No matter what the economic pundits tell us about our economy having become diversified, if you live in Houston, you’re in the oil business.
The past six months have seen oil prices plummet. In response, oil companies have slashed their capital spending by more than 40 percent, sold noncore assets, frozen new hires, reduced salaries, cut staff, reduced or eliminated dividends and put surplus office space on the sublease market.
They have done all this to bring costs in line with cash flow, hoping they can lower their burn rate until oil prices recover. They shouldn’t hold their breath. And the Houston economy shouldn’t bet on oil prices recovering quickly.
Sadly, the fundamentals of oil prices have shifted. In the future, oil is going to behave more like natural gas. Since the advent of shale gas production, natural gas prices have spiked periodically. But, given the speed at which pro ducers have been able to ramp up natural gas production in response to a shortage or higher prices, prices trended lower. Oil production has performed similarly and is trending lower. Ultimately, natural gas prices stabilized in light of this new reality. There is every reason to expect the same thing will eventually take place with oil prices, but we’re not there yet.
The remaining “healthy” E&P companies need to abandon previously promising prospects instead of drilling them and then delaying completion. The cost of completing a well and putting it into service accounts for 60 percent of a well’s total cost. Why not conserve that cash until the oil price recovers and completion costs decline? There is a Catch-22 though, in that the device that these companies are using to wait out oil’s price depression is also working to keep oil prices low. It also relies upon the questionable assumption that an oil price recovery is imminent.
Given what will soon be understood as the new normal, a stabilized oil price below $50/ bbl will break the backs of many oil companies. This will also result in large-scale defaults in subprime debt obligations, and scores of oil companies will be restructured, either through M&A or bankruptcy. Some bankruptcies will be Chapter 7 liquidations, some will be Chap ter Il restructurings, but tens of thousands of additional jobs will be lost under whatever scenario. And, millions of square feet of office space, brand-new and secondgeneration, will go wanting.
Sadly, for Houston, the world is awash in oil, and it’s impossible to justify exploring for more.
Demand has been seasonally depressed, as winter/spring is not prime drive-time. We have been in a period of seasonal weakness and refinery turnarounds. Refineries have been revamping to produce summer-blend gasoline. Record production combined with diminished capacity to refine has stor-
GITTINGS HEX J. W Wall Ill, senior vice president with Moody Rambin in Houston, specializes in tenant representation
age filled to its highest level in 80 years, north of 70 percent of capacity. Meanwhile, the European and Asian economies are arguably in recession, and our economy has been reluctant to grow. Emerging markets’ growth has disappointed as well.
It should come as no surprise that all this will have a direct and long lasting impact on Houston’s office market. As new construction completes and second-generation space comes back onto the market, prices for space will come down. Way down. It will take time to digest, but it’s like grain through a goose. Sooner or later, the bottom will drop out.
This article originally appeared in the Houston Business Journal April 27, 2016.