It was all going so well. Contributing 35 percent of all US crude oil production in 2014, the oil capital of the US has long enjoyed a thriving economy as a result. Many argue that Texas largely carried the US out of the depths of its economic crisis on the legs of an energy boom: one in seven jobs created in the 50 months following the recession were in Texas, and unemployment in the state is a whole percentage point lower than the national average.
But as oil prices threaten to fall below $40 a barrel after nearly five years of stability at around $110, economists have warned that 2015 could be when it all crashes and burns. While the rest of the world rejoices at the reduced cost of heating their homes or filling their cars, energy export-dependent regions like Texas have been hit by significant revenue shortfalls.
“While the overall US economy is going to be affected in a positive way by the fall in oil prices (see Fig. 1) – household income will rise overall – in places like Texas, the impact is certainly going to be negative”, said Paul Dales, senior US economist at Capital Economics. “This is simply because so much of their money is dependent on the oil industry. Employment will likely fall, household income will shrink, there’s going to be fewer jobs and it’ll hit the housing market too.”
The oil and natural gas industry makes up a significant chunk of the US economy: it contributes around $1.2trn to GDP per year and supports over 9.3 million permanent jobs, either directly within the sector, or as a result of the multiplier effect on local economies, according to a study by the Perryman Group. And that multiplier effect is not to be underestimated – the American Petroleum Institute found that each direct job in the oil and natural gas industry supported approximately 2.7 jobs elsewhere in the US economy in 2011.
From boom to bust
The luxury homes market has been thriving in Texas for years, particularly in areas with a high concentration of well-paid energy sector jobs. Wealthy Houston residents purchased 1,194 homes valued at $1m or higher in 2014, up from 688 five years prior and a 13 percent increase from 2013, according to a report by the Texas Association of Realtors. While the highly skilled, highly paid jobs are the safest in case of a downturn, instability is bound to be on the minds of potential buyers. For example, a buyer eyeing a $3m property may opt for a $1m property, as a safer option.
Now predictions for job growth in the Houston area have been halved from last year, and cuts have already been announced by some of the leading oil producers in the area – Baker Hughes and Schlumberger have axed 7,000 and 9,000 respectively. More are expected well into 2015, and this kind of activity has made analysts justifiably uneasy.
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In December, JPMorgan Chase chief US Economist Michael Feroli warned: “We think Texas will, at least, have a rough 2015 ahead, and is at risk of slipping into a regional recession”, CNN Money reported.
But while some especially nervous market watchers throw around speculation that the state could see another 1980s-style crash, when oil prices completely folded and the Texan economy was hit hard as a result, such extreme predictions are largely unfounded. Aside from that being the last time such a drastic price tumble took place – the price of oil has fallen by more than 40 percent per barrel since June 2014 – the similarities tend to end there. Not only did the price of natural gas also fall in 1986 – which rapidly exacerbated existing revenue shortfalls – but since then, the state of Texas has endeavoured to learn from the past.
Following the painful recession of that period, it sought to diversify its economy so as to be less dependent on an occasionally volatile commodity like shale gas. Now, it’s attracted workers from other industries including medicine, finance, education and technology: Dallas Fort Worth’s office rental market is now more saturated by tech companies than any other industry. Plus, the oil sector has come a long way in those almost 30 years, having undergone significant technological changes that have increased both the efficiency and profitability of extraction. When the 1986 crash happened, the effect couldn’t be prevented from seeping into the real estate market: home prices dropped 14 percent from their peak, with Houston, the most energy-concentrated area, hit the hardest: housing permits nose dived a drastic 75 percent in the months following.
So admittedly, it might not be a dramatic crash echoing that of 30 years prior, but even so, the price has tumbled by more than 40 percent in a worryingly short period of time, and that simply cannot be ignored. “There are some reasons to think it may not be as bad this time around, but there are even better reasons not be complacent about the risk of a regional recession in Texas”, Feroli added.
While most markets remain relatively untouched at this point – CBRE claims a strong fourth quarter in 2014 for both the residential and commercial real estate sectors – most are bracing for a tumultuous 2015. The cracks have already begun forming: evidence from the Houston Business Cycle Index shows growth to have slowed from 7.4 percent in October to six percent the following month. An excerpt from the report reads: “Lower oil prices and declines in drilling activity will likely take considerable steam out of the region’s economic engine in coming months. While prospects for the Houston region are more uncertain, the outlook is for positive, though weaker, growth.”
Keeping a watchful eye
Although warnings of a recession may be somewhat premature, the Lone Star state is certainly one to watch in 2015. Sara Rutledge, Director of Research and Analysis at CBRE and based in Texas, says that her team is keeping a close eye on the real estate market for energy-related headwinds, as they expect firms to be cutting capital expenditure, and potentially streamlining their workforces.
Forecasts vary drastically. Credit Suisse warned that new home construction could tumble by as much as 20 percent in Texas this year, while Rutledge says that figure is between two to three percent, due to the ideal position the market already finds itself in. Quarter after quarter of unabated growth in the residential real estate market has prepared it well for an eventual slow down.
“We’ve been growing at an incredibly robust pace on multi-family rentals, at 8-10 percent for a few years now, so we had expected that to slow down anyway, as that momentum is simply not sustainable”, Rutledge added.
According to Rutledge, the minimal impact on growth thus far is due to supply never having been able to catch up with demand throughout the industry’s peak. While six months worth of property supply is the standard recommendation for a healthy inventory, for single-family homes, Texas’ stands at three months even now. That figure drops to 2.7 months in Houston, where the highest concentration of energy companies can be found, so a decrease in activity will take even longer to throw that market into turmoil.
It may not be such a breeze for commercial real estate, however. Despite the sector also coming in to 2015 fighting with the strongest net absorption since 1997 and 5.5 million square feet of office space leased across the state, Rutledge does anticipate some fallout from the drop in oil prices in the near future. This is expected in both leasing and construction – more office space is currently in construction in Houston than anywhere else in the US – and if companies begin downsizing their operations, those new spaces will only further flood the market.
The missing detail
When considering the job cuts already announced, it’s important to remember that a Halliburton-Baker Hughes merger was announced in November 2014, valued at $34.6bn. Based on combined revenues, the deal will create a new company – which will trade as Halliburton – worth $67bn and with 140,000 employees. It’s undoubtedly a massive deal, but still only makes the new entity half the size of industry leader Schlumberger, which has a market capitalisation of $125bn.
What fervent analysts are failing to acknowledge, however, is that the majority of these job cuts are likely to be as a result of the merger, as opposed to falling revenues. The counter argument is that the deal itself only took place because the sudden drop in prices caused the two companies to panic: it will insulate the two from a slowdown in drilling, and may allow them to keep prices slightly higher than if they were in competition with each other.
Halliburton derives around half of its total revenues from North American operations, so a bit of nervousness is to be expected. But the more likely argument is that as the two companies have a considerable overlap in their key product segments and similar geographical footprints, it’s an ideal opportunity to cut costs and improve profit margins as a result. Halliburton estimates that the combined entity will yield annual cost synergies of around $2bn, in fact.
Plus, as Rutledge pointed out, just how many of those cuts relate to Texas-based roles has yet to be announced. In December, Halliburton said it was slashing 1,000 jobs in its eastern hemisphere offices amid tumbling global oil prices, affecting Europe, Asia, Africa, the Middle East and Australia, yet leaving the Americas untouched. Further takeovers are anticipated in the future, as falling prices put increasing pressure on exploration companies to cut their capital expenditure and eliminate competition. The extreme result of that would see a very limited number of gargantuan companies controlling the entire global energy market; a worryingly dystopian image, and certainly one that anti-competitiveness watchdogs will be working hard to prevent.
An alternative way of looking at the sudden drop in prices is that it could give the energy industry the makeover it needs. For decades now, a vast shortage of engineers and similarly highly skilled workers has seen oil companies awarding obscene bonuses and offering unfathomable benefits packages to its employees, in an attempt to win over the strongest talent.
Perhaps the reduced revenues for these companies will come as a blessing in disguise, allowing them to better consolidate their outgoings. Even so, whichever way you look at it, paying staff less will have an adverse effect on household income and therefore overall domestic spending.
While the energy sector plunges into an uncertain future and a likely state of turmoil for 2015, Texas has successfully spent the last few decades shielding itself from such downturns. A slowdown can certainly be expected, and some sectors will be hit harder than others, but a strong performance from the wider US economy combined with other thriving industries within the state should help it weather the storm with minimal damage incurred.