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Oil Volatility Expected To Take A Heavy Toll On Houston’s Office Market

Offshore oil rig

Houston’s tepid office market is facing greater hardship than initially expected this year, as major energy industry tenants struggle to mitigate wildly fluctuating crude oil prices.

The combination of a price war between two global producers and the ongoing effects of the coronavirus outbreak sent oil prices plummeting to a four-year low this week, placing further pressure on the already-faltering U.S. energy industry.

U.S. West Texas Intermediate fell nearly 25% in a single day, to settle at $31.13 per barrel. Monday's drop coincided with the worst day for oil trading since January 1991.

JLL International Director Bruce Rutherford told Bisnow that energy companies specializing in exploration and production are unable to make a profit at current oil prices, and would likely place many offshore drilling projects on hold.

As offshore drilling slows and profits disappear, energy companies will have limited financial ability to expand operations, and in some cases, could reduce their footprint.

“It's going to be a very tough six to nine months for our real estate market, despite the fact that the Houston economy has never been so well-diversified,” Rutherford said.

Oil prices have been trending lower since early January, reflecting the dampening effects of the coronavirus on major energy consumers like airlines, cruise ships and China-based manufacturers.

However, the violent downward price movement Monday occurred after Saudi Arabia slashed its oil prices over the weekend and promised to increase production, a retaliatory measure against Russia and other OPEC members after they refused to curtail their own production to help boost prices.

With billions of dollars effectively wiped out from the stock market, some energy companies are likely facing layoffs, bankruptcies or mergers.

“We could be looking at an accelerated pace of bankruptcies and an accelerated pace of opportunistic acquisitions and mergers, which will further reduce the demand for real estate from the energy industry,” Rutherford said.

“The effects on the local real estate markets is to essentially say, all the E&P companies are now out of the market.”

Rutherford noted that leasing demand from natural gas-oriented companies was already effectively zero, owing to the oversupply of gas and extremely low prices, but other energy-related office users could see an impact.

“The energy engineering companies are really going to be hurt by this, and they are generally larger office users,” Rutherford said.

Houston’s technology industry is also likely to feel the effects of lower demand from the oil and gas industry.

“A lot of people don't realize that the North American energy industry is the second-largest consumer of technology on the planet after the United States Department of Defense,” Rutherford said.

Nearly 2M SF of new office space was occupied in the fourth quarter of 2019, the most positive net absorption recorded over a single quarter in 20 years, according to JLL’s Q4 2019 Office Insight report. As a result, total office vacancy in Houston dropped to 22.8% at the end of 2019.

Rutherford said he expects those numbers to be drastically different for Q1 2020.

“I think the absorption numbers are going to be way down. It's a huge leap to say they're going to be negative, but I think they're going to be way down,” Rutherford said.

“We're going to see a lot of product coming onto the market, it's just not going to lease up as fast as the developers hope to.”

Over 3.5M SF of office development was under construction or renovation in Q4 2019, and nearly 1.9M SF of that is slated for delivery in 2020, according to JLL.