In response to the Saudi-driven collapse of energy prices, Houston energy companies are drastically reducing their exploration and production capacity, cutting capital projects by 30 percent or more, which will have a big impact on Houston’s office real estate market.
Most important to our conversation, they are dramatically reducing head counts. Houston-based Halliburton Co. (NYSE: HAL), Houston-based Baker Hughes Inc. (NYSE: BHI), Schlumberger Ltd. (NYSE: SLB) and Weatherford International PLC (NYSE: WFT) are just a few of the firms announcing significant layoffs.
Reportedly, one-third of all oil and gas projects slated for 2015 will be canceled or postponed. Of course, new West Texas and North Dakota production is being affected, too. Watch the rig count. From peak to trough, estimates show it falling by 850 rigs over the next 18 months, which is approximately 44 percent.
This will have a big impact on Houston’s office real estate market for two reasons: overbuilding by Houston developers in response to the growth in energy prices and the expanding local economy over the past few years; and the decline in energy prices, which will cause industry consolidation, employee cuts and general economic contraction.
Beyond the short-term fall of energy prices, Saudi Arabia’s actions represent the end of the oil price stability that has characterized energy markets since the 2008 financial crisis. For almost five years, a perfect storm of coincidences has kept supply and demand in balance at historically high prices and fueled the Houston economy.
While revenues continue to fall, affected companies will be more stretched, often unable to make debt service payments and/or in violation of their debt covenants. This will undoubtedly trigger asset sales at distressed prices, shotgun marriages and bankruptcies. But it will take time.
Distressed operators will be reluctant to sell too cheaply, lenders will want to be protected, and acquirers won’t consider buying company assets without the cash to do so. It will be a substantial buying opportunity for well-capitalized operators and investors.
It’s no secret that major players are now, more than ever, exploring the capital markets for acquisitions of companies more than they are exploring the world for more high-cost massive discoveries.
How long will oil prices remain depressed? There’s a growing body of opinion that it will be long enough to cause economic pain and permanent reduction of worldwide production. At some point, however, price declines will stimulate consumption and demand will rise again. Thus, prices will bottom out and then begin to climb.
The first effect, however, will be industry consolidation. Translation: excess office space.
Leases and drilling rigs may be in new hands. The service companies may be operating under new flags. But, the heart of capitalism is all about creative destruction, inefficient enterprises shutting down and assets being reallocated toward more efficient usage. This increased efficiency, together with lower prices for consumers and manufacturers, should lead to a more prosperous U.S. economy. But Texas and the Houston office market will suffer as the price-driven oil bubble settles.