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Houston Beige Book
An Update on the Houston Economy
March 2006

Bill Gilmer reviews recent economic conditions in Houston.

Energy is clearly beginning to move the Houston economy again. Oil and gas extraction jobs were up 5.9 percent in 2005, and manufacturing jobs rose 3.3 percent. The Houston Purchasing Managers Index jumped to 67.9 in January, its highest level since the measure’s inception in 1995. Downtown real estate remains distressed, but energy companies are taking space again. Energy-driven corporate relocations are boosting an already healthy housing market.

Retail Sales
Houston retailers reported strong January sales, perhaps partly the result of finally closing out the holiday season with the redemption of gift cards sold in December. But the strong start to 2006 turned soft in February, as department stores and discounters struggled to stay on plan. Upscale stores continue to report very good sales, while furniture stores complain of continued weakness.

Real Estate
Energy is stirring the pot for downtown real estate, with at least one major office building acquisition by an energy company and others rumored to be in the works. However, energy mergers and downsizing are also returning space to the market, so the net change remains uncertain. At present, Houston still has too much space, and rents in the central business district are depressed. Citywide, at year-end Houston saw healthy gains in absorption, largely in Class A space.

Apartment absorption also picked up in late 2005, as many hurricane evacuees moved from hotels. Class B space seemed to be the major beneficiary, based on absorption and improved rents.

After a record year for both new and existing home sales, the housing market accelerated in early 2006, thanks to an improving job market and corporate relocations. January might have been helped by warm weather, but that can’t account for the fact that existing home sales were up 16 percent over last year. New home sales were up 23 percent.

Energy Prices
Crude oil prices were near $63 per barrel in early January and have ranged from $58 to $68 over the past two months. The primary factor driving prices has been geopolitical situations that threaten deliveries to a very tight market: militants in Nigeria, U.N. sanctions against Iran and attacks on Saudi oil facilities. A much warmer than normal winter pushed natural gas from $9 per thousand cubic feet to below $7. Inventories are currently 48 percent above their five-year average. Unless the weather turns extraordinarily cold soon, we will go into spring and summer with record-high inventories.

Refining and Petrochemicals
Weak gasoline and heating oil prices have pulled refining margins down sharply, although even negative margins rebounded to five-year average levels by the end of February. Some refineries briefly cut back production for economic reasons. Margins should strengthen, however, as gasoline prices bounce back over the summer. Operating rates on the Gulf Coast are declining as the industry begins the spring turnaround season. Many maintenance turnarounds will be longer than normal because last fall’s hurricanes resulted in the postponement of so much work.

Prices of petrochemicals (such as ethylene, polyethylene, polypropylene, PVC and chlorine) have given ground this year but remain well above prehurricane levels. Downward price pressure has resulted from precautionary stocking of imports following the hurricanes, seasonal weakness and domestic production’s return to normal levels. Product margins have been under pressure from price declines, but this has been offset by the declining price of natural gas feedstock.

Oil Services
The domestic drilling market remains extremely strong, with the rig count adding about 75 rigs since early January. The increase is partly the addition of some foreign rigs and some hurricane-damaged rigs returning to service, but it’s primarily new rigs going to work. Another 250 rigs are under construction, with some delivery delays caused by shortages of components. The key driver of activity is the same: land-based drilling directed toward natural gas.

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