The rebalancing in the oil commodities market is a ways off, which means more pain for the Houston economy. When oil prices started dropping in mid-2014, not even the best forecasters could have guessed they’d slip below $30 a barrel in 2016 (the lowest level since 2003). Over the past 18 months, the impact of lower gas prices crushed investors in the futures markets, hurt shares of oil and gas companies, and rattled domestic energy-dependent cities. Many oil experts predict we are near bottom, and prices will either be flat or higher next year. However, some forecasters are saying prices could drop as low as $10 a barrel. As history shows us, it’s impossible to actually know what will happen to the commodity’s price. Our Manager of Housing Economics, Ali Wolf, describes in detail the major causes of lower gas prices and its impact on the Houston economy.
The change in oil prices boils down to basic economics: supply is greater than demand. Oil supply is up (the two predominant reasons are explained below), but demand for the product from the largest oil consuming countries, like the US and China, is slowing.
KEY REASONS FOR LOWER OIL PRICES
Disruptive Technology: Fracking
- Fracking makes extracting oil cheaper and easier
- It significantly boosts domestic oil production
- More accessible oil creates increased supply (and lower prices)
- Congress recently lifted a 40-year ban allowing the US to export oil
Our Texas expert, Glenn Barton, explains “the US technology of fracking has assisted with driving down oil prices, which has negatively impacted oil-reliant countries’ budgets like Russia, Venezuela, and Nigeria. Disruptive technology indeed!”
The Cartel of Oil Producers: OPEC
- OPEC suppliers are keeping their production levels unchanged (some even increased production in recent months)
- The group seems unwilling to cut supply to stabilize prices
- Market share is the main reason they will not cut production. If one country cuts, they will lose their market share, prices will go up in result of tighter supply, and their competitors will benefit
- There’s a good chance the glut will grow even more once Iran starts supplying oil again since the economic sanctions were lifted in January
Our Chief Economist, Kevin Gillen Ph.D., describes another issue with OPEC. “This situation is unlikely to reverse itself anytime soon. OPEC and Russia are in a race to see who can drive each other out of the marketplace first, and they’ve both signaled to the world that this is going to be a long game. But, keep in mind that while cheap oil may mean layoffs and foreclosures in Houston, it means significantly lower commuting, transportation, and travel costs for the rest of us.”
THE IMPACT ON HOUSTON
People that lived in Houston through the 1980s are still scarred from the experience. Back then, 1 in every 7 local workers lost their job. This oil slump won’t create the same disastrous effect (82% of the jobs in 1980 were energy-related and now it’s 45%), but there’s no doubt the tumbling prices have negatively impacted the Houston market.
The uncertainty about oil prices, in particular whether or not they have reached bottom, is making companies weary and affecting the overall economic climate in Houston.
- Earnings are down. Earnings for oil-related companies were down in the fourth quarter after posting record profits in recent years. For example, Anadarko Petroleum reported a $1.25 billion loss in 4Q, Exxon-Mobile saw profits fall 58%, and BP stated a loss of $2.72 billion.
- Cutting jobs and investments. Companies are shutting down 2/3 of their rigs, which has resulted in an estimated 250,000 oil-related jobs lost globally. Companies like Chevron, Royal Dutch Shell, and BP have all announced even more cuts to payroll. In addition, investments are on hold for many companies for exploration, research, and development. According to the Challenger Job Cut Report, 94,409 layoffs were announced in energy and other related sectors across the US in 2015, nearly 7 times the 14,262 in 2014.
- Fewer Permits Pulled. 2014 was a boom year for building permits in the Houston market, with the annualized rate back to 2007 levels. Total permit activity slowed by nearly 10% YOY in December (LTM). Spot prices for oil, as measured by West Texas Intermediate, declined 53% in 2015 compared to 2014.
- Home Sales Slowing. Houston new home sales are also cooler than last year’s levels. Over the last twelve months, total new home closings slipped nearly 15% compared to last year. In addition to slower sales, the breakdown of sales has shifted more towards lower priced homes; the most popular new home price in Houston is between $100K and $200K. Home sellers are also now offering more incentives to help close the deal.
There are some bright spots for Houston’s economy, however. As mentioned earlier, the city has diversified considerably since the 1980s and the economy is benefiting from the momentum in sectors such as petrochemicals, health care, and construction. The industry diversity has helped keep consumer confidence afloat as seen by the strong activity at restaurants and bars. Furthermore, Houston’s available housing stock is still low enough to drive bidding wars and flash sales for the right projects and neighborhoods, which is driving up prices. For example, home prices rose 30% from 2011-2015.
It appears rebalancing in the oil commodities market is a ways off. Tehran can produce oil at a very low price and plans to export hefty oil supply in the coming months. Meanwhile, both OPEC and the US have not announced plans to cut production yet. Continued job losses will persist in the energy sector as long as prices remain low since current oil prices are below the breakeven point for many producers; Houston employs 1/3 of the nation’s oil and gas extraction jobs, so we expect the metro to take the brunt of additional cuts. Undoubtedly the “energy capital of the world” will slow, but increased diversity will help provide more economic stability than in the 80s.
If you have any questions, please contact Ali Wolf, Manager Housing Economics.