The Impact of Oil Prices on US Real Estate Market - January 2015

The Impact of Oil Prices on U.S. Real Estate Markets

Exhibit 1: WTI Crude Price vs. Average Imported Crude Oil Price (Inflation- Adjusted, 2014 Dollars)

The price per barrel of West Texas Intermediate (WTI) crude declined over 50% from June 2014 to January 2015. The sharp drop in oil prices has triggered concern throughout investment communities, particularly as some investors have pondered whether it may be time to slow real estate investments in energy- dependent regions. In the near term, we remain cautious regarding these markets; however, we have a bullish long-term outlook as several underlying factors suggest that markets supported by hydrocarbon exploration and development (in cities like Houston) are capable of weathering recent oil price declines. Following the Great Recession, the energy industry’s rapid expansion has been a major growth factor driving the U.S. economy. The country’s total oil output eclipsed 8.6 million barrels per day in August 2014, the highest volume in over 25 years, and an increase of over 50% from the average of 5.5 million barrels per day from 2005 to 2012. Consequently, crude imports from foreign nations have declined 31% since 2005. 1 A PricewaterhouseCoopers report completed in 2013 found that domestic oil companies account for $598 billion a year of economic output, roughly 8% of gross domestic product (GDP). Collectively, this translates into 9.8 million jobs, and 6.3% of the nation’s labor income. 2 Clearly, the energy sector, which is sensitive to oil price volatility, is a key component to a healthy American economy. From a historical perspective, current oil prices are just slightly below the long-run average. As shown in Exhibit 1 , the mean price of an imported barrel of oil fell to $72.30 during the fourth quarter of 2014; however, the average inflation-adjusted cost has been just $56.16 since 1973. Furthermore, U.S. shale production has a break-even point of roughly $65 per barrel based on some estimates (see Exhibit 2 ). Various sources, however, have shown breakeven costs that range from $45 to $90 per barrel – all of which may be accurate given that oil drillers’ fixed costs can vary greatly. Thus, at current prices, the market should experience reduced production and larger oil companies may start to acquire weaker companies. In addition, there are concerns that debt levels in the oil patch are alarming relative to exploration companies’ ability to service their liabilities at today’s product prices. Production and Prosperity

140.00

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80.00

60.00

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1974Q1

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Real Oil Price

Post-1973 Average

Source: USAA RealCo; Moody’s Analytics; Energy Information Administration

Exhibit 2: Crude Cost of Production Rises as Demand Grows 3

Source: USAA RealCo; Rystad Energy; Morgan Stanley Commodity Research Estimates

Debt and Repercussions

Excessive debt has become a source of risk in the oil market. According to Bloomberg, “Most [oil producers] are spending money faster than they make it, an average of $1.17 for every dollar earned in the 12 months [that] ended on June 30 [2014].” Of the 60 U.S. firms in Bloomberg Intelligence's E&P index, which tracks U.S. exploration and production companies, only seven, or 12%, made a profit during that period. Yet, these companies collectively incurred $190.2 billion in debt based largely on an expectation of elevated oil prices. 4

1 Murtaugh, “Oil Import Decline to U.S. Revealed by Louisiana as Truth.” November 5, 2014, www.bloomberg.com. 2 PricewaterhouseCoopers, “Economic Impacts of the Oil and Natural Gas Industry on the US Economy.” Energy API, 2013, www.api.org.

3 Ro, “The Middle East Has a Huge Advantage in the Global Oil Market.” Business Insider, May 2014, www.businessinsider.com. 4 Loder, “Drillers Piling Up More Debt than Oil Hunting Fortunes in Shale.” Bloomberg, September 2014, www.bloomberg.com.

THE IMPACT OF OIL PRICES ON U.S. REAL ESTATE MARKETS

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