Rising Oil Prices Have Yet To Benefit Houston’s Struggling Office Sector – And Footprints Could Actually Shrink
Houston’s reputation as a boom or bust town is the product of its long-standing relationship with the energy sector. High oil prices have traditionally equaled aggressive expansion by energy firms of all sizes, both in hiring and consumption of office space.
Or at least, that's how it used to be.
The oil bust of late 2014 caused an economic shock that Houston’s office market was still in the process of recovering from when another energy downturn began in 2020. The coronavirus pandemic compounded that pain, causing a sharp drop-off in global demand that rocked the entire energy sector.
After falling into historic negative price territory last April, oil prices have been in recovery and are now hovering above $70 per barrel. But economic and office experts say those price gains are unlikely to mean more office usage by energy tenants, with many continuing to operate with caution or directing their focus toward the transition to renewable energy sources.
“The vast majority of companies, out of an abundance of caution, out of uncertainty, have a desire to be risk-averse,” JLL International Director Bruce Rutherford said. “They are in the process of reducing their real estate footprints.”
Economists were already voicing concerns about the U.S. entering a recession, as well as an energy downturn, at the beginning of 2020. But those concerns paled in comparison to the reality of the pandemic, which plunged the global economy into disarray.
Historically high U.S. oil production levels collided with the pandemic, reducing demand from sectors that typically use oil, like transportation fuels and manufacturing. Further volatility was driven by disagreements over production cuts and a subsequent price war between Saudi Arabia and Russia.
West Texas Intermediate prices fell from between $50 and $60 per barrel in early 2020 to negative pricing in April, before recovering to around $30 per barrel in mid-May. The hardest-hit companies were upstream oil and gas companies involved with exploration and production, resulting in a wave of bankruptcies, furloughs and layoffs.
As the global economy began to recover in the second half of 2020, demand for oil products also started to rise. By the beginning of 2021, oil prices were averaging between $40 and $50 a barrel again.
In early spring, those prices began to increase more rapidly, reflecting the vaccine rollout’s impact on travel and rising demand for oil and refined products, according to University of Houston Chief Energy Officer Ramanan Krishnamoorti.
“It's been a pretty steady rise in oil prices, and that's simply because the excess inventory that was in place, that drove down prices a year and a half ago, are vanishing,” Krishnamoorti said.
The steady rise is also attributed to OPEC’s discipline around its production over the past year. The organization of oil-producing countries and its allies agreed to cut production in the face of the pandemic, which has helped to keep supply in balance with demand.
Yet the continued rise of oil prices is uncertain. Krishnamoorti noted that future price growth will depend on the spread of the delta variant of the coronavirus. At this stage, it’s a race between the variant and the vaccines — and if the variant wins, it could pull the brakes on higher oil prices.
“In [that] case, we're going to see that supply will be out of step with demand and the price hike that we're seeing is unlikely to continue. That's one scenario,” Krishnamoorti said.
The delta variant’s potential impact on oil prices could be compounded by OPEC Plus’ decision to wind back production cuts. The member countries began increasing production in May and will raise output by 400,000 barrels each month between August and December.
The U.S. Energy Information Administration’s July Short-Term Energy Outlook report said that rising global oil production is expected to outpace demand, causing Brent oil prices to average $67 per barrel in 2022, while WTI is expected to average about $4 below that price.
Krishnamoorti said many of the future challenges suggest oil prices won’t remain so high. For oil to reach the $100-per-barrel mark, there would need to be a major supply shock.
“You need almost a geopolitical challenge for prices to go up. Everything else, all the other pressures seem to suggest prices actually not going significantly higher than say, $75, $80 a barrel,” Krishnamoorti said.
Despite the uncertainty, rising oil prices have brought some relief to Houston’s energy sector. Greater Houston Partnership Senior Vice President of Research Patrick Jankowski said higher prices have taken some of the financial pressure off oil and gas firms, especially those that were close to bankruptcy.
“The firms have taken on a lot of debt over the last five years. Many of them are struggling to pay down that debt. And you saw that happen last year, especially the middle of the year when we saw so many bankruptcies,” Jankowski said.
Higher oil prices have provided firms with cash to service their debts, as well as additional funds they can return to shareholders in the form of dividends or profits. It has also provided more money for drilling, though that activity has not been as fevered as in the past.
The U.S. rig count, which serves as an indication of drilling activity, was 491 in the week ending July 23, according to Baker Hughes. That number represents a significant improvement from August 2020, when the rig count bottomed out at 244 rigs. However, the rig count is still far below the peak of 1,083 active rigs in December 2018.
Jankowski said that based on the EIA’s forecast of WTI averaging $63 per barrel next year, the near-term outlook for oil prices is not strong enough to spur major expansion activity by U.S. energy firms.
“That's not the sort of price which is going to tell me, I need to go out and hire a large cadre of geologists and engineers. That tells me that things are going to be pretty much next year, just as they are now,” Jankowski said.
Krishnamoorti said that the response to high oil prices from Houston’s energy sector has been muted — partially due to uncertainty, but also because the capital markets have been pulling back from the energy sector for years.
“There isn't a whole lot of capital that's available for the medium and small-sized companies to really go in and try and do exploration and production at this point,” Krishnamoorti said.
Both Jankowski and Krishnamoorti also pointed to the growing pressure for energy companies to discuss environmental, social and governance criteria, or ESG. Shareholders are demanding that energy firms focus on the energy transition, leading to hesitancy about aggressively pursuing drilling opportunities.
The culmination of these pressures, along with significant labor cuts and work-from-home policies, is having a real impact on how energy firms are thinking about their real estate, according to Rutherford, who leads JLL’s Global Energy Practice Group.
Rutherford said that many energy companies have cut their staff levels by as much as 30%, and the ones remaining are often working from home a few days a week, if not all the time.
“That has significantly reduced the demand for real estate, [and] significantly reduced the footprint of real estate that these companies need,” Rutherford said.
The Greater Houston Partnership conducted a survey of 140 member companies in June, and it found that roughly 1 in 5 firms expected to reduce their real estate.
“You're not going to be seeing people adding to their office footprint. When their contracts come up for renewal, you're going to see them trying to reduce their footprint by anywhere from 10% to 20%,” Jankowski said.
Rutherford said that range is in line with what he has been seeing from energy clients, including larger firms.
“In many cases, it's not easy for these companies to reduce their footprint. They're committed over a long period of time under leases, [and] the real estate market may not have enough demand for them to get out from under these leases quickly. It's a difficult problem,” Rutherford said.
JLL’s research has found that many firms are actively trying to get out of long-term leases, Rutherford said, which is being reflected in the amount of sublease space available, as well as the ongoing negative absorption in Houston. Year-to-date, negative office absorption stood at 1.8M SF in Houston, according to JLL’s Houston Q2 office report.
Jankowski said he doesn’t see that trend changing for at least another two to three years.
“Over the last 14 quarters, we've had 10 of them [where] we've seen negative absorption. And we're going to see negative absorption still, for the next four to six quarters,” Jankowski said.
Compared with a year ago, oil prices above $70 per barrel are an improvement. But rather than a dramatic windfall, those prices seem to be helping to stem the bleeding, rather than facilitating a huge boost in growth.
Krishnamoorti said that more workers are being brought back into the workforce, but so far, only between 20% and 30% of the people who were laid off.
Even as workers slowly return, the rise of remote work is expected to affect how energy firms think about their office footprint. And with so much caution holding energy firms back from major capital outlays, it’s likely that a frugal approach to expansion will persist in the near term.
“Everybody is being really, really cautious because they don't want to go at this and then be left holding the bag. Because they will be the ones holding the bag, should the price of oil suddenly plummet,” Krishnamoorti said.