November 30, 2005

Eleventh District economic activity accelerated from mid-October to mid-November. The energy industry continues to clean up from the hurricanes, but activity is strong. Manufacturing activity rebounded, and demand for business services was up. Construction and real estate markets steadily improved, and retail sales were stronger than expected. The financial service industry reported little change in activity. Dry weather stressed ranching conditions but boosted cotton yields.

Business contacts were generally more optimistic about the outlook for economic growth than they were at the time of the last report, mostly because energy prices have subsided and are not showing signs of seriously disrupting economic activity.

Prices
Although prices for most energy products have drifted down since the last Beige Book, most contacts continue to express concerns about high utility and shipping costs. Prices have increased for some products and services, but many contacts say stiff competition is limiting price increases. Some manufacturers report that they have scheduled price increases for January 2006, and a few retailers confirm that they expect vendor price increases in the first quarter of 2006, but many retailers say stiff competitive pressures will limit their ability to increase final selling prices.

Crude oil prices weakened steadily since mid-October. The wholesale price of heating oil and diesel tended to follow the price of crude down, although strong diesel demand and the approach of the winter heating season kept distillates from falling as much as gasoline. Domestic demand for crude oil increased in October after plunging in September. Still demand remains weak at about 5 percent below normal. Crude inventories have been building and are now about 10 percent above normal. Distillate and gasoline demand bounced back sharply in October, and inventories are near normal levels. Imports of refined products are 70 percent higher than this time last year.

Natural gas prices have moderated from $14 per million Btu to below $12. Natural gas production in the Gulf of Mexico has come back slowly, but a combination of unseasonably warm weather and slow recovery of the petrochemical industry has kept natural gas inventories near normal levels. Industry contacts say that the first cold snap is expected to push natural gas prices back up.

Prices have increased significantly for basic petrochemical products, including polyethylene, acrylic, polypropylene, polystyrene, and PVC. Spot prices for caustic soda have doubled in recent weeks. Ethylene prices have risen sharply, as supply problems on the Gulf Coast were compounded by plant and pipeline outages in Canada. Transportation problems continue to plague the Gulf Coast with contacts complaining that they have difficulty arranging delivery if they can locate supply. Most commodity plastics and polymers have built margins to very favorable levels.

Prices are up for paper, clay, minerals, steel and aluminum. Contacts say copper prices are "setting records every other day." The high-tech industry reports price increases for some high-end products. Trucking firms say fuel surcharges and strong demand have pushed up shipping charges by roughly 15 to 20 percent. Rail shipping charges are also higher.

House prices increased at a slightly faster pace in recent weeks. Builders say they are concerned about higher prices for construction materials and fuel surcharges. There continued to be reports that investors are contributing to home price increases in Austin and San Antonio.

Legal firms report a 2 to 3 percent increase in fees, driven by rising health insurance and professional liability insurance costs. The accounting industry reports that salaries are rising, but it is more difficult to pass costs to clients.

Labor Market
There was little change in labor markets. There are scattered reports of hiring and shortages of some types of skilled workers, such as auditors, security technology workers, truck drivers and workers to supply the energy industry. There were some reports of layoffs in manufacturing, although there were also reports of hiring. The airline industry continued to report downward pressure on wages.

Manufacturing
Manufacturing activity rebounded, with ongoing recovery of facilities shut down after the hurricanes. Refinery capacity utilization on the Texas and Louisiana Gulf Coast has increased to 75 percent in early November from 40 percent in early October. Three refineries are still down, one is restarting, and two are operating at reduced rates.

The chemical industry continues to clean up from the hurricanes. Polyethylene production was hit hard by the hurricanes and continues to be disrupted with further outages and a transportation tie-up on the Gulf Coast. Supplies were tight prior to the storms, and inventories are now 10 days below normal. Roughly 16 percent of ethylene capacity remains down. Despite very high shipping costs, chemical imports are beginning to make their way into the U.S., responding to high prices. Contacts complained of chaotic shipping conditions and say trucks are in short supply.

Demand remained vibrant for most construction-related materials, such as lumber, cement, brick and glass. Contacts credited favorable weather and continued strength in residential construction. Demand was particularly strong for ready-mix concrete, and one contact reported meeting demand through cement imports from overseas, including Thailand, Korea, Europe and China. Inventories were low for many construction-related products.

High-tech manufacturers reported continued good growth in sales and orders. There was a slight pick up in the growth of orders for products containing semiconductors, such as digital televisions, music devices, DVD players and cell phones. There were reports of lean inventories for some products.

Paper producers said orders picked up over the past 30 days and were better than expected. The increase in activity was partly the result of competitors going out of business. There has been little change in the overall demand for metals. Some producers of primary metals reported a strong increase in orders to offset production lost due to hurricane damage in Louisiana and a labor dispute in Texas. There has been scattered softness in demand for food products, and inventories are up for some products. Apparel producers report stronger demand.

Services
Service sector activity increased. Temporary employment firms reported an unexpected and significant increase in billable hours. New business was primarily for call centers (some relocations from overseas), legal services, support services, auditing and tax services and information technology services (especially internet security) employees. Orders remained strong to supply workers to light industrial and steel manufacturers, telecom service firms and the oil and gas industry.

Legal firms reported good demand for their services. Litigation activity has slowed a bit, but transactional and real estate work is up. Accounting firms say activity is still strong, particularly for audit services, and many firms are expanding.

Transportation firms continued to report strong activity but are less optimistic than a month ago because of high fuel costs and expectations for slower economic growth. Demand remains strong for trucking and rail, and contacts say the industry is operating at capacity. One manufacturer reported that rail capacity issues were limiting expansion into new markets. Airlines reported stronger demand for air travel, partly stimulated by high gasoline prices boosting the cost of car travel. Some reductions in capacity have allowed air carriers to increase prices.

Retail Sales
Retailers reported good sales growth, although some noted that post-hurricane sales are hard to interpret given the influx of evacuees into the region. Still, sales have been better than expected, and contacts have become more optimistic about the outlook for holiday sales. Auto sales were mixed. Demand is strong for foreign cars, but sales of domestic vehicles are down over 30 percent. Domestic car makers are offering new incentives and they expect sales to pick up.

Construction and Real Estate
Real estate markets steadily improved over the past six weeks. Strong demand buoyed residential home construction. Existing home sales were strong in most major metros. Only Dallas/Fort Worth reported slower sales than expected. Hurricane evacuees are still stimulating demand for apartments, but contacts say this is perceived as largely temporary. While rental rates on new properties in Houston were reportedly up, Dallas rents were flat to down.

Demand for office space continued to pick up in major metropolitan areas, and rental rates edged up in Houston and Austin. In Dallas, however, some respondents expressed unease over increased construction in some Dallas markets despite a large amount of vacant space overall. Demand for industrial space in Dallas and Houston rose at a faster pace over the past six weeks.

Financial Services
Financial service activity is little changed according to contacts. Competition for loans remains fierce, but lending is strong and credit quality is good. There are reports of a pick-up in merger and acquisition activity. While the recent law change led to a flurry of personal bankruptcies, respondents said the write-offs are less than feared and should be only a temporary hit to earnings and uncollectible loans.

Energy
Energy activity continues to be strong, although the industry is still assessing hurricane damage. Exploration in the Gulf of Mexico has been reduced significantly by the storms, but activity has shifted elsewhere. The industry reports shortages of cement and sand. Capacity is being added aggressively in some lines of the oil service industry. The rig count has been unchanged in recent weeks, but an estimated 200 new rigs are under construction, with about 50 for offshore use. These will take from months to years to bring online. Contacts expressed concern that there would not be skilled crews available when they come on line and said training programs will be necessary to be sure there are adequate skills and labor to operate additional capacity. The industry is increasingly looking abroad for skills and labor.

Agriculture
Extremely dry weather stimulated better than anticipated cotton yields, but stressed pasture conditions, forcing ranchers to purchase supplemental hay and protein feed to maintain herds. Producers are very concerned about low crop prices and high costs for many inputs, including natural gas, fuel, chemicals, fertilizers and seeds. Many corn producers are expected to turn to another crop next year. Contacts in the banking industry say it will be difficult for several farm operations to be profitable at current crop prices and fuel costs.