August 2009

The U.S. economy appears to be turning the corner toward growth and recovery, and oil prices have bounced back to near $70 per barrel. The Houston economy reacted to this news with fewer job losses in June and July. The energy picture remains mixed, however, as natural gas prices have slid to the lowest levels since 2002. The local Purchasing Managers Index is telling us that the improvement in Houston is not keeping pace with the U.S. Natural gas markets will continue to weigh heavily on local recovery.

Retail and Auto Sales
Retail activity continues to be soft in Houston, with sales alternately described as “weak,” “an uphill struggle” and “very disheartening.” A rough summer is turning into an equally rough fall, and concern is growing about the prospects for the approaching holiday season. Department stores, specialty stores and furniture stores all fell short of their own low expectations in recent weeks. Even the sales-tax holiday failed to stir up much consumer enthusiasm.

July data on auto sales, measured before the cash-for-clunkers program, indicated auto sales were still running a poor 31 percent below the level of last year.

Housing
Low mortgage rates, still-low Houston home prices and a tax credit for first-time homebuyers have been good for local single-family home sales. New home sales were up slightly in July compared with 12 months earlier, although local home construction is still quite weak. Single-family permits have improved rapidly every month this year but are still down 10 percent over 12 months and 28 percent over the past 24 months. The rate of decline in existing home sales slowed sharply in July, falling by only 5.1 percent over 12 months. The year-to-date decline is near 20 percent. Existing home prices remain stable, and inventories improved to near a six-month supply at the current rate of sale.

Energy Prices and Refining
The price of light sweet crude strengthened to near $70 per barrel in recent weeks. The gain was primarily driven by the news of the improving U.S. and European economies and the prospect of increased demand. Poor fundamentals continue in the crude market, with high inventories and little seasonal demand, but expectations of better demand dominated.

Natural gas prices have fallen under $3 per thousand cubic feet for the first time since 2002. High production levels, weak demand, rising inventories and continued LNG imports weighed heavily on prices. Inventories are 20 percent above normal, reaching the highest levels ever, and storage capacity could fill before winter. New technology, especially in shale fields, is pointing to greater supplies and much cheaper gas over the next several years.

Demand for oil products has been growing since June and is up about 3 percent since mid-July. However, demand remains about 10 percent below the peak in early 2008. Apart from some seasonal weakness in gasoline and strength in heating oil, product prices largely followed the price of crude oil upward. Inventories of products remain high, especially diesel and heating oil. Refiners cut production to 84 percent of capacity, a response to poor margins and high inventories.

Petrochemicals
The demand for petrochemicals varies according to product. Producers of products that sell widely into manufacturing or auto-related markets (caustic soda, specialty chemicals and polymers) cited a jump in demand in recent weeks. Manufacturers of vinyl products—especially PVC—said the improvement in housing markets (for pipe, siding, window frames, etc.) was not yet visible in domestic sales, and they are still waiting for significant stimulus in infrastructure to spur sales of larger pipe. Vinyl and polyethylene experienced sharp growth in export demand from Europe and Asia. The prices of a number of oil-based products rose along with the price of crude.

Oil Services and Machinery
The domestic rig count continues to rise, up by over 100 rigs from the trough in mid-June. The improvement has been driven primarily by oil-directed drilling. The mix of gas- and oil-directed drilling is normally 80-20 but is now 70-30. The pickup in the rig count has not been enough to change the general status of the industry, which continues to operate manufacturing facilities at 50 percent capacity for many durables, like bits or drill pipe. Consolidation and rationalization of operations continue to reduce headcount. The outlook is one of growing pessimism about natural gas prices, raising questions about the durability of the current growth in drilling activity if natural gas prices continue to deteriorate.