America’s energy independence was an illusion created by cheap debt. All that’s left to tally is the damage.
Ever since the oil shocks of the 1970s, the idea of energy independence, which in its grandest incarnation meant freedom from the world’s oil-rich trouble spots, has been a dream for Democrats and Republicans alike. It once seemed utterly unattainable — until the advent of fracking, which unleashed a torrent of oil. By early 2019, America was the world’s largest producer of crude oil, surpassing both Saudi Arabia and Russia. And President Trump reveled in the rhetoric: We hadn’t merely achieved independence, his administration said, but rather “energy dominance.”
Then came Covid-19, and, on March 8, the sudden and vicious end to the truce between Saudi Arabia and Russia, under which both countries limited production to prop up prices. On March 9, the price of oil plunged by almost a third, its steepest one-day drop in almost 30 years.
As a result, the stocks that make up the S.&P. 500 energy sector fell 20 percent, marking the sector’s largest drop on record. There were rumblings that shale companies would seek a federal lifeline. Whiting Petroleum, whose stock once traded for $150 a share, filed for bankruptcy. Tens of thousands of Texans are being laid off in the Permian Basin and other parts of the state, and the whole industry is bracing for worse.
On the surface, it appears that two unforeseeable and random shocks are threatening our dream.
In reality, the dream was always an illusion, and its collapse was already underway. That’s because oil fracking has never been financially viable. America’s energy independence was built on an industry that is the very definition of dependent — dependent on investors to keeping pouring billions upon billions in capital into money-losing companies to fund their drilling. Investors were willing to do this only as long as oil prices, which are not under America’s control, were high — and when they believed that one day, profits would materialize.
Even before the coronavirus crisis, the spigot was drying up. Now, it has been shut off.
The industry’s lack of profits wasn’t exactly a secret. In early 2015, the hedge fund manager David Einhorn announced at an investment conference that he had looked at the financial statements of 16 publicly traded shale producers and found that from 2006 to 2014, they spent $80 billion more than they received from selling oil. The basic reason is that the amount of oil coming out of a fracked well declines steeply after the first year — more than 50 percent in year two. To keep growing, companies have to keep plowing billions back into the ground.
The industry’s boosters argue that technological gains, such as drilling ever bigger wells, and clustering wells more tightly together to reduce the cost of moving equipment, eventually would lead to a gusher of profits. Fracking, they said, was just manufacturing, in which process and human intelligence could reduce costs and conquer geology.
Actually, no. The key issue is the “parent child problem.” When wells are clustered tightly together, with so-called child wells drilled around the parent, the wells interfere with one another, resulting in less oil, not more. (This may not surprise anyone who is attempting to be productive while working in close quarters with their children.)
The promised profits haven’t materialized. In the first half of 2019, when oil was around $55 a barrel, only a few top-tier companies were profitable. “By now, it should be abundantly clear that the current shale oil business model does not work — even for the very best companies in the industry,” the investment firm SailingStone Capital Partners explained in a recent note.
Policymakers who wanted to tout energy independence disregarded all this, even as investors were starting to lose patience. As early as 2018, some investors had begun to tell companies that they wanted to see free cash flow, and that they were tired of compensation models that rewarded executives with rich paydays for increasing production, but failed to take profits into account. As a result, fracking stocks badly underperformed the market.
But with super-low interest rates, investors in search of yield were still willing to buy debt. Over the past 10 years, the entire energy industry has issued over $400 billion in high-yield debt. “They subprimed the American energy ecosystem,” says a longtime energy market observer.
Even as the public equity and debt markets grew cautious, drilling continued. That’s because one big source of funding didn’t dry up: private equity. And why not? Private equity financiers typically get a 2 percent management fee on funds they can raise, so they are incentivized to take all the money that pension funds, desperate for returns to shore up their promises to retirees, have been willing to give them.
In the Haynesville and the Utica Shales, two major natural gas plays, over half of the drilling is being done by private equity-backed companies; in the oil-rich Permian Basin, it’s about a quarter of the drilling. From 2015 through 2019, private equity firms raised almost $80 billion in funds focused mostly on shale production, according to Barclays.
Until the capital markets began to get suspicious, private equity investors could flip companies they had funded to larger, public companies, making a profitable exit regardless of whether or not the underlying business was making money.
That, too, is ending, as investors in such funds have become disillusioned.
You can see how all of this is playing out by looking at Occidental Petroleum. In 2019, Oxy, as it’s known, topped a competing bid from Chevron and paid $38 billion to take over Anadarko Petroleum, which is one of the major shale companies. Since that time, Oxy’s stock has plummeted almost 80 percent in part due to fears that the Anadarko acquisition is going to prove so wildly unprofitable that it sinks the company.
On March 10, the company announced that it would slash its dividend for the first time since the early 1990s, when Saddam Hussein’s invasion of Kuwait sent oil prices plummeting.
Occidental is just one piece of the puzzle. In April, the Energy Information Administration cut its forecast for U.S. oil production, estimating that it will fall both this year and next — suggesting that the days of huge growth in production from shale are over.
On March 10, Scott Sheffield, the chief executive of Pioneer Natural Resources, a major driller in the Permian Basin, told Bloomberg that U.S. oil output could fall by more than two million barrels per day by next year if prices remain where they are today.
“This is late ’80s bad,” a close observer of the industry says.
After the United States engaged in a high-stakes negotiation with Russia and Saudi Arabia to curtail production, a tentative deal was struck on Thursday. Certainly, President Trump, who has staked so much on the American shale industry, wants to save it. “We really need Trump to do something or he’s going to lose all the energy states in this election,” Mr. Sheffield told CNBC in late March.
A deal, and higher oil prices, might help the industry. But they won’t fix its fundamental problem with profitability. Energy independence was a fever dream, fed by cheap debt and frothy capital markets.
All that’s left to tally is the environmental and financial damage. In the five years ending in April, there were 215 bankruptcies for oil and gas companies, involving $130 billion in debt, according to the law firm Haynes and Boone. Moody’s, the rating agency, said that in the third quarter of 2019, 91 percent of defaulted U.S. corporate debt was due to oil and gas companies. And North American oil and gas drillers have almost $100 billion of debt that is set to mature in the next four years.
It’s still unclear where most of this debt is held. Some of it has been packaged into so-called collateralized loan obligations, pieces of which are held by hedge funds. Some of it may be on bank balance sheets. Investors in the equity of these companies have already seen the value of their holdings decimated. Pension funds that have poured money into private equity firms may take a hit soon, too. All we know for sure is that fracking company executives and private equity financiers have made a fortune by touting the myth of energy independence — and they won’t be the ones who have to pick up the pieces.
Among the hoops that candidates for plum consulting jobs at McKinsey & Company had to jump through in late 2006 was a bit of play acting: They were given a scenario involving a hypothetical client, “a business under siege,” and told they would be meeting with its chief executive the next day. How would they structure the conversation?
One contender stood out that year: a 24-year-old Rhodes scholar named Pete Buttigieg.
“He was the only one who put all the pieces together,” recalled Jeff Helbling, a McKinsey partner at the time who was involved in recruiting. Mr. Buttigieg soon won the other candidates over to his approach.
“He was very good at taking this ambiguous thing that he literally had no background on and making sense of it,” Mr. Helbling said. “That is rare for anyone at any level.”
The preternatural poise that got Mr. Buttigieg hired at McKinsey has helped him rise from obscurity to the top tier of the 2020 Democratic primary presidential contest.
On the way there, he ticked all the boxes. Harvard. Rhodes scholar. War veteran. Elected mayor of a midsize city before age 30.
Mr. Buttigieg sells his candidacy, in large part, on his mayoralty of South Bend, Ind., and a civic revitalization there rooted in the kind of data-driven techniques espoused by McKinsey. His nearly three years at “the firm” set him apart from many of his campaign rivals, underpinning his position as a more centrist alternative to progressive front-runners like Senators Bernie Sanders and Elizabeth Warren.
Yet Mr. Buttigieg’s time at the world’s most prestigious management-consulting company is one piece of his meticulously programmed biography that he mentions barely, if at all, on the campaign trail.
As Mr. Buttigieg explains it, that is not a matter of choice. For all of his efforts to run an open, accessible campaign — marked by frequent on-the-record conversations with reporters on his blue-and-yellow barnstorming bus — McKinsey is a famously secretive employer, and Mr. Buttigieg says he signed a nondisclosure agreement that keeps him from going into detail about his work there.
But as he gains ground in polls, his reticence about McKinsey is being tested, including by his rivals for the Democratic presidential nomination. Senator Warren, responding last month to needling by Mr. Buttigieg that she release more than the 11 years of tax returns she already had to account for her private-sector work, retorted, “There are some candidates who want to distract from the fact that they have not released the names of their clients and have not released the names of their bundlers.”
Beyond Mr. Buttigieg’s agreement with McKinsey, this is something of an awkward moment to be associated with the consultancy, especially if you happen to be a Democratic politician in an election year shadowed by questions of corporate power and growing wealth inequality. The firm has long advocated business strategies like
- raising executive compensation,
- moving labor offshore and
- laying off workers to cut costs.
And over the last couple of years, reporting in The New York Times and other publications has revealed episodes tarnishing McKinsey’s once-sterling reputation: its work advising Purdue Pharma on how to “turbocharge” opioid sales, its consulting for authoritarian governments in places like China and Saudi Arabia, and its role in a wide-ranging corruption scandal in South Africa. (All of these came after Mr. Buttigieg left the firm.)
Just this week, ProPublica, copublishing with The Times, revealed that McKinsey consultants had recommended in 2017 that Immigration and Customs Enforcement cut its spending on food for migrants and medical care for detainees.
After a campaign event on Wednesday in Birmingham, Ala., Mr. Buttigieg remarked on the latest revelations. “The decision to do what was reported yesterday in The Times is disgusting,” he said. “And as somebody who left the firm a decade ago, seeing what certain people in that firm have decided to do is extremely frustrating and extremely disappointing.”
The Buttigieg campaign says he has asked to be let out of his nondisclosure agreement so he can be more forthcoming about that formative time in his life. A McKinsey spokesman said Mr. Buttigieg “worked with several different clients” during his time with the firm, but “beyond that, we have no comment on specific client work.”
But interviews with six people who were involved in projects that Mr. Buttigieg worked on at McKinsey, along with gleanings from his autobiography, fill in some of the blanks.
Mr. Buttigieg was recruited by McKinsey at Oxford. The company seeks out Rhodes scholars like him, banking that their intellects will make up for their lack of M.B.A.s from traditional recruiting grounds like Harvard Business School.
Yet even during the recruitment process, Mr. Helbling recalled, Mr. Buttigieg made it known that, like many applicants, he saw the business experience on offer at McKinsey as a good job “in the near term,” in his case an asset on the way to a career in public service.
The work he did in his first year and a half at the firm — nearly a 10th of his adult life — is effectively a blank slate, though tax records give some hints. In 2007, his first year with the company, he filed tax returns in Illinois, where he worked out of the Chicago office, as well as in his home state of Indiana. But he also filed in Michigan, and in the city of Detroit, where he worked on a McKinsey project. In 2008, he filed a return in Connecticut (McKinsey has an office in Stamford). The next year, he filed in Connecticut and in California.
In early 2009 Mr. Buttigieg was spending his days, and many nights, in a glass-walled conference room in suburban Toronto. He was analyzing Canadian grocery prices, plugging the numbers into a database running on a souped-up laptop his colleagues nicknamed “Bertha.” PowerPoint slides and spreadsheets crept into his dreams.
He knew this wasn’t his calling.
“And so it may have been inevitable that one afternoon, as I set Bertha to sleep mode to go out to the hallway for a cup of coffee, I realized with overwhelming clarity the reason this could not be a career for very long: I didn’t care,” Mr. Buttigieg wrote in his autobiography, “Shortest Way Home.”
It was the only experience at McKinsey that Mr. Buttigieg wrote about in any detail. His next act at the firm didn’t merit a single complete sentence in the book. But it was a radically different, and for him far more interesting, public-spirited project: More than four years before he would be deployed as a Navy Reserve officer, he was heading to Iraq and Afghanistan.
McKinsey’s focus in Iraq during the latter part of George W. Bush’s presidency and the early years of Barack Obama’s was to help the defense department identify Iraqi state-owned enterprises that could be revived. The idea was to provide employment for men who might otherwise join the insurgency against the American-led occupation.
The McKinsey consultants on the ground in 2006 and 2007 were almost exclusively military veterans like Alan Armstrong, who flew fighters for the Navy and had an M.B.A. from the Wharton School at the University of Pennsylvania. Mr. Armstrong, in an interview, said that while the reasoning behind the program was sound, the ongoing insurgency and a crippled infrastructure — electricity, for example, was spotty or nonexistent — made execution very difficult.
But the program was popular among the top brass at the Pentagon. In 2006, the defense secretary, Donald H. Rumsfeld, met with the team in Iraq and asked about the “whiz kids” from McKinsey, which struck Mr. Armstrong as an obvious parallel to the Vietnam War era, when whiz kids of an earlier generation had worked for another defense secretary: Robert S. McNamara.
“McKinsey was more than willing to play along — they were being paid extraordinary rates to keep playing,” Mr. Armstrong said.
Another former McKinsey consultant who worked in Iraq recalled a surreal moment preparing a PowerPoint presentation while on a convoy to a shuttered food-processing factory, under the watchful eye of a burly private security guard. “It felt like we were completely half-assing everything — it wasn’t particularly effective,” he said.
Other former McKinsey consultants who worked on the Iraq project, Task Force for Business and Stability Operations, have a more positive recollection of the firm’s work.
“Over all I’m very proud of it,” said one consultant, who had met Mr. Buttigieg in Washington, where most of the McKinsey consultants assigned to the project worked when not visiting Iraq. Four of the six former McKinsey employees spoke on the condition that their names not be used, citing confidentiality agreements or the press policies of their current employers.
By 2009, the security situation in Baghdad was stable enough that McKinsey allowed in some nonveterans like Mr. Buttigieg, who had studied Arabic at Harvard. He went to Iraq aware of the stark similarities between the American experiences there and in Vietnam decades earlier.
At Harvard, his senior thesis had drawn parallels between the United States’ seeking to “save” Vietnam from “godless Communism,” and the 17th-century Puritan ministers who had come to America to civilize “savage lands.” In his autobiography and in an interview that has drawn charges of out-of-touch elitism from some quarters, he reflected on that history by quoting a passage from “The Quiet American” by Graham Greene: “Innocence is like a dumb leper who has lost his bell, wandering the world, meaning no harm.”
“I had protested the Iraq war,” Mr. Buttigieg said in an interview with The Times. “But I also believed that it was important to try to do my part to help have good outcomes there.” He found echoes, he said, of “the stories I had studied about well-intentioned Americans sometimes causing as many problems as they addressed.”
Mr. Buttigieg recalled spending only two nights in Baghdad, where McKinsey consultants were quartered in a building near the Tigris River, and “going to a ministry.” He never left the city during his time there, he said.
“Remember I’m like the junior guy, kind of new,” Mr. Buttigieg said. “It’s not like I was the one whose expertise was needed to sort out what was going on in the provinces.
“Eventually I knew what I was doing a little more and was more useful by the time I got to the Afghan side.”
Mission in Afghanistan
Mr. Buttigieg spent more time in Afghanistan. While Iraq had a fairly well-educated populace, a modern road system and large oil revenues, Afghanistan was far less developed. But the mission was similar: identify small and medium-size businesses to nurture so that they could employ Afghans, providing an attractive alternative to joining the Taliban while fueling economic growth.
Citing his nondisclosure agreement, Mr. Buttigieg declined to specify in the interview what he had worked on, though he mentioned having looked at opportunities in the agricultural industry — onions, tomatoes, olive oil — as well as paint manufacturing.
“They had some things to work with,” he said, “but would have benefited from support on things like business planning, more resources on how to plug in and eventually connections to markets too.”
In the years after Mr. Buttigieg left McKinsey, that program came under criticism from the Special Inspector General for Afghanistan Reconstruction. McKinsey had been awarded $18.6 million for the project, but the watchdog wrote in an April 2018 report that it had been able to find just one piece of related work product: a 50-page report on the economic potential of the city of Herat.
A former McKinsey consultant who worked in Afghanistan described a more extensive McKinsey presence there, involving work in the mining industry and a government transparency project, along with the Herat study.
“One of those sounds just exactly like what I was doing,” Mr. Buttigieg said. When asked which one, he said, “I can’t think of a way to answer that without getting in trouble with the N.D.A.”
Mr. Buttigieg’s work on the Afghanistan project ended in late 2009, close to the time he was commissioned as an officer in the Navy Reserve. And that October, when he was still several months from leaving McKinsey, he set in motion the next phase of his life: He registered as a candidate for office with the State of Indiana.
The next year, he lost a bid for state treasurer, after emphasizing his McKinsey experience during the campaign. (He recounted at one campaign event that after his Rhodes scholarship, “I came back and went into business, and I worked for a company where my job was to do math. I’m a card-carrying nerd.”) In 2011, at age 29, he was elected mayor of South Bend.
The full range of Mr. Buttigieg’s work at McKinsey isn’t clear, though in his autobiography he says that he worked on other projects, including “energy efficiency research” to help curb greenhouse-gas emissions for a client he didn’t name. He also found time in the summer of 2008 to travel to Somaliland, the autonomous region in the Horn of Africa. He went as a tourist, but while there talked to local officials and wrote an account of his experience for The International Herald Tribune.
Mr. Buttigieg has been asked on the presidential campaign trail about his time at McKinsey and, in several interviews this year, has sought to reconcile the company’s recent troubles with his own work there.
For Mr. Buttigieg, the solution to McKinsey’s ethical pitfalls may come in a rethinking of the rules that business abides by. Maximizing shareholder value, the North Star of modern American capitalism, has a downside when the rules of the game leave many people worse off, he said.
“The challenge is that’s not good enough at a time when we are seeing how the economy continues to become more and more unequal, and we are seeing the ways in which a lot of corporate behavior that is technically legal is also not acceptable in terms of its impact,” he said. “There has got to be a higher standard.”
That places the retailer 10th among S&P 500 companies with the widest gap in pay between the CEO and a typical worker, based on an analysis of more than 330 firms that have disclosed the figures so far.
Retailers, which often rely on part-time and seasonal workers to fill their labor force, take four of the top 10 spots on the list of companies with the largest pay gap, including Kohl’s Corp. and Gap Inc. Mr. McMillon earns 1,188 times more than the median employee, according to the filing.
“Our company is unique because we are significantly larger than most of our peer group companies in terms of revenue, market capitalization, and the size and scope of our world-wide associate population,” said Walmart in the filing.
The company is one of the largest private employers with more than 2.3 million employees world-wide and around 1.5 million in the U.S. The figures include both full-time and part-time workers.
Walmart disclosed the pay ratio as part of a broader requirement of the postcrisis Dodd-Frank law that went into effect this year.
Among the 18 retailers that have reported this data so far, Walmart’s median pay falls near the middle. By comparison, Amazon.com Inc. ’s median worker earns $28,446, while Gap employees fall at the bottom of the group at $5,375.
“We have focused on our associates and we have focused on the pay, the training, so they can build a career with us,” said Walmart spokesman Randy Hargrove.
Walmart has raised the minimum pay for its U.S. store workers in recent years, moving to $11 earlier this year, amid a tight labor market.
Retail-industry officials argue that median-pay and pay-ratio figures for their industry shouldn’t be compared with others because the widespread use of part-time and seasonal workers makes both look more extreme. The rules for calculating the figures don’t allow companies to annualize most pay figures.
Walmart also said it will shuffle its board. McDonald’s Corp. Chief Executive Steve Easterbrook will join the board, while longtime independent lead director James Cash and Instagram Chief Executive Kevin Systrom won’t stand for re-election, according to the filing. Earlier this year, Sarah Friar, chief financial officer of mobile payment company Square Inc, joined Walmart’s board.
But how can the economic and political power of the middle class be restored to save capitalism?
Capitalism can be saved through the formation of a new political party. For instance, did you know that the largest political party in the country is neither the Republican Party nor the Democratic Party, but the party of nonvoters?
Just consider the 2012 presidential election. Only 58.2 percent of eligible voters exercised their right to vote.
A third party could be founded to unite apathetic voters, returning a political voice to disenfranchised Americans. This party should endeavor to enable the economic success of the country’s majority.
But to do this, the party would need to reform America’s system of campaign financing, which currently allows wealthy individuals to leverage their money to influence politicians. Beyond that, the party would need to raise the minimum wage, give priority to labor agreements instead of creditor agreements and limit the size of Wall Street’s gigantic banks.
When that’s completed, the corporation too will need to be reinvented. As the system is set up today, the financial interest of corporations means lower pay for the average worker and extremely high pay for executives.
One strategy for changing this system would be to tie corporate tax rates to the ratio of what a CEO makes compared with the pay of an average worker. The greater the difference, the higher the tax. This would give corporations an economic incentive to increase the average wage of employees.
Capitalism is not lost. Yet if it is to survive, it will have to be reorganized to better distribute its profits.