Low oil prices and the Texas economy

For the last few weeks there has been great interest in the decline in oil prices. I wanted to address the many questions I have received about how this will impact the Texas economy. I am not an expert on oil futures, but living in Texas for the last half century has given me a healthy respect for its economic impact.

In recent years, America’s energy boom has added $300–$400 billion annually to the nation’s economy – without this contribution, our national GDP growth would have been negative and the nation would have continued to be in a recession.

GDP Annual Growth Rate in the United States averaged 3.24 percent from 1948 until 2014, reaching an all time high of 13.40 percent in the fourth quarter of 1950 and a record low of -4.10 percent in the second quarter of 2009. The United States has the world’s largest economy, and greatly influences the global economy. In the last two decades, like in the case of many other developed nations, the US GDP growth rates have been declining. In the 50’s and 60’s the average growth rate was above 4 percent, and in the 70’s and 80’s it dropped to around 3 percent. In the last ten years, the average rate has been below 2 percent, and since the second quarter of 2000 has never reached the 5 percent level until late last year. So the energy industry improvement has had a sizable long term economic impact on the nation and subsequently the world.

America’s energy (fracking) revolution and its associated job creation are almost entirely the result of drilling & production by more than 20,000 small and midsize businesses (the majority with headquarters in Texas and North Dakota), not a handful of “Big Oil” companies. In fact, the typical firm in the oil & gas industry employs fewer than 15 people. Many of us don’t think of the oil business as the place where small businesses are created, but for those of us who have been around the oil patch, we all know that it is. That tendency is becoming even more pronounced as the drilling process becomes more complicated and the need for specialists keeps rising.

Fracking, or the shale oil & gas revolution has been the nation’s biggest single creator of solid, middle-class jobs throughout the economy, from construction to services to information technology. Overall, nearly 1 million Americans work directly in the oil & gas industry, and a total of 10 million jobs are associated with that industry. Oil & gas jobs are widely geographically dispersed and have had a significant impact in more than a dozen states.

Oil is off its high of $112/barrel in June of this year. Today, WTI crude oil opened at just $48/barrel. According to the Texas A&M Real Estate Center, as well as University of Texas, economists, oil under $70/barrel begins to affect profitability in the Eagle Ford Shale region in South Texas.

The Texas Railroad Commission is definitely seeing a slowdown in activity as the price of crude oil nosedives. Late in 2014, the state agency issued 1,508 original permits to drill compared to 3,046 permits in October. The slowdown in new permits is a precursor to layoffs to come. The Dallas Federal Reserve currently projects that Texas could lose up to 125,000 jobs related to the falling price of oil by mid 2015.

Global players

Let’s start by looking at the ‘breakeven’ oil price for the world’s drilling projects. This is the level at which the price of oil covers the cost of extracting the oil.

A simpler way to look at when the biggest oil players will start feeling the squeeze from lower prices is the “cash cost.”

Without OPEC action, an outage, or other response, cash cost is the only true floor. Cash cost is basically what it takes to keep oil production going, not what it takes to make oil production profitable or for a government to hit its budget projection. If you drop below your cash cost on a project, you’ve got to turn out the lights.

Below is a chart from Morgan Stanley analysts of operating costs with and without royalty effects currently.


As you can see on the far right, the Canadian oil sands and the US shale basins are very expensive to tap. Meanwhile in the Middle East, producers basically stick a straw in the ground, and oil comes out.
It’s worth mentioning that oil values can change faster than the fundamentals of supply and demand. In a recent 30-day period the price of oil fell by 20 percent. There was no change in the demand or supply over that month to justify such a large change. What happened is that commodity traders look at expected future prices, based on long-term supply and long-term demand. When the traders’ expectations change, they buy or sell and the price changes.

The fundamentals of supply and demand are straightforward. Demand moves up or down as the global economy moves up or down, but with a pronounced trend toward less energy use per dollar of economic production.

Economists and analysts have been slowly lowering their projections for global economic growth in the coming years, triggering lower expectations for oil demand, triggering lower values (OPEC leaders have also shown reluctance to keep values high).

Very few of these OPEC’s members interests were served by the OPEC decision not to limit production and let the price of oil continue to drop. For example:

• Iran and Iraq are reportedly pleading with Saudi Arabia to stabilize the price and have cut back on their government budgets
• Venezuela, which is basically funded by oil production, is so broke that parts of Caracas are having blackouts.
• Libya has not regained any traction and needs oil to stay high (for this, continued civil war, and many other reasons)
• There’s a huge threat of civil unrest in Nigeria during the upcoming national elections, heightened by falling oil prices. Meanwhile, the Saudis are sitting back, letting prices fall, and trying to starve out American producers — because they can. That said, it does seem that smaller Gulf states like Kuwait and the UAE are on board with this plan.

As you can see there is very little solidarity on where OPEC values should be from the OPEC members. Many of the counties mentioned are not only in economic and political turmoil.

Presently the strongest OPEC member, Saudi Arabia, is trying to reduce US production, particularly as the world moves toward emissions caps and more energy-efficient technologies. But long-term strategy is a luxury of those who can afford the losses.

Oil could go lower. In my lifetime I have seen it hit $10/barrel from a high of $85 in the same year. But keeping it low will crush many of the world’s economies, including Russia. It is hard to tell how long the Saudis want a free market.

Oil price weakness is a function of excess supply, rather than a problem with demand (recession, for example). It is true that much of the developed world is struggling with growth, and the emerging economy’s growth profile is contracting. But global GDP is still growing, and demand for oil is still rising – just not as rapidly as supply.

Regional impacts

How does this affect Texas? The good news is that our state and metro economies are not as single industry based on oil as they were in the late 80’s. Houston, the energy capital of the world, has energy as 20-25% of their total GDP, compared to over 40% in the late 80’s. D/FW is not strongly energy based, so the effect will be minimal presently. San Antonio will have greater exposure, due to their good luck of being close to Eagle Ford shale. Austin will see some impact because of our state and university funds coming from oil.

Texas had tremendous growth from 2010 to 2012, but this ‘mini oil boom” has definitively ended. In the short to intermediate term, the Texas oil patch is more about making the most productive use of existing assets than finding new ones.

If oil stays below $50/barrel long term, it will affect regional banks lending as they call oil loans to protect their cash reserves, which in turn affects all the other outstanding regional loans. So oil prices staying below $60-70/barrel will have a negative effect on our economy, including real estate. The Dallas Federal Reserve estimates if oil stays below $60/barrel the state could lose 125,000 jobs. Texas produces 36 percent of the crude oil in the United States so Texas will be harder hit than other states.

Impact on real estate

Metrostudy’s Scott Davis wrote on the Houston housing blog earlier this year that, “…there is a “sweet spot” between $55 and $90/bbl that produces the highest demand for housing in the Houston market. Above $90 it appears that high energy prices dampen demand for housing because of the squeeze on consumer budgets for housing and, in a market the size of Houston, transportation. Below $55 it appears that demand is lessened because of weaker job growth.”

The chart below came from a research report published earlier this year by the Manhattan Institute, entitled “The Power and Growth Initiative Report”. The author Mark Mills highlighted the importance of oil in employment growth:


The important takeaway is that, without new energy production, post-recession US growth would have looked more like Europe’s – much weaker, to say the least. Job growth would have barely budged over the last five years.

Further, energy is not just a Texas and North Dakota play. The benefits have been widespread throughout the country. “For every person working directly in the oil and gas ecosystem, three are employed in related businesses,” says the report.

The next chart is from the Dallas Federal Reserve, and it’s fascinating. It shows total payroll employment in each of the 12 Federal Reserve districts. No surprise, Texas (the Dallas Fed district) shows the largest growth (there are around 1.8 million oil-related jobs in Texas, according to the Manhattan Institute). Next largest is the Minneapolis Fed district, which includes North Dakota and the Bakken oil play. Note in the chart below that four districts have not gotten back to where they were in 2007, and another four have seen very little growth even after eight years.


New oil well permits collapsed 40% in November. Since December 2007, or roughly the start of the global depression, shale oil states have added 1.36 million jobs while non-shale states have lost 424,000 jobs. As stated earlier, the decline will have a dampening effect on the regional and national economy if values stay depressed long term. Low oil prices aren’t good for everyone.

Realize that although oil and energy have played a large part in economic growth, thanks to booms in the Eagle Ford Shale and the Permian Basin, oil production in Texas has soared to more than 3 million barrels per day. Energy has accounted for 11.9 percent of Texas’ nongovernment gross domestic product in 2012, according to the Federal Bureau of Economic Analysis. In numbers the state could lose an estimated 212,000 jobs and $13.5 billion in total earnings. In turn, the Austin metro area could see a loss of 4,200 jobs and $210 million in earnings.

Currently the oil and gas sector, which includes a dozen related industries, accounts for over 400,000+ jobs throughout Texas, about 3.2 percent of jobs statewide. The core oil and gas extraction industry on its own accounted for 111,422 jobs, about 0.9 percent of Texas payrolls.

Positive effects of the decline

The strength of the Texas housing market could be helped by the decline in energy employment. This decline in energy employment could be shifted to the construction industry, reducing the cost of labor, one of the housing market’s key constraints.
In addition, lower gas prices help favor the more remote markets in our metros, opening up lower land costs and encouraging development in the most underserved portion of our regional housing market, entry level homes under $250k.

The real test of the resilience in Texas will come when/if economic indicators go from stable to declining or from sustained out-performance to sustained under-performance relative to the rest of the U.S. However, there is no reason to believe yet that such a decline is either imminent or inevitable as a result of declines in the oil patch. The oil-rig count has already begun to drop as previously mentioned, and it will continue to drop as long as oil stays below $60. That said, however, there is the real possibility that oil production in the United States will actually rise in 2015 because of projects already in the works. If you have already spent (or committed to spend) 30 or 40% of the cost of a well, you’re probably going to go ahead and finish that well. There’s enough work in the pipeline that drilling and production are not going to fall off a cliff next quarter. But by the close of 2015 we could see a significant reduction in drilling.

Employment associated with energy production should fall over the course of next year. It’s not all bad news, though. Employment that benefits from lower energy prices is likely to remain stable or even rise. Think chemical or manufacturing companies that use natural gas as an input as an example. In addition the lower energy costs and potential softness in office will allow more out of state companies to compete.

However, there really aren’t any industries that could replace the jobs and GDP growth that the energy industry has recently created. Certainly, reduced production is going to impact capital expenditures. This all leads me to think that the US economy will be slower in 2015.

One last thought

A decline in the price of gasoline induces people to drive more and not be as energy efficient, increasing the demand for oil.

A decline in the price of oil negatively impacts the economics of drilling, reducing additions to supply.

A decline in the price of oil causes producers to cut production, quit exploring new ways to drill, and will ultimately leave oil in the ground to be sold later at higher prices.

In other words, lower oil prices — in and of themselves — eventually make for higher oil prices.