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Institute for Regional Forecasting

Oil in Freefall! And the Economic Outlook for Houston

Robert W. Gilmer Bauer College of Business March 2015

Here We go again! Oil Prices In Freefall

103.59 96.54 93.221 84.4 75.79 59.29 47.22 50.58 47.69 20 30 40 50 60 70 80 90 100 110 120 Jul Aug Sep Oct Nov Dec Jan Feb Mar*

Spot Price of WTI in $/barrel

*Through 3/13/2015

The Last Four Times We Did This…?

Period Rigs Houston Jobs (000)

Quarters Count % Decline Quarters Number % Decline Oil Bust

81Q4 4222

• 82.4

81Q4 1704

• 17.0

86Q3 742 86Q3 1414.8

Asian Financial Crisis

98Q1 998

• 45.9

98Q1 2128.6

none

99Q2 540 99Q2 2186.9

Enron, Tech Bust, Recession

01Q2 1253

• 35.4

01Q3 2294.4

• 1.3

02Q2 809 03Q3 2265.6

Financial Crisis, Recession

08Q3 1944

• 50.9

08Q4 2608.9

• 4.1

09Q2 953.8 09Q4 2501.7

Texas Ratio Well-Behaved in 2009 Crisis – In Texas!

Let’s Move the Focus to Current Slide in Oil Prices

How Did We Get Here?

• Weak demand for crude

– Seasonal weakness/refinery turnarounds – Europe and Japan near recession and fear of deflation – Emerging market growth disappoints

• Excess supply of crude oil

– Sales by Syria and Iraq for revenue to fight insurgencies – The usual OPEC cheating by Venezuela, Iran, Nigeria and

• ther

– Increased U.S. production from the Gulf of Mexico and from shale

Global Growth Sluggish in 2014-15

(% GDP Growth) 2012 2013 2014 2015 2016 World 3.4 3.3 3.3 3.5 3.7 U.S. 2.3 2.2 2.4 3.6 3.3 Europe

• 0.7
• 0.5

0.8 1.2 1.4 Japan 1.4 1.6 0.1 0.6 0.8

• China

7.7 7.8 7.4 6.8 6.3 India 4.7 5.0 5.8 6.3 6.5 Brazil 1.0 2.5 0.1 0.3 1.5

Source: IMF World Economic Outlook: Update, January 2015

Is the Commodity SuperCycle Over?

Jan-00 Apr-00 Jul-00 Oct-00 Feb-01 May-01 Aug-01 Food Ag Raw Materials Metals Crude Oil

Growth in the Demand for Oil Comes From Emerging Markets

(million b/d)

8 15.9

• 5

5 10 15 20

1996-2003 2003-2014

Global OECD Non-OECD

International Energy Agency

On Supply Side? US Shale Reverses 40 Years of Declining Oil Production

(million barrels/day)

4 5 6 7 8 9 10 11

US Shale Is a High-Cost Source of Oil: $100/Barrel Was Part of the Magic

Reuters Survey

The Saudi Revenue Dilemma

• Raise price/lose market share OR cut price/keep

market share

• The low oil prices work on many levels for the

Saudis

– Help their friends in the U.S. and – especially -- European economies – Punish their adversaries and enemies: Isis, Iran, Iraq, Venezuela, Russia – Force U.S. shale into the role of the swing producer

• Have deep pockets for this venture with $800

billion and more in sovereign fund

E&P Spending Had Already Slowed from the 20 Percent Growth of the Last Decade

Real $ billion capital expenditures

50000 100000 150000 200000 250000 300000 350000 400000

Baker Hughes rig count

500 700 900 1100 1300 1500 1700 1900 2100

Oil-Directed Drilling Has Driven the Rig Count Since 2011

0.0% 10.0% 20.0% 30.0% 40.0% 50.0% 60.0% 70.0% 80.0% 90.0%

05-Jan-07 29-Aug-08 23-Apr-10 16-Dec-11 09-Aug-13

Oil-Directed Gas-Directed Baker Hughes

Domestic Rig Count Already Down Sharply from September Peak

1000 1100 1200 1300 1400 1500 1600 1700 1800 1900 2000

Sep-14 Oct-14 Nov-14 Dec-14 Jan-15 Feb-15 Mar-15

Weekly Count of Working Rigs

Another Major Decline in the Oil Fields

• How deep? Oil prices easily below $40 per

barrel, E&P spending down one-third, more than a 50 percent cut in the rig count

• Recovery? Probably need oil at $60 per barrel
• r more for a significant upswing in drilling
• How long? Stability in oil prices by late 2015
• r early 2016, recovery in drilling activity in

2016

Fracking Continues, but the Fracking Frenzy is Probably Over

• A healthy dose of caution was much needed, a

reminder that $100 per barrel is a not fixture in oil

• This has been a painful reminder that fracking is a high-

cost source of oil, but probably not fatal

• Fracking is with us to stay – as long as oil prices near or

above $60 per barrel, there will be significant activity

• BUT US shale comes out of this as a more cyclical and

slowly-growing industry – cutting back with every oil surplus, expanding only with high crude price

Houston Economy Looks Great in the Rear View Mirror

Houston Employment: Off to the Races Again in 2014

3.6

• 6
• 4
• 2

2 4 6

Note: December to December changes, except 2014 which is year-to-date, annualized and s.a.

Houston Employment Rides Rising Wave of Oil

(3-month percent change at annual rates)

• 8.0
• 6.0
• 4.0
• 2.0

0.0 2.0 4.0 6.0 Jan-07 May Sep Jan-08 May Sep Jan-09 May Sep Jan-10 may sept 11-Jan may sep 12-Jan may sept 13-Jan may sept 14-Jan may sept 2016-jan

US Houston

Bureau of Labor Statistics

Purchasing Managers’ Index US and Houston Compared (s.a.)

30.0 35.0 40.0 45.0 50.0 55.0 60.0 65.0 70.0

Houston US

Index > 50 means expansion Index < 50 contraction

Houston PMI Now Showing Rapid Deterioration

35 40 45 50 55 60 65 Houston US 50

Houston Unemployment Rate Falls on Strong Job Growth

2.0 3.0 4.0 5.0 6.0 7.0 8.0 9.0 10.0 11.0

U.S. Houston

Bureau of Labor Statistics

%, s.a.

Two Scenarios for Houston’s Near-Term Future

Assume the US Economy Continues to Perform Well

• US economy showing signs of putting the effects
• f the Great Recession behind it
• Consumer has deleveraged, state and local

government revenues are restored, and single- family housing on the mend

• GDP growth solid in recent quarters, just finished

the best year for job growth since 1999

• Assume 1.7 percent job growth annually from

2015-2018

Rules of Thumb for Counting Jobs in Houston

• Over a period of 4 to 6 quarters, a one percent change

in jobs in Houston’s energy cluster means a change of 18,000 total local jobs

• Similarly, a one percent growth in U.S. employment

brings 33,000 jobs. At 1.7 percent, add 56,100 jobs

• How jobs add up annually in Houston:

– Job growth of 1.7% PLUS 3% energy base growth = 110,000 new jobs in Houston – 1.7% US job growth MINUS 3% energy base growth = 2,100 jobs in Houston

• Minus 6% energy base growth? Recession and the loss of

45,900 jobs

Scenario #1: 20 Percent Cut in Exploration and Production

• E&P expenditures fall 10 percent in 2015Q1, then

another 10 percent in Q2. They stay flat until 2015Q4, then recover. By 2016Q2. E&P growth then resumes rapid growth at 8 percent per year

• U.S. growth remains solid, with 1.7 percent job

growth throughout the outlook

• As a result, the energy base jobs shrink by

18,700, or 6.2 percent

• OTHER THINGS EQUAL this is enough to induce a

mild recession in Houston with 50,000 jobs lost in 2015-2016, before growth resumes in early 2017

Scenario #2: 33 Percent Cut in Exploration and Production

• Similar to Scenario 1, but with initial 16.5 percent

cut, rising to 33 percent. E&P growth resumes at steady 5 percent annually on the same schedule as Scenario #1.

• US growth remains solid at 1.7 percent
• As a result, the energy base jobs shrink by 23,600
• r 7.9 percent. Similar cuts in E&P in 2008-09

resulted in a decline of 30,000 energy jobs

• OTHER THINGS EQUAL, the resulting recession in

Houston means 78,000 jobs lost in 2015-2016, before growth resumes in early 2017

Figure 2: Houston Job Growth if E&P Falls Without Chemical Expansion

(Quarterly % change, annual rates)

• 8
• 6
• 4
• 2

2 4 6 Jan-07 Sep-07 May-08 Jan-09 Sep-09 May-10 Jan-11 Sep-11 May-12 Jan-13 Sep-13 May-14 Jan-15 Sep-15 May-16 Jan-17 Sep-17 May-18 Scenario 1 Scenario 2

A Construction Boom Built on Low Energy Prices Now More Certain to Continue

Natural gas prices collapsed in late 2011

($/mcf)

2 4 6 8 10 12 14 Jan-1997 Sep-1999 May-2002 Jan-2005 Sep-2007 May-2010 Jan-2013 DOE/EIA

• New ethylene crackers, more ethylene-related

expansion in PE, PVC and other derivative plants

• LNG export terminals to sell surplus natural

gas into global markets

• Gas processing facilities, natural gas liquid

export terminals, pipelines and other basic infrastructure

• The Gulf Coast is the focus of this expansion

$100 Billion U.S. Construction Boom is Based on Cheap Energy and Exports

Natural Gas Energy Content Equivalent to $20-$40 per Barrel for Oil

0.00 20.00 40.00 60.00 80.00 100.00 120.00 140.00 160.00 Jan-01 Feb-03 Mar-05 Apr-07 May-09 Jun-11 Jul-13

• il $/b

nat gas $/b

DOE/EIA and calculations of the author

Ethylene Margins

(cents per pound)

10 20 30 40 50 60 70

Ethylene Projects Proposed or Under Construction In or Near Houston

Company Scale (thousand m tons/yr) Location Completion ChevronPhillips 1,500 Baytown 2017 ExxonMobil 1,500 Baytown 2017 Dow 1,500 Freeport 2017 Sasol 1,500 Lake Charles DELAYED Occidental 500 Ingleside 2017 Formosa Plastic 1,200 Point Comfort 2017 LyondellBasell 450 La Porte and Channelview 2016 Total S.A. 900 Port Arthur Proposed

LNG Export Terminals Being Approved

• Built to export cheap North American gas into

a global market

• Permits and approvals are in place, and

construction underway at five sites: Sabine Pass; Hackberry, La.; Freeport; Corpus Christi; and Cove Point, Md.

• $5 to $10 billion projects, bringing thousands
• f workers on-site

A Counterweight to Upstream Damage From Low Oil Prices

• Jobs adds up quickly given the number and scale
• f proposed construction projects in 2015-2017
• These are temporary jobs, disappearing as

projects end and capital expenditures wind down

• Normally, downstream capital expenditures are

small compared to the upstream, move in a narrow range, and create relatively few jobs

• The construction projects just described means

the downstream can’t be ignored right now. Can this spending substitute for losses upstream?

Two Scenarios Downstream

• Begin with $90 billion in shale-related chemical

construction in the US, plus 5 new LNG plants

• Chemical construction begins to wind down by

2017, and LNG plants by 2017-18

• Scenario 1 assumes that one-third of this

announced construction never materializes. Scenario 2 assumes only one-half are built. The expansion still is massive and completely unprecedented

• Combine these with Scenario 1 and Scenario 2

upstream

New Construction Workers Needed in East Houston, 2015-2018

Year Build 2/3 Build 1/2 2014 3,655 3,655 2015 23,113 17,973 2016 12,556 11,479 2017

• 4,419
• 4,101

2018

• 6,254
• 5697

Build 1/2 assumes that only one-half of announced construction moves forward; Build 2/3 assumes two-thirds of the projects move forward

Does This Really Work?

• Are the workers and skills available?

– AGC union negotiations to bring workers to Gulf Coast – Companies were scouring the nation – probably still looking – Many more workers available now than we thought a couple of months ago – as drilling winds down

• Do projects move forward?

– Chemical margins are squeezed with cheaper oil – Doubts raised about the availability of some products as drilling falls? Propane, butane, and ethane for export? – Yes. Most do. Projects still being announced

• Plenty of questions about the accuracy of the scenario –

but assumptions are conservative. There is a substantial cushion against upstream problems

Temporary Jobs, Temporary Workers

• Does one construction job equal one lost in drilling? Compensation

is good for the skilled, unionized jobs

• BUT we are replacing long-term employment with temporary

construction jobs

– These jobs will be important in keeping machine shops and industrial base for machinery and fabricated metal busy – But they won’t need high-end apartments, luxury retail, office space,

• r other amenities?
• Industrial east side booms while the air could be sucked out of the

white-collar west side. There is plenty of scope for economic disruption, even if overall job numbers stay healthy

• Assume multipliers for the construction workers are half of the

white-collar jobs they replace

How It Adds Up for Houston

Scenario 1: 20% Drop in E&P and 2/3 of Projects Completed

• Replace upstream jobs with construction workers
• n a 2-for-1 basis
• Energy employment rises in early 2015, then sees

a net drop in energy- related jobs in energy- related jobs of 6,150 or 2.1 percent

• Payroll job growth grows continues at 2.0 percent

in 2015 and 1.9 percent in 2016, both faster than assumed for the US

• Rapid job growth in late 2017-2018 is driven by 8

percent growth in fracking

Scenario 2 : 33% Drop in E&P and 1/2 of Chemical Projects Completed

• Replace upstream jobs with construction workers
• n a 2-for 1 basis
• Energy jobs initially rise, then see a decline of

11,263 or 3.8 percent

• Payroll job growth in Houston during this period

is cut to 1.6 percent in 2015 and 1.3 percent in 2016

• The recovery in 2017-2018 is subdued compared

to Scenario 1 because of the slower expansion of fracking, assumed to be only 5 percent

Energy Jobs in Houston if We Include Construction Workers

280 290 300 310 320 330 340

Scenario 1 Scenario 2

Chemical and other construction workers replace upstream jobs on 2-for 1 basis

Current Events Are More Like a 1/3 Cut in E&P and of 2/3 of Chemical Projects Completed

(thousand jobs in energy base)

290 295 300 305 310 315 320 325 330 335 340

Scenario 1 Scenario 2 Mix 1/3 2/3

Factors That Dominate Houston’s Outlook: By Scenario 2015-2018

Scenario 2015-2016 2016-2017

High E&P (-) 20% Cut in Cap Ex (++) Recovery at 8% annual rate Petrochem (+) 2/3 Projects Completed (--) More Construction Jobs to Lose MIX E&P (--) 33% Cut in Cap Ex (+) Recovery at 5% annual rate Petrochem (+) 2/3 Projects Completed (--) More Construction Jobs to Lose

Low

E&P (--) 33% Cut in Cap Ex (+) Recovery at 5% annual rate Petrochem (-) 1/2 Projects Completed (--) Fewer Construction Jobs to Lose

Houston Job Growth Stays Positive in Three Scenarios

(quarterly % change at annual rates)

0.5 1 1.5 2 2.5 3 3.5 4 4.5 5 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 Jul-15 Jan-16 Jul-16 Jan-17 Jul-17 Jan-18 Jul-18

MIX Scenario 1 Scenario 2

Long-term trend = 2.0 percent

Houston Job Growth in Three Scenarios

New Jobs: Q4/Q4 in '000 Percent Increase

Likely Scenario 1 Scenario 2 Likely Scenario 1 Scenario 2 2012 117.6 117.6 117.6 4.5 4.5 4.5 2013 84.3 84.3 84.3 3.1 3.1 3.1 2014 99.9 99.9 99.9 3.5 3.5 3.5 2015 53.6 60.1 46.9 1.8 2.1 1.6 2016 46.1 57.5 38.3 1.6 1.9 1.3 2017 47.1 58.1 40.8 1.6 1.9 1.4 2018 60.6 78 56.1 2 1.9 1.8

The Wheel Turns Again in 2017-18

• West Houston lags for the next couple of

years, waiting for oil prices to rise and upstream energy to recover

• But by 2017, the construction boom peaks,

the number of construction workers decline rapidly, and recovery of upstream again drives jobs

• West Houston returns to the economic

driver’s seat as the price of oil recovers

Bottom Line: Several Years of Modest Growth

• We are facing a significant downturn in drilling, and taken

alone it would easily bring a mild recession to Houston

• The drilling downturn seems on the usual 12- to 18 month

track, with a likely rebound in drilling by 2016

• The longer-term outlook for fracking is a more cyclical and

slower-growing industry

• At the other end of the oil industry – and east side of town

– there is an unprecedented construction boom underway in petrochemicals and natural gas exports

• The east side booms – while the white-collar west feels

much of the pain of the drilling downturn

• Taken together they mean several years of modest growth

instead of near-term recession

Oil in Freefall! And the Economic Outlook for Houston

Robert W. Gilmer Bauer College of Business March 2015

East Meets West on Highway 59

Is the East/West Split Real?

• Is it really upstream versus downstream?

Blue-collar versus white-collar?

• Close to half the jobs in the energy corridor or

the Galleria are in sectors that are at-risk because of the drilling downturn

• Drilling has much less impact in the east – and

all the benefits of the construction boom

BAYTOWN AREA AND EAST HOUSTON: COMPARISON TO THE WEST

East versus West: Number of Jobs in At-Risk Sectors

Color of Cell in Table West Houston Galleria Combined Baytown

Red or Yellow 128,820 102,909 231,730 15,690 Percent of total 60.7% 40.0% 49.4% 19.1% Jobs Under Red Only 62,190 67,487 129,677 7,020 Percent of Total 29.3% 26.3% 27.6% 8.5% Jobs Under Green 25,624 Percent of Total 0.0% 0.0% 0.0% 31.1%

Additional Slides

Houston Single-Family: Still Okay in 2015?

Existing home sales in Houston return to 2006 levels

(sales/month, s.a.)

3500 4000 4500 5000 5500 6000 6500 7000 7500 8000

Houston Home Prices Stable Through Crisis, But Then Rose Quickly

(median price, s.a.)

100 110 120 130 140 150 160 170 180 190 200

000 Dollars

MLS, Texas A&M Real Estate Center

Price Increases for Houston’s Single-Family homes

(% quarterly change, annual rates)

• 10
• 5

5 10 15 20 FHFA all-transaction housing quarterly housing price index

Houston Single-Family Market Still Below 3-Month Supply

2.0 3.0 4.0 5.0 6.0 7.0 8.0 9.0 MLS, Texas A&M Real Estate Center, seasonally adjusted

Houston Single-Family Permits Constrained by Lot Shortages

(monthly permits, s.a.)

6-mo average

SF Permits FRED, St Louis Federal Reserve Bank, s.a.

Change in Home Value, Construction Cost, and Land Prices Since 2011Q4

Home value (%) Construction cost (%) Land value (%) Houston 17.1 9.0

271.8

Fort Worth 16.8 7.4

176.9

Dallas 23.0 7.7

342.4

San Antonio 11.6 8.0

179.4

Kansas City 8.7 5.7

65.8

Los Angeles 31.7 9.6

44.5

Miami 30.5 7.3

65.9

Tampa 23.4 8.8

390.5

Contribution of Land Value to Price of Single-Family Home in Houston

(constant $2014)

10 20 30 40 50 60 70 Thousands

Land value Average since 1984

Local Multi-Family Permits Still Trending Up?

(units/mo at annual rate, s.a., 6-mo avg)

500 1000 1500 2000 2500 3000 3500

February Margins for Ethylene Were 24 Cents per Pound in North America, 1.8 Cents Elsewhere

Feedstock Feedstock Margin Margin

• 30
• 10

10 30 50 70 90

Ethane Naphtha

Muse, Stancil Cash Ethylene Margins, Oil and Gas Journal, monthly report

Missing sectors add to GDP again

(percent contribution to GDP growth)

• 6
• 4
• 2

2 4 6 8 St/Local Gov't Housing Pers Cons

Developed Land Cost for the Average House by Metro Area

Metro Land Cost ($) Metro Land Cost ($) Atlanta 47,760 Detroit 37,044 Buffalo 13,205 Hartford 48,811 Charlotte 50,912 Indianapolis 10,792 Chicago 32,997 Houston 38,863 Cincinnati 8,644 Los Angeles 417,610 Cleveland 10,497 San Diego 378,803 Columbia 16,027 San Jose 720,707 Dallas 84,881 Washington, D.C. 251,765

Affordability of Homes in Other Selected Metropolitan Areas

Metro area 2011Q4* 2014Q3*

Los Angeles 48.3 16.3 Miami 63.6 47.7 New York 29.0 21.6 Phoenix 83.8 68.3 San Diego 57.3 23.4 San Jose 56.8 20.9 Washington, D.C. 77.6 63.8

*Percentage of homes sold in the area that are affordable to families that earn the median income in the metro area and based on a standard 30-year mortgage

Growth of Personal Income Among 12 Largest US Metros: 1969-2013

5.0 5.5 6.0 6.5 7.0 7.5 8.0 8.5 US Metro Avg Houston Dallas Atlanta Miami Seattle Washington San Franciso Boston Los Angeles Philadellphia New York Chicago

Annual Percentage Rate

Breakeven Oil Price for 2014 OPEC Government Budgets

140 121 121 119 117 106 98 93 90 75 70 65 40 60 80 100 120 140 160 Iran Venezuela Algeria Nigeria Ecuador Iraq Angola Saudi Arabia Libya Kuwait U.A.E Qatar

$/bbl

Deutsche Bank and the Wall Street Journal

Energy Led the Expansion of Houston’s Economic Base

(Thousand Jobs, s.a.)

200 220 240 260 280 300 320

Energy Base Other Base