Deep Dive into Why Houston and Oil Tied at the Hip

HOUSTON (Houston Bisnow) – May 20, 2020 – Houston’s Energy Corridor experienced a major economic shock during the 2014-2016 oil downturn, when the energy industry shed more than 90,000 jobs and vacancy rates in that market went from around 5% to 21%, exacerbated by the delivery of new office inventory.

Not fully recovered from the last downturn, the submarket is now contending with the latest decline in crude oil prices, which could elevate the vacancy rates and dampen absorption in the Energy Corridor for the next two years.                                                                                                                                                                                                                                                                                                                      

“In our current forecast, so far, we have vacancies going up by the middle of 2021 to around 23%, from where they are at 21%,” CoStar Advisory Services Senior Consultant Juan Arias told Bisnow.

Including sublease listings, availability is already around 25% in the submarket, and likely to grow as absorption potentially turns negative this year.

Economists had already predicted a downturn in the energy sector, which was anticipated to dampen Houston’s economic growth this year. Those expectations have taken a sharp downward trajectory, reflecting the dramatic effects of the coronavirus pandemic and a price war between two of the world’s largest oil producers, Saudi Arabia and Russia. “This will likely hurt as keenly as any recession we’ve documented,” Jesse Thompson, a senior business economist at the Houston branch of the Federal Reserve Bank of Dallas, told Bisnow.

The energy sector is deeply tied to Houston’s office market, influencing both demand and rent prices. When there is a downturn in oil and gas, the office market is usually the first to reflect an impact. Last week, OPEC reached an agreement to cut 9.7 million barrels per day of global oil production. Many speculators hoped that by reducing production, oil prices might have a chance to stabilize — with less supply, pricing might increase. But while it may be a historic production cut, the reality of how the OPEC decision will affect oil prices is actually less significant. “They’re not cutting from where they were producing last month, they’re cutting from where they were producing at an earlier time,” Thompson said. “As far as the market’s concerned, the net cut will be smaller, somewhere in the order of between 7 and 8 million barrels per day, depending on compliance and a bunch of other factors.”

An even bigger problem is the global decline in demand. Global energy demand in April is expected to fall by 29 million barrels per day from a year ago, down to a level last seen in 1995, according to the latest oil market report from the International Energy Agency. For the entire second quarter of 2020, demand is expected to average about 23.1 million barrels per day lower than Q2 2019. That plummeting global demand for oil means that even with the major OPEC production cuts, oil prices won’t see much improvement. “You’re still in a dramatically oversupplied market,” Thompson said. “We’re actually physically running out of space to store excess crude very quickly.” The combination of a major oil downturn and the coronavirus pandemic doesn’t bode well for Houston’s economy. Though the city has made strides in diversifying its workforce across other sectors, energy is still a dominant force in Houston.

“Oil markets are always the differentiator between Houston and the rest of Texas, and Houston and the rest of the country,” Thompson said. “When oil markets are doing poorly, then Houston is going to underperform the rest of the country.” The timeline for the recovery of Houston’s broader economy is uncertain, but will be impacted by how quickly coronavirus-related shelter-in-place orders are rolled back so people can return to work. However, Thompson said that it could take as long as 18 months to two years for Houston to recover, even with the OPEC production cuts, as huge global inventories will continue to weigh on prices through 2021. “Any kind of recovery that we might see on the other side of the virus effects is going to be muted by that lackluster recovery, just off the inventory side,” Thompson said.