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for April, 2014

SERIES: Survivor or Victim? How to Excel in a Resource-Constrained Environment (Introduction)

Posted on April 30, 2014 in Homebuilding - 0 comments - 0

Arctic Expedition

Imagine that you were lost in the Arctic for months, or 7 years as the case may be. It has taken every ounce of your strength, endurance and resources to make it back to civilization alive, barely. You have lost members of your party along the way, have learned to live with less of everything that you require to survive and have had to fight for your very existence from the time you wake up in the morning until you lay down at night, snatching periods of restless sleep in between listening for polar bears. Now you are home at last! You can relax and enjoy the hard earned rewards of survival: food, shelter, warmth and security. Except you arrive home to find that your home belongs to someone else, the grocery stores are low on food and you don’t have enough money to put gas in your car.

Sound extreme? Or does it feel familiar to some of you out there? In 2007, while helping a client in the building product space test the durability of its organization and strategy by measuring it against various possible future scenarios for the homebuilding industry from then until 2012, I proposed a “worst case” scenario that we named “New Ice Age”. At the time, most of the executive team refused to even consider this scenario — it was so bad that it seemed impossible. As it turns out, it was off the mark… it was too optimistic by 25%!

So here we are, back in the present. Demand came back in 2013. The demand for new housing began to rebound in many markets in 2012 but 2013 saw a more significant resurgence across most key primary and secondary markets with the exception of some areas of the country that have been experiencing structural economic challenges above and beyond the great boom and bust of the last decade. This rebound, which has actually been relatively modest from unit and percentage gain perspectives, has stressed the industry resource base across all aspects.

This stress reflects a multifaceted set of challenges that are the legacy of the severity of the last business cycle. Builders, particularly mid-sized private builders, are faced with a new, more challenging and risky growth environment.  While growth opportunities abound, many mid-sized production builders are like the wayward explorer returned home to find that his world has changed while he was gone. The resources that were plentiful in the prior expansion period are now scarce, expensive or simply gone: capital, staff, trade contractors and lot inventory are all less available today than they were in the past.

In this harsh new environment, the large organizations appear to have the advantage. Public builders are able to access public capital markets to fund expansion, can afford to pay more for top talent and can offer trade contractors larger chunks of work so that they can manage their businesses more efficiently. Differences in capital cost, availability and the need to push volume are fueling land buying binges and acquisitions of mid-sized builders in various markets across the country. When mid-sized builders sell to large builders at the front-end of a cycle, they rarely come close to maximizing the enterprise value.

So, what do you do if you are a mid-sized homebuilder who wants to stick around to capitalize on the next expansionary cycle in the US housing market? How can you achieve profitable growth in a resource-constrained business environment?

Continuum Advisory Group and Continuum Capital will be releasing a series of brief articles over the course of this year to help you think about how to excel in this challenging yet potentially rewarding business environment. Our intent is to challenge your assumptions and get you thinking about how you and your leadership team will make the right calls to build your organization’s capacity for success and competitive advantage.

This series, titled “Survivor or Victim?  How to Excel in a Resource-Constrained Environment”, will address what is arguably the most significant challenge faced by all homebuilders today:  Human Capital.  The lack of available and qualified people for hire within the industry will ultimately challenge your ability to execute in the short term and will remain the most persistent constraint on your ability to grow profitably over the next few years. We will examine various aspects and elements of your business, including the processes, systems and capital needed to overcome the severe scarcity of human resources.

People are typically viewed as the “soft side” of the business. Investing in people beyond the fully loaded payroll and benefits cost is something for good times or for large organizations. People are also typically viewed as a commodity to be purchased in a growth environment just like building products or office supplies. “Do we need to grow? Let’s hire another superintendent and a couple more sales people.”

Our way of looking at employees in homebuilding organizations is that they are actually one of the “hardest” aspects to making a homebuilding company sustainably successful. Investing in training, process improvement, assessment and evaluation, technology and tools that help improve your staff’s ability to drive more revenue per head, more gross profit per head, more starts per head, more closings per head, etc. is one of the most critical elements of any business plan. In today’s environment of persistent human capital shortages, how builders manage these investments will be the difference between success and failure.

The homebuilding industry lost approximately 400,000 employees from its peak in 2006 through 2013. In addition the trade contractor base lost close to 600,000 craft workers and approximately 75,000 companies in that same time period[1]. This contraction is unprecedented in the modern residential construction industry. The result is that the existing industry capacity for growth is constrained by the availability of qualified and productive people at all levels.

Historically, homebuilding companies have tended to maintain relatively consistent processes as business cycles rise and fall, using headcount scaling and reductions in force to manage capacity on either side of the cycle. Based on the current industry staffing levels, it is very unlikely that homebuilders will be able to “Hire their way to Growth” in this current expansion cycle.

Our series will explore several core operational areas that will demand new processes, procedures and systems in order to increase output per head so that homebuilders are able to grow production capacity at a faster rate than they grow headcount. The builders who understand and embrace the current constraints, we’ll call them the “Survivors”, have an opportunity to separate themselves from competitors who believe that they can operate on a “business as usual” platform, the “Victims”. Growth and scarcity create the conditions for industry leading firms to achieve step-change performance in comparison to their peers.

We invite you to examine our point of view, challenge your thinking, challenge our thinking and ultimately prepare your organization to be on the positive side of this coming industry divide of “Survivors” and “Victims”. We welcome your criticism. We welcome your feedback. Whatever your perspective, we welcome your engagement. Now that you are back from your odyssey, it’s time to get to work!


[1] All employment data taken from the US Bureau of Labor Statistics

Survivor or Victim?  How to Excel in a Resource-Constrained Environment is a joint series by Clark Ellis and Brandon Hart.

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Energy Megatrends April 2014

Posted on April 4, 2014 in Energy Utility & Pipeline - 0 comments - 0
An update on Trends Related to the Shale Oil/Gas Revolution – Power Production & Crude Oil Transport

Continuum Advisory Group is continually tracking trends that will drive your business now and in the future. In this blog post I’ve provided a summary of the latest data and shared my insights on what it means for the future.

The rapid development of shale oil and gas resources has been a major driver of market changes affecting a wide range of industries including utilities, pipeline owners and operators, pipeline contractors and other service providers, power producers and petrochemical manufactures, to name a few. The latest data from the US Energy Information Administration (EIA) (@EIAgov) and the United States Census Bureau (@uscensusbureau) provides some new insight into how key trends driven by shale are developing. Highlights include the following:

  • The three year decline in US electric power demand stopped in 2013. It is unclear if electric power demand growth is back or if this is a short term pause in the decline. Demand numbers for the second half of 2014 will provide clarity.
  • The five year decline in coal fired electric generation also stopped in 2013. This is more likely a short term pause as continuing coal plant retirements will reduce overall coal generation. Increased natural gas fired electric generation will continue through the decade with a strong focus on the Southeast.
  • The initial phase of shale oil development characterized by production exceeding local takeaway capacity and bottlenecks in midstream infrastructure leading to supply gluts is passing. The liquid transportation market will continue to stabilize though significant investment in new liquid transportation infrastructure will continue for another three to five years.
  • Shale oil & gas was by far the largest driver of new US employment from 2007 to 2012. The mining, quarrying, and oil and gas extraction sector grew employment by 23.7% with payroll up 51% from 2007 to 2012. As other sectors of the economy continue to recover, the war for talent among companies operating in this space combined with other companies seeking individuals with similar skills will intensify. Finding and retaining employees, particularly engineers, managers and skilled trades, will be a key element of success over the next decade.
Electric Power Trends

Trends in Power Generation by Fuel Type

Shale gas, in combination with increasing regulation of coal and falling electric demand, is reshaping the electric power industry. The winning fuels in this environment have been Natural Gas and Renewables. Beginning in 2008, net generation provided by Coal began to fall rapidly. At the same time net generation from Natural Gas began to accelerate. Generation from renewable sources has experienced steady growth for the last decade.

Total Power Generation in the US fell rapidly in 2009, before recovering in 2010, only to begin a slow decline over the next two years. The EIA’s Electric Power Monthly provides detailed data around these issues. The latest update provides final numbers for 2013 along with January 2014 data. This year appears to be a reprieve for a few industries (Coal & Electric Power) that have been down lately.

Recent Total Power Gen

Coal had a strong winter in 2013, followed by a summer with generation holding near 2012 levels. December 2013, and January 2014, again saw Coal outpace its performance in previous years.

Total electric generation also improved in 2013, with generation up 0.26% after declines in 2011 & 2012. This return to slow electric demand growth would appear in line with EIA projections for future electric growth. The trend appears to continue with January 2014 generation up 8.2% from January 2013.

Electric Demand Forecast
A closer look at the data raises some doubts that we are moving beyond the period of electric demand decline. During the first 8 months of 2013 electric demand continued to fall, down 0.9%. It was only during that last four months of 2013 that generation increased, up 2.7%. Anyone living east of the Rockies is painfully aware of the potential driver of this demand. The winter in the east has been brutal, particularly in the heavily populated Midwest.

 

 

 

9_13 to 2_14 Temp

 

1_14_Temp

 

January in particular was very cold with several states recording temperature averages that ranked in the top ten coldest Januarys since 1894. This was particularly disruptive to energy markets, and those unfortunate enough to live there, as the last decade has typically seen winters well above the long term averages in terms of temperatures.  A good example of this disruption is natural gas prices over the last few months.

 

 

Henry Hub Gas

The details behind the growth in electric demand also offer some insight into the cause to the growth experienced over the last several months. In January 2014, generation to residential customers was up 11.5%, commercial was up 6.4% while industrial was down 0.7% relative to January 2013. Like the EIA, we do expect electric demand in the US to stabilize soon and resume very slow growth. What is not clear is if this stabilization is already occurring. The spring/summer/fall numbers from EIA will be very telling in terms of the future outlook for the power sector.

 

EIA Planned Capacity

The stemming of the decline in coal power generation in 2013 is much more likely to be short lived. The most recent EIA projections for new power plants and retirements through 2018 heavily favor natural gas and renewables. In excess of 20,000 megawatts of coal generation is scheduled for retirement by 2018. The vast majority of this will be replaced by a combination of Natural Gas and Solar/Wind.

 

Despite the recent volatility in natural gas prices, long term forecasts of low (below $4) gas prices are still valid, making natural gas the most cost effective replacement for utilities forced to retire coal generation assets. The somewhat uncertain future of electric demand will have little effect on the future of coal, as regulation is the primary driver of the decline. Future electric demand will have some effect on the level of opportunity related to new natural gas fired power plants and the pipeline activity necessary to support them. Overall the long term trend of power generation being the primary driver of increased natural gas demand will continue.

Shale Oil Trends

The rapid drop in natural gas prices in combination with sustained high oil prices led to a historic shift in the focus of US energy exploration in 2009. Data from Baker Hughes rig count database shows the change.

 

Shale Gas Trends

 

The rapid shift in focus to oil has created many opportunities related to crude oil production, transportation and refining. Moving this oil to refineries has been a challenge that is reflected in the price spread between WTI and Brent Crude.

WTI vs BrentStarting in early 2011, as the shale oil boom accelerated, rising inventories in places like Cushing, OK led to falling WTI prices and a persistent spread between WTI and Brent Crude pricing. A recent report by the EIA indicates that the significant investment in midstream infrastructure is beginning to have an effect as Cushing inventories have fallen below recent peaks.

The report highlights the following reasons for declining Cushing inventory:

  • The startup of TransCanada’s Cushing Marketlink pipeline, which is now moving crude oil from Cushing to the US Gulf Coast
  • Sustained high crude oil runs at refineries in Petroleum Administration for Defense Districts (PADD) 2 (Midwest) and 3 (Gulf Coast), which are partially supplied from Cushing
  • Expanded pipeline infrastructure and railroad shipments that have made it possible for crude oil to bypass Cushing storage and move directly to refining centers in PADDs 1 (East Coast), 3 (Gulf Coast), and 5 (West Coast)

This data indicates that we are catching up with takeaway capacity needed to service the largest US shale plays. New rail facilities, new pipelines, and gas to liquid pipeline conversions, such as Energy Transfers Trunkline and Kinder Morgan’s Pony Express, will continue to improve crude oil transportation capacity regardless of the decision to approve KeystoneXL. For contractors and service providers focused on new liquid transportation projects there is still likely 3 to 5 years of strong activity ahead. Beyond that, activity will likely shift to smaller lateral, capacity expansion, and O&M work to support continued high levels of domestic crude production.

One last item on the overall effect of the Shale Oil/Gas Boom comes from Ben Casselman (@bencasselman) writing for Nate Silver’s new FiveThirtyEight site. Casselman looks at the latest census data and notes:

Oil and gas states dominated the list of fastest-growing cities: Six of the top 10 were in Texas, North Dakota or Wyoming, where an oil and gas boom has brought unemployment rates below 5 percent. A separate census report on Wednesday showed just how powerful an economic engine the drilling bonanza has been. Employment in the mining sector grew 23.7 percent between 2007 and 2012, and total payroll by 51 percent, by far the fastest growth of any industry.

 

Continuum will continue to monitor the major trends related to the shale oil & gas revolution and provide periodic updates to keep you informed.

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