometimes careless trash-tossers like you and me – is a far more risky and manual-labor intensive process. Clayton Leonard – until recently the President of New Earth – explained to me that New Earth had to double their workforce to handle the city contract. They also had to invest in a multi-million dollar piece of equipment to sort through the waste. Leonard climbed up with me onto one of their giant sorting machines.
We watched the household waste pass through a conveyer belt while guys with rakes – some of their new hires – separated the non organic waste from the pile. Pro-tip: Neither your old iPhone case nor your plastic bags should go into organic waste. Not all households, I saw from the conveyer belt process, have gotten that memo.
I mention all this to say that it takes significant capital and labor costs to try to make money on a citywide organic waste contract. The key point for me, however, is that New Earth is being run in my version of a green, sustainable way – to make a profit.
At the same time, the City of San Antonio has their own green, sustainable, reasons – saving money. Here’s how.
When the city hauls and dumps regular trash, it pays an average of $24 per ton to local landfills for that privilege.
When the city hauls and dumps organic waste over to New Earth it pays $16.50 per ton. The city is incentivized therefore to redirect as much volume of trash as it can to organic waste. As New Earth’s Leonard told me, “In order for us to survive, we have to be cheaper than a landfill.”
As the city fully rolls out the green barrel program – scheduled for completion in April 2017 – it hopes to get a lot of residents dumping their compostable waste into those barrels. The goal for the household organic waste program is 60,000 tons per year, according to Nick Galus, Assistant Director for the Solid Waste Management Department. At current prices, that would save an estimated $450,000 per year.
As a public entity, Galus notes, their goals are a combination of financial gains and sustainability, traditionally understood.
“Our goal is to capture the greatest amount of the waste. The cost isn’t the driving force. We’re trying to get to our goal in the most cost-conscious way,” he said.
Interestingly, San Antonio is the first major Texas city to roll out an organic recycling program city-wide. The fact that other Texas cities haven’t done the same – despite some financial incentive to do so – indicates that there are risks for a city as well. Any city, including San Antonio, has costs for rollout and household education. Other Texas cities have pursued strategies focused on yard waste, according to Galus, making it costly to switch over to a plan that also accommodates food waste.
The San Antonio goal is to have 60 percent of all waste hauled by the city be recycled, composted, or repurposed in some way by 2025. They’re at 33 percent as of 2016.
If San Antonio can show cost savings, the case becomes more compelling for other cities. If they can even figure out the household financial incentives, the whole process becomes my kind of green and sustainable.
If you have a fancy educational background, the tempting thing is to go into a glamorous field, full of smart people with equally good educations. Maybe investment banking, consulting, or a stint with a hedge fund? I tried all that. Because I’m a slow learner, I realized late that there’s got to be a better way. It took me a while to figure out the following: Dirty jobs might be a smarter bet for making money.
What I really wish I could do is invest in my friend Bryant’s business, but I’ll tell you his story as maybe it helps you make money starting or investing in your own business.
Bryant’s Ivy League education initially took him to book publishing in Brooklyn, which – while not as lucrative as other high-status jobs – is definitely full of bright shiny minds. Then a buddy lured him down to the Eagle Ford shale in South Texas in 2007, and he’s been knee deep in the oil field services business ever since.
I took a field trip 30 minutes south of my house where Bryant is currently building a new oil-field services business, called CRU Railcar services.
Railcar cleaning
He and his boss got inspired because they move sand into the oil field in South Texas via rail, and they found existing services to periodically clean their train cars expensive, slow, and unreliable.
Here’s some background on cleaning railcars: Railcars that move the products of the oil and gas business have to be cleaned before being used for carrying anything else and/or before being put into storage. If the railcar previously hauled diesel but will convert to move heavy sour crude in the future, then a professional cleaner has to completely scour the inside of the car. If the car moved propane before but will be retired into a rail yard for storage, the whole thing has to be cleaned as well.
This is a dirty job. It’s also dangerous, scary, and complicated.
During our visit, Bryant and his team of five other roughnecks all wear the company uniform: The left-pocket nametags stitched on nylon with reflective safety stripes give them a look somewhere between an Astros throwback jerseys and a bowling team. It’s the kind of thing his book-publishing hipsters buddies might wear in Williamsburg, Brooklyn, but for them in a totally ironic way. There’s no irony to Bryant’s pret-a-porter style. This job kills.
A Houston Chronicle investigative report in 2014 found the tank cleaning business highly risky, with the main regulatory agency OSHA unable to keep track of cleaning companies or their safety standards.
In reading reports of accidents on the job, a haphazard approach to risk appears common.
Bryant’s attention to detail when it comes to risk, by contrast, impressed the heck out of me.
Bryant walked me through the process he’s created for cleaning fuel cars.
First, they assume the air inside a fuel car is totally incompatible with human life. All cleaners breathe only from oxygen tanks, like scuba divers under water. As a backup, they carry 5-minute emergency tanks in the event of a failure. A spotter stands over a hole in the top of the train car at all times, watching for any signs of trouble. The spotter stands next to a crane for lifting an unconscious body, while an electronic monitor for air toxicity runs at all times. In addition to the spotter, a rescue person stands by, with his own oxygen supply at the ready, in case of trouble. That covers the air problem.
Then there’s the explosion problem. To hack at dried petroleum that might cake the fuel tank floor, the cleaners use a spark-proof shovel. Shovels are just one method.
Train cars arrive in a wide variety of dirty states, having carried any number of oil and gas products. In tests, Bryant’s team has found that only trial-and-error can determine what cleans the cars best. Sometimes a splash of diesel loosens up the gunk. Sometimes a high-pressure water hose that would cut your limbs off works best. Sometimes, he reports, the simple household cleaner Dawn is magically effective.
Seek dirty jobs
Thomas Stanley, author of bestselling personal-finance book The Millionaire Next Door urged “dirty jobs” for successful entrepreneurs. Stanley tells the story of junk-yard owner Richard with his $700,000 annual income and $10 million net worth as the quintessential model to follow. Seek businesses with that might have little to no competition, Stanley urges, because they lack the prestige that attracts the brightest minds.
Many things will determine the success of failure of your new business venture: The cost of materials, your ability to make the big sale at the right time, the difficulty of finding investment capital, your skill in hiring and retaining key people, and of course the sign of the zodiac under which you were born.
But one of the things that could save you – as you screw up everything early in your business venture – is the quality of your competition. In a sense this is just another restatement of the old “bear and the two hunters” joke. You don’t necessarily have to outrun the bear, you just have to outrun your competition. If you can choose a field where the competition is thin, you’ve got a good chance of thriving.
Bryant’s railcar cleaning business is dirty, dangerous, claustrophobic, and complicated. I would not do it for anything in the world. I also have a hunch they’re going to clean up on the competition and make a lot of money.
Note: I reviewed Gary Sernovitz’ book in September, and we did a phone interview back then, which I’ve now posted as an audio interview, Part I – on the big personalities in fracking. Part II – on environmental issues, will follow. I recommend listening to the audio version, but I’ve posted a transcript of our conversation as well.
Mike: Hi, my name is Mike, and I used to be a banker.
Gary: And I’m Gary. I guess I’m sort of still a banker, at least a private equity investor.
Mike: As you know, I read and really enjoyed your book, and I reviewed it on my site. I just want to praise you for doing what I think is my favorite thing, which is taking a complex issue upon which nobody agrees, and everybody thinks the other side is complete fucking idiots, and saying no, we’re not all idiots. We could understand each other. So thank you for doing that. That’s really great.
Gary: Thanks for the praise and clearly, that is not the dominant mode of American discourse, as evidenced by the discussions heading into November.
Mike: Yeah, it’s really difficult to not see the other side as either morons or dupes or evil. And I would say if you just say the word “fracking” we’ve already introduced the idea the other side is one or all of those things. I appreciate you describing yourself as a New York liberal. And I described you as deep in enemy territory there for fracking, and yet you have to both answer for your profession, which is to be investors in energy and in oil and gas and fracking, but at the same time, be a thinking person.
Gary Sernovitz
I don’t know who’s more unattractive, oilmen or Wall Street guys, but every once in a while, I’ll say something mildly positive about a Wall Street guy in some column and people will write inevitably “You’re such a jerk talking about the banksters as if they’re not all evil.” Okay, sorry.
Gary: I manage to work for a private equity firm that invests in the oil and gas business to be the worst of both worlds.
Celebrities of Fracking – Aubrey McClendon
Mike: Some of the interesting parts about your book are combinations of celebrating capitalism, and ingenuity of the shale revolution, and incremental changes. And then part of that celebrating capitalism is celebrating some of the funny and interesting characters who made good off of the thing.
I’m interested in some of those. Some of them I’ve heard some of their names but don’t particularly know them, but I understand they’re rock stars of your industry. I’d love to chat about those if you don’t mind.
One, your favorite seems to be Aubrey McClendon who I guess died after you’d written the book. I don’t think you referenced his death, or maybe you do?
Gary: No, he died in what is not terribly clear ‑‑ whether it was self-inflicted or not, but drove about 80 miles an hour into a highway overpass the day after being indicted.1 Obviously, a lot of speculation on the timing of that.
The late Aubrey McClendon, from a 2011 cover story
Mike: Certainly looks suspicious, as a complete outsider.
Gary: The conclusions most people have drawn ‑‑ but I think there has been no official word from the investigation one way or the other. Not necessarily that there needs to be, but the funny thing about the book is there was an alternate book that was just sort of a straight biography of McClendon that kind of was impractical to write with my job and with need to write ‑ he’s backed by a firm in his later life that competes against my firm in terms of providing capital to oilmen. I ended up putting that to the side.
Mike: There’s a book worth or more of Aubrey McClendon stories?
Gary: Yeah, sort of every chapter you find he’s Zelig of the book. In every chapter he kind of finds his way. There is a small Aubrey biography woven through it unwittingly, just because he is one of the more colorful characters. He kind of harkens back to a different kind of swashbuckling capitalism. Partly he enters the oil business, kind of a wildcatter, and partly he did have a very unusual role just that effectively the company he had, Chesapeake, was thought of as somewhat small, sort of volatile, high risk.
Mike: A wildcatter spirit of a company versus the more corporate people?
Gary: And hold onto your seatbelts when you deal with Aubrey and Chesapeake in general. When the shale revolution started ‑‑ it wasn’t really him, it was another company, Mitchell Energy that started it. So when it started, what Aubrey did was really kind of sort of start this competitive frenzy in successive basins where people would discover oil, maybe we have a shale here in north Louisiana or east Texas or North Dakota on the oil side, or Pennsylvania or Ohio. And Aubrey had thousands of guys knocking on doors, and an unlimited appetite for capital and complexity, and everything that just got billions of dollars.
Then everyone looked around and oil companies pursuing more normal course ambition ‑‑ “Well, Aubrey’s going to suck up all the opportunities!” and so he was the catalyst in these basins for this frenzy. Then ultimately, you know what happened was he kind of didn’t fully grasp ‑‑ no one did, how good this was going to be. So he ended up with a lot more gas and crashed the price of gas. So many basins worked, and successively cheaper prices, and that happened on the oil side, and then also just any companies with too much debt heading into a downturn is always going to be in trouble. He kind of got a margin call on his personal account for two billion dollars.
Mike: I should be so lucky someday. I will be so upset when I get a two-billion-dollar margin call.
Gary: That’s how much he was worth at the peak. I don’t know what the margin calls was for but my net worth went down by a couple billion dollars. Then he kind of got kicked out of Chesapeake because of all sorts of other somewhat old-school CEO perks that are sort of beyond ‑‑
Mike: Sort of pledging shares, right, for his own purchases?
Gary: More like he had the right to buy interests personally in all the oil wells Chesapeake owned, which is a thing ‑‑
Mike: I see, a conflict of interest.
Gary: Yeah, just kind of was not done that much anymore. Then he got backed by a private equity firm and they bought eight billion dollars of properties, oil properties right before the oil price collapsed. The bigger issue facing him was not really this indictment, which is somewhat on a pretty secondary issue, but really was on financial difficulties, and five or six different companies all bleeding cash, and all big debt problems.
Just sort of the world coming in ‑‑ he owned 20% of the Oklahoma Thunder and he had pledged that for a loan. I think maybe it was last weekend [September 2016] for some reason he needed to have the largest collection of Bordeaux in the world. So that’s being auctioned off now by his estate. Somewhat in bad form, and got a lot of bad publicity. He had pledged 20 million dollars to Duke his alma mater.
Mike: I read about that, that Duke said “where’s our 20 [million]?,” and the heirs didn’t find that tasteful.
Gary: Oh, the Duke alumni, the Duke community ‑‑ just say yeah, that’s a charitable donation. It is unclear what will happen, but it is definitely a very 19th century or very early 20th century, Dreiser story of rising and falling and rising and falling.
Mike: Captain of Industry or Robber Baron type.
Gary: Outside the realms of normal corporate America or the norms of it. Obviously kind of very entertaining but did have an impact on it. He was known to be an extremely nice guy.
Mike: Presumably a gregarious salesman type.
Gary: Yeah, he wasn’t cynical. His margin call was on buying – insatiably – stock in his own company, so he obviously believed in it. He was not a dark figure but an irresponsible figure, then left a lot of obviously shareholders, partners, and everything holding the bag, based on sort of a wild irresponsibility in terms of how he built his business.
Mount Rushmore of Fracking – Lucky or Good?
Mike: What I liked about your ‑‑ on the one hand celebration of capitalism and innovation and in a sense “here’s the new shale billionaires” ‑‑ you have a “Mount Rushmore” of four of them, who rose above the others. On the one hand, we have a tradition in the United States of celebrating these people as paragons of capitalism and far-seeing geniuses, of which Aubrey is included with that, with Mark Papa from EOG and this guy Harold Hamm, and I guess George Mitchell, one of the originators of the techniques.
Sernovitz has a “Mount Rushmore” of fracking
But then I appreciate that you also say there’s an aspect of the story which is these guys have just sort of dumb luck combined with bizarre personalities, like you’re describing with McClendon with his appetite for risk and appetite for everything ‑‑ I appreciate it. And then trying to figure out: Are these guys just beholden to their own personalities and limitations and that’s why they did these odd, risky, crazy things, which turned out to be “right place, right time,” at the right scale? Which is obviously huge they all did that.
There’s this awesome passage which I’d also like to read, which is among my favorites of the whole book, which is describing Aubrey:
“Aubrey feels sometimes like seeing the country’s best restaurant critic blissfully eating from a box of day-old donuts. People respect the critic for the sensitivity of his palate, but maybe the man just likes to eat.”
I really liked that.
Gary: That’s brilliant.
Mike: It is really. It encapsulates that we celebrate these capitalists for their amazing talent and yet I don’t know, maybe the guy’s slightly insane and just has no taste at all. It’s just awesome, but of course, I love day-old donuts too. I can relate.
Gary: I think people in the oil business are very fond, and this is probably in any business, “My successes are because I’m smart; his successes are because he’s lucky.” Being in a business one gets a bit more color on who was lucky, who was smart. Most people are some combination thereof. But I think the thing to remember about the entire industry is before the shale revolution the US onshore ‑‑ we had a company in Corpus [Christi] working in South Texas, about drilling wells for 400,000 dollars to find 2 million dollars’ worth of gas.
Mike: Scratch and peck kind of little tiny companies.
Gary: Yeah. And anyone in the oil business, like Exxon, which looked in contempt at the US onshore business as a bunch of losers who couldn’t make it doing big international stuff in Kazakhstan or offshore Angola or Equatorial Guinea. There was a certain very admirable hustle, that kind of never-say-die that kept ‑‑ people shouldn’t have been drilling before ’98 in the US if you think about where were the best reserves of oil and gas.
It was just – globally – it was just the infrastructure wasn’t there to displace it. Then the shale revolution came and suddenly ‑‑ the amazing thing wasn’t just that actually underneath the stuff that these guys were scratching and pecking, as you say, were an amazing volume of oil and gas but actually oil and gas was a lot cheaper to extract than the stuff Exxon was doing.
Mark Papa
It’s one of these stories of “the first shall be last, last shall be first” that really came out of nowhere. And everyone got caught up in it. Then there’s all these micro stores because there’s a lot of basins that have risen. Think about there in Eagle Ford, which is the one closest to you guys. Eagle Ford now is – the most shale wells have been drilled in Eagle Ford. It’s now kind of a mature basin. It was really developed by EOG, gets a lot of the credit ‑‑ Mark Papa.
Mark Papa left EOG in 2013
And kind of was one where it was a stealth play. And then there’s this mad rush for the Eagle Ford. Now the Eagle Ford is kind of considered well, there’s A) it’s drilled up a lot, and some of it’s more natural gas, and some of it’s more natural gas liquids, and it’s not that good. And by the way, if you go to West Texas, the Permian, there’s an Eagle Ford stacked on top of another Eagle Ford. There’s all these thousands of feet of different benches you can drill horizontal wells in.
Eagle Ford is now considered okay, a little mature, maybe some opportunities, but you’re only interested in moving back there if you can’t find anything in the Permian in West Texas and New Mexico. There’s dozens of different kinds of stories of rises and falls and the business ‑‑ there’s not just a lot of amazing oilmen who picked exactly the rise and fall correctly. There were some who were just there in a basin that ended up rising. And there are some that did guess it correctly. There are some who came in too late and ended up losing a lot of money.
Mike: There’s a bunch of things I want to follow up on that. One is the Permian which I don’t know much about but a month ago [September 2016] the general newspaper readership got a sense that Apache Energy had a huge find. I want to follow up on the “genius capitalists” of the thing.
There’s a local guy who I don’t know personally, but was celebrated around the discovery of the Eagle Ford. Suddenly this guy I hadn’t heard of before, named Rod Lewis became a known shale revolution gas billionaire. Part of his legend – and I don’t think he appears in your book, is as a very blue-collar guy checking old oil wells and then ‑‑ sudden success is always overnight and it took 20 years that we didn’t know about…
But you do describe a guy, and I don’t know if you have stories about him or his thing, but you do have a thing that sounded very similar to that, in your book. Terry Pegula, who sounds similarly this blue-collar guy in the business of helping plug old oil wells and then suddenly seems to, out of nowhere, have acquired a massive amount of leases, which is then first worth a billion and then three or four billion a couple years later. Do you know the Rod Lewis story to tell? Local people might be interested. I’ve only heard basically what I just told you.
Terry Pegula
Gary: Petro-Lewis is a very well respected company and definitely considered one of the Eagle Ford’s central private play. I don’t know his story particularly, but Terry Pegula, who now owns the Bills2 and Sabers and the savior of Buffalo was definitely almost like a hoarder of leases.
Terry Pegula and wife Kim
Mike: Clean your stuff out, man. We’re going to call the cops on you. He was that guy?
Gary: Yeah, and would take them from other companies with the agreement that I will plug these wells ‑‑ a natural gas well sometimes can produce for a century maybe, at very low volumes, but it gives you the right, based on the lease, to actually drill beneath it. Even if you have a well producing 50 dollars a day of stuff, it does give you the optionality ‑‑
Mike: Vertically you can go below that existing small-producing well.
Gary: Yeah. He didn’t do that on purpose. No one thought when he was hoarding these leases that there was going – Qatar was going to be in Pennsylvania and eastern Ohio. He was just doing it because he liked doing it. I think also as a car dealer once said to my wife his view, “If it’s free, it’s for me.” People would just give it to him because it took liabilities off their hands. I don’t know the Petro-Lewis story but that’s one of those kind of amazing stories, sort of the wheels of markets and capitalism and fortune and luck and idiosyncratic histories that people like to wrap up sometimes in a more heroic narrative.
Mike: We love the narrative of the blue-collar guy making good. That’s a pleasing capitalist ‑‑ it’s terrible when the rich remain rich. It’s great when the poor suddenly make it rich.
Harold Hamm: Humble, but sensitive, Trump supporter
Gary: That’s why Harold Hamm, hearing him getting offended by “fracking,” he is the single person who’s gotten richest individually off the shale revolution. He is one of 13 kids, a sharecropper in Oklahoma, who barely graduated high school. Never went to college. Didn’t have shoes until he was six. A story out of a different century and now is the 70th richest man in the world. He signed a giving pledge with Bill Gates.
Mike: I think you described him getting into North Dakota because he was one of these losers who had no other chance.
Continental Resources CEO Harold Hamm endorsed Republican Presidential front runner Donald Turmp.
Gary: Exactly. He admits it. He’s a humble guy in some ways. He kind of admits “I couldn’t afford what we were paying” ‑‑ basically you’re paying option value for leases in North Dakota.
And I heard Harold Hamm speak, and he gave a very pro-Trump soliloquy, like 45 minutes long with slides, more of a presentation. He talked about a very obscure argument. I don’t even know what happened, but Trump came to Colorado and also said basically the same thing Hillary said, which is communities should be allowed to regulate fracking in their backyard.
And Hamm’s like: “Forgive my friend Donald. He didn’t know what he was saying. He agrees with me.” Even the word “fracking.” He’s one of Trump’s chief supporters. And he made it clear that if you use the word fracking around him, the conversation is over, because it is an insulting term to describe hydraulic fracturing.
Mike: Okay, words matter and that’s a hurtful word for him.
Gary: Yes.
Mike: Okay. He sounds a little sensitive, but anyway.
Gary: You’d think 70th richest man in the world and 12 billion dollars would make you less sensitive. Apparently, that’s not the case.
Mike: Words have power and he’s a man who can be hurt by that word.
Please see related audio post (upcoming)
Part II with Gary Sernovitz – on the environmental issues of fracking
Before becoming an oil private equity guy, Gary Sernovitz was the next F. Scott Fitzgerald, and authored two novels, Great American Plain, and The Contrarians.
Voters living within the Houston ISD catchment area on November 8th face a “Scylla and Charybdis” vote – and it’s not Clinton vs. Trump – but rather equally terrible public school funding choices.
What’s happening in Houston gives Texans everywhere an insight into a complex problem with no easy solutions, as Glen Read the general manager of budgeting and financial planning for HISD explained to me in a conversation recently.
A “yes” vote on the ballot question in Houston will authorize “the board of trustees of Houston Independent School District to purchase attendance credits from the state with local tax revenues,” which means sending an estimated $162 million from the state’s largest school district to a state education fund, known as the Foundation School Program (FSP). It also means future payments from HISD in increasing amounts in future years, as Houston’s property values increase.
A “no” vote – barring legislative intervention this Spring – triggers something that has never yet happened in Texas, which is to separate commercial properties from HISD’s tax rolls and assign them to other school districts. Like I said, neither of these choices feels good.
It’s also an opportunity – albeit a painful one – for Texans to learn more about a financing system which the Texas Supreme court in their May 2016 ruling named “Daedelean,” “Byzantine,” “Augean,” and an “ossified regime ill-suited for 21st Century Texas,” while simultaneously declining to over-rule previous legislative decisions.
These upcoming payments from HISD have been mislabeled “Robin Hood” and “recapture.” But “Robin Hood” is a terrible nickname for this upcoming process, for two reasons, having to do with the definition of “wealthy” and for the specific meaning of “recapture.”
First, labeling HISD a “wealthy” district is odd. The “wealthy” designation that triggers HISD’s payment comes from a math formula – specifically the ratio of total real estate property values to student population, with a few adjustments to the population number for attendance rates plus specific student designations. The “wealthy” label does not take into sufficient account a measure that seems more important to me, like the fact that 76 percent of HISD kids are designated “economically disadvantaged.” Robin Hood – the mythical man in tights – did not after all make a habit of stealing from the poor.
Second, also unlike our mythical Robin Hood that “recaptured” money does not necessarily get redistributed to poorer school districts. Now, this is the point where Texans everywhere should sit up and pay special attention. Right here. Ready?
HISD’s “recaptured” money goes into the state’s primary education fund – the FSP – but that money is not doled out subsequently to poorer districts. This is the key point. The math ratio of property value to student population determines which districts pay money in to the FSP and which districts take money out of FSP, but none of that determines whether the state, as a whole, allocates sufficient money to the FSP. In fact, as property values rise locally – and you, the taxpayer, pay more – you’re not really funding your local district, or even the poorer districts. You are relieving the state of the obligation to pay more for education. More money into the FSP from higher property values means less the state has to pay. That’s the finance trick you need to know.
And that’s really nice if you’re trying to save money at the state level, but not exactly Robin Hood-style redistribution, nor a great plan for funding great public education.
For these reasons, The Houston Chronicle editorial page has twiceurged a “No” vote, and which would trigger either the never-before-enacted property-tax-separation method or daring the state legislature to try something different before July 2017 – when property rolls would shifted. To be clear, a “No” vote is a sort of game of financial chicken between the voters of Houston and the state, with unknown consequences.
We can do what we usually do about this type of thing, which is to shut off our brains in order to take comfortable refuge behind pre-existing ideological prejudices, and take potshots at the other side’s idiocy. But if you are under the impression that you could start a conversation about school finance with “All we need to do is…” then you are mistaken. This subject does not admit of easy solutions.
Hacking our way intelligently through the overgrown jungle of public school finance, we have to hold a number of contradictory thoughts in our head simultaneously. For what its worth, my process goes like this:
The socioeconomic background of an individual student appears to affect student outcomes far more than funding-levels-per-student at a school or district. As a result, poor performance at poor schools and higher performance at wealthier schools can persist indefinitely, despite roughly equal funding-levels per student. “Social reproduction” – or a society with little economic mobility – can’t be undone easily by throwing more money at the problem.
And yet, just giving up on the idea of economic mobility – our hope that poorer kids have a chance to get ahead in life through a combination of hard work and a good education seems – I don’t know, what’s the word? Maybe: Un-American?
When we talk about public school finance in Texas, really what we’re talking about is educating poorer kids: 59 percent of kids in Texas public schools overall are classified “economically disadvantaged.” The school districts subject to ballot questions that I’m writing about this week and next week, in the Houston and San Antonio ISDs, educate 76 and 92 percent economically disadvantaged kids, respectively.
To which I conclude that we can’t fix this quickly with more money, or by simply equalizing scarce resources, but at the same time, to not try to improve it some how, some way, some day is to resign ourselves to a bleak future of haves and have-nots with no end in sight.
I have no solutions. I’m just trying to educate myself on one of the most complex finance problems out there.
I can see that the HISD ballot question is a terrible choice to make.
Texas State Senator Paul Bettencourt, (R-Houston) poked the bear when he filed Senate Bills 1750 and 1751, which would allow the Teachers Retirement System of Texas (TRS) and Employee Retirement System of Texas (ERS) to study, and possibly implement, changes in their public pensions. Change would mean moving – in an as-yet unspecified way – from a traditional “defined benefit” to a more 401K-style “defined contribution” plan. The effect would be to shift the burden of paying for retirement, somewhat, from taxpayers to employees. The bills as written specifically would only affect newly hired employees, not existing employees or retirees.
As a finance guy, I want my public officials staying up late worried about public pensions, seeking ways to reduce their systemic risks. TRS has more than 1.5 million members, more than $130 billion in net assets, and represents the ultimate “Too Big To Fail” public pension in Texas.
Mike: Hi, my name is Mike, and I used to be a banker.
