- While cheaper oil is generally a net positive for commercial property markets, the severe shock that the oil markets have recently experienced is likely going to have an outsized negative impact on many US markets that rely on energy production as a local economy employer and GDP contributor.
- This is not the first oil price collapse – the price collapse starting in 2014 can help illustrate the impact on local commercial property markets. However, there are many differences between the oil price collapse of 2014 and the current one.
- Ten states (Alaska, Colorado, Louisiana, Montana, New Mexico, North Dakota, Oklahoma, Texas, West Virginia, Wyoming) are more energy-concentrated than the rest, and likely more sensitive to the recent oil price decline.
Since early March, the market news cycle has been dominated by COVID-19 updates – and little else. US presidential elections, US-China trade negotiations, and Brexit – issues that once were top of mind and center stage seem so distant now. However, in mid-April a new story garnered the attention of the markets and the media: oil.
What has happened?
On April 20th, oil was selling for less than nothing. In fact, it was selling for nearly negative $40. That’s right, you could be paid to take oil. While this didn’t mean that you could go to your nearest gas station and demand payment for filling up, it was a very significant and unprecedented period for the world’s largest traded commodity market, and a strong signal of the impact that the global slowdown has had on the economy and expectations for future growth.
The US energy industry includes predominantly oil, natural gas, coal, and electricity. However, the first two (oil and natural gas) play dominant roles, given their abundance in the US and wide use in nearly all other industries. From electricity to plastic to synthetic fabrics to pretty much every modern mode of travel – the energy sources that we know as oil and gas, are everywhere in our lives and economy.
Commercial property is no exception. Even though it might not be obvious, these energy sources impact commercial property in multiple ways.
At a very high-level, cheaper oil is generally a net positive for commercial property markets. This is because cheaper energy translates into lower production costs of other goods, and consumer savings which can then be spent elsewhere in the economy. So long as the energy companies that produce and refine the oil are able to stay profitable, the drop in oil prices is not harmful to the economy.
However, when there is a supply and demand mismatch, and the supply of oil exceeds the demand significantly, as it currently does, oil prices fall below the breakeven price that oil companies need to stay in business. This situation is known as an oil glut.
The current oil glut is not isolated in the US, but is much more pronounced here than it is globally, given the US’s ample reserves and highly competitive and productive energy industry. Despite oil producers agreeing on the largest production cut in history, the US energy industry is in for a great deal of stress and an extended period of uncertainty.
The risk that the oil price shock will negatively impact commercial property markets is really at the business level. If the energy companies are able to stay in business, pay their employees, and continue to contribute to their local economies, much of the negative impact should be mitigated from the local commercial property markets. However, many energy companies are not going to be so lucky. As these less-fortunate companies shutter, jobs will be lost and local economies negatively impacted.
While the current market turmoil has rocked oil traders and is stressing energy production firms, the impact on commercial property markets is still to be determined. Apart from the indirect relationship that the price of oil has on commercial property markets, the severity and duration of the oil price collapse are still not known, making it challenging to estimate the first and second order impacts on local economies. Currently the risk appears to be geographically concentrated in population centers that have energy production as a key part of the local economy – however, beyond that, it is too soon to tell.
Brief history lesson
This is also not the first time that the US energy sector has seen glut and price shock. Advancements in hydraulic fracturing (aka “fracking”), helped the US energy producers to recover more gas than ever before in the period following the global financial crisis (GFC). While production ramped up, the price of oil had been holding steady around $100 per barrel, until the summer of 2014 when it began to fall. WTI fell nearly 70% over a two year period, before it began its recovery. While the price fell, many energy companies went bust and those that survived took rigs offline and decreased production.
Impact to commercial property markets?
While less significant decreases in the price of oil are positive to the economy as a whole, the precipitous price declines seen in the 2010’s and again this year are cause for concern in those local markets which have outsized exposure to energy companies.
We wanted to get a better understanding of how the current oil price collapse might impact different areas of the commercial property market. To do so, we estimated the contribution of the energy sector to gross domestic product (GDP) across metropolitan statistical areas (MSAs) at the end of 2013 – before the price collapse. Grouping the top 20 MSA’s by energy industry contribution to GDP, we created a proxy group for high energy exposure markets. Using this energy market proxy, we are able to see how energy markets performed compared to the broad market (all other MSAs not included in the energy proxy) over the period August 2014 to January 2016.
The MSAs that make up the energy proxy include and 2013 energy portion of GDP (in parentheses):
- Alaska: Fairbanks (9%)
- Colorado: Greeley (31%)
- Louisiana: Shreveport-Bossier City (18%), Houma-Thibodaux (17%), Lafayette (17%)
- New Mexico: Farmington (30%)
- Oklahoma: Enid (32%), Oklahoma City (20%), Tulsa (10%)
- Texas: Midland (51%), Odessa (41%), Laredo (31%), San Angelo (29%), College Station-Bryan (23%), Longview (22%), Victoria (15%), Wichita Falls (10%)
- West Virginia: Beckley (17%), Charleston (11%)
- Wyoming: Casper (14%)
From this high-energy exposure proxy, we are able to see that during the 6 quarters when the price of oil was falling, total market activity in the energy markets drop with the price of oil. The total number of transactions completed, the total square footage traded, and the total dollar volume, all decline in the proxy energy market but stay flat or increase in the broad market (non-energy market). Additionally, the energy market proxy shows more frequent negative month-over-month price changes in median price per square foot transacted – which also shows up in the overall sideways moving pricing. During this same time, the broad market median pricing increased by nearly 5%, while median pricing in energy markets increased by only 3%.
Turning attention to the differences across property types, there is a noticeable drop off in total transactions and square footage transacted across the four main property types observed (Industrial, Multifamily, Office, Retail) during the start of the energy price decline. Industrial, Multifamily, and Office all had local lows in February 2015, when the price of oil finished its initial fall and started to have a partial recovery before falling again. At the same time pricing for Retail, on the other hand, was improving before peaking around April 2015.
Where’s the risk now?
To see where there is the greatest risk, we look at the current energy exposure by state and MSA. Using the relative contribution that energy (approximated by mining, quarrying, and oil and gas extraction) makes to each state by employment and GDP, we can see that the majority of the energy risk for commercial property markets is concentrated in 10 states. The top 10 states are: Alaska, Colorado, Louisiana, Montana, New Mexico, North Dakota, Oklahoma, Texas, West Virginia, Wyoming.
These top 10 states employ 453k energy related workers (65% of US energy workers) and contribute $237 billion in national GDP (76% of US energy GDP).
On a more granular basis, the following are MSAs which have large exposures to energy.
Prescott Valley-Prescott, AZ
Grand Junction, CO
Shreveport-Bossier City, LA
Oklahoma City, OK
College Station-Bryan, TX
Houston-The Woodlands-Sugar Land, TX
|San Angelo, TX|
|Wichita Falls, TX|
History vs current
While the 2010’s glut and oil price decline can be a helpful illustration of how oil prices can affect energy-centric markets, it is important to note some of the factors that may contribute to differences between the past experience and the current situation. Some of these key factors include:
Possibly the biggest difference between 2014 and now is the economic backdrop. In 2014, the country was still sore from the GFC, but was in the early phases of a long recovery. Currently, the economy is suffering through a virus-induced contraction and there are many signals that it is the start of a longer and very painful recession. While the full impact of the pandemic has not been felt and cannot be measured, the recent shift in market sentiment from positive to negative is one which may have more immediate repercussions. As lenders shift their attention to risk mitigation and less on volume of origination, underwriting standards will tighten and money will not flow as easily into transactions as before.
The 2014 price decline was approximately $70 which is much greater than the current price decline of approximately $30; however, when looking at the drop in relative terms the situations appear to be much closer both roughly 70%. However, at the time of writing this, the price of WTI still seems to be trying to find a bottom, which could mean that the current drop is more severe. Also, the starting point of $50 per barrel is much closer to the breakeven price that producers need in order to stay profitable – meaning that there was much more of a buffer during the last glut than there was at the start of this one.
Rig counts were trending upward at the start of the 2014 price drop. It took nearly four months before rig counts reversed their upward trend and started falling in early 2015. It took nearly 8 months for the rig count to halve from roughly 2k active rigs to 1k active rigs. This time around, the rig count has halved about twice as fast – there were 793 rigs in the US at the start of March and 465 by the second to last week of April.