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Southwest Economy, Fourth Quarter 2020

Energy Woes to Weigh on Houston Recovery, Local Economist Says

On the Record: A Conversation with Bill Gilmer
Bill Gilmer is director of the Institute for Regional Forecasting at the University of Houston’s Bauer College of Business. The institute monitors the Houston and Gulf Coast business cycle, analyzing the impact of oil markets, the national economy and global expansion. Gilmer was appointed as an inaugural energy fellow of the University of Houston in 2015 after serving 23 years at the Federal Reserve Bank of Dallas, where he retired as a senior economist and vice president.
Q. What’s your assessment of the Houston economy?

Like everyplace else, Houston is in COVID shock. With COVID-19 hitting the Houston economy early in the year, the graph of economic activity looks like an upward-leaning fishing pole with the line hanging straight down. Houston lost 300,000 jobs in April, as much of the service sector went into lockdown. While the decline was broad based across industries, there are about nine sectors that are very sensitive to social distancing. These high-contact industries represent 45 percent of the Houston economy and 70 percent of the job loss.

The recovery of lost jobs has been pretty slow. Through September, about 45 percent of total jobs lost in the economy have come back, with the high-contact industries recovering about 55 percent of their job losses. Most of this recovery occurred in May and June. With the surge in COVID-19 during the summer, job growth has slowed, and I am a little afraid we will see a slow slog of growth going forward.

Q. Are you surprised Houston has not declined more, given that both upstream and downstream energy have performed so poorly?

First, let’s talk about the downstream—which includes industries such as refining and petrochemicals. These plants are super-highly automated, and there are simply not many jobs in these plants. In 2015 and 2016, there was a collapse in the price of natural gas. All of a sudden, Texas was a cheap place for hydrocarbons, which is what is used to make plastics.

We had $180 billion in U.S. plastics-related construction projects—and perhaps $50 billion in Houston—which created lots of construction jobs on the east side of Houston. That building boom ended by 2018. But all of that time, while the boom in construction was going on, jobs in petrochemicals and refining were pretty stable.

In upstream oil and gas, we have been hit hard again. If you go back to 2014 and 2015, that was Houston’s 1980s [energy collapse] moment. The fracking bust cost Houston 77,000 jobs in the upstream energy sector. In 2014, Houston jobs in oil and gas peaked at almost the same number of jobs as in 1982.

Jobs collapsed at about the same pace in both periods. By 2018, only about 20,000 of the jobs lost had come back, and then we entered 2019 with many energy companies struggling to attract capital.

The credit crunch within the energy sector renewed the downward pressure on jobs, so by the time COVID-19 hit, the upstream energy sector in Houston was already very lean. We have lost 28,000 upstream energy jobs in Houston since the pandemic began, which is a lot but not near the hit as in 2015–16.

I am somewhat surprised that the Houston economy has not been hit harder than the current data show, but for the reasons just outlined, it is still a reasonable outcome. While Houston is a global center for oil and gas, it also has many industries tied to growth in the national economy.

By my estimates since the 1990s, about 60 percent of the growth in Houston has been driven by the national economy, about 30 percent by the oil industry and about 10 percent by longer-term factors that drive the Texas economy as a whole. These shares have generally been stable over this time.

Q. What is the outlook for commercial real estate in Houston?

It’s pretty dreary. There was a lot of commercial building during the boom, from 2010 to 2014, on the premise of continued strong energy markets. In 2014, Houston added about 8 million square feet of space. When the boom ended, despite the job loss in energy, Houston added an additional 12.9 million square feet in 2015 and 6 million more in 2016.

The office vacancy rate was 10.3 percent in 2014 and rose to 20.2 percent by 2017 and basically has been stuck at around 20 percent until this year when COVID and the weakness in energy hit. Now, it is near 23 percent. I have no idea how we are going to fill that office space, and it’s certainly not going to happen in a short amount of time. It’s 20 years of overhang. We had a similar overhang in the 1980s; eventually space became so cheap companies bought it up and moved into Houston.

Bill Gilmer

By my estimates since the 1990s, about 60 percent of the growth in Houston has been driven by the national economy, about 30 percent by the oil industry and about 10 percent by longer-term factors that drive the Texas economy as a whole.

Moving to retail space, brick-and-mortar retail in Houston has been incredibly cautious over the past few years with all of the online growth. Almost all of the retail development has been in the Grand Parkway [a ring, running from west to north suburban Houston] following new residential expansion in this area. It’s a safe bet.

Industrial has an east-west split. The east side has seen a boom due to the petrochemical expansion from 2015 to 2017—essentially making plastic pellets that are later used by firms to make plastic products. Warehouses were built where these pellets were bagged, stored and put in containers to be shipped off around the world.

On the west side of town, the history of moving goods from China to the Houston area is that they are shipped through [the ports of] LA/Long Beach then moved by train to Fort Worth, where they are broken down for distribution throughout this entire region, including Houston.

Over the last several years, there has been a lot of focus by e-commerce on the breakdown and distribution of these goods once they arrive in Houston. Lots of warehouses have been built at major highway intersections to speed distribution within the metro area. Industrial occupancy and rents held up until about a year ago.

The problem is that we have continued building even as demand has dropped off. This year, about 21 million square feet of industrial space was brought onto the market, and only about 8 million square feet was absorbed. There is still about 16 million square feet in the pipeline.

Q. The Port of Houston is a major feature of Houston’s economic profile. How does the more-pessimistic outlook for U.S. oil and gas production affect the trade through the port?

It is the second-largest seaport in the U.S. based on tonnage—almost all of that tonnage has been either imports or exports of oil and gas or exports of oil and gas products. Beginning around 2016, petrochemical exports were the main source of growth. The expansion phase wound down recently; the growth shifted to oil exports after the [President Jimmy] Carter-era ban on oil exports was lifted in 2015.

One area that is apart from the energy sector is the containerized cargo business. The Port of Houston is No. 6 in container traffic. LA/Long Beach is by far the leader, with about one-third of all the container traffic, versus Houston, with 6.3 percent of national volume.

With the winding down of the boom in petrochemical exports and a recent decline in oil demand due to COVID, the short-term outlook for the port is not good. On the container side, however, labor issues and strikes at the ports of LA/Long Beach have pushed some shipments to Houston. For example, Walmart put in a huge facility in the Port of Houston strictly as a hedge against problems in LA/Long Beach.

Q. What is your outlook for the Houston economy for 2021?

COVID has caused a very mixed bag of economic indicators, with many service industries hit hard, but overall consumer spending is holding up. The situation is due to large government support payments that don’t directly impact GDP (gross domestic product) growth but do impact personal income, which has continued to grow this year.

If I assume that the COVID crisis will essentially be over by the middle of 2021, with widespread vaccination available by mid-year, we will be recovering like we have done in the past following a moderate recession.

Overall, relief from social distancing and public health orders should allow the net decline [in jobs] from February 2020 to June 2021 to be on pace with most recessions since World War II.

In the middle of 2021, Houston jobs will likely be down about 3 percent from pre-COVID, and we will progress forward in recovery over the next five quarters. Not a great spot to be in, but we can deal with it. Houston will initially grow slowly in the post-COVID period because the energy sector will not likely come back until a year after the recovery begins. Then, 2022 should be a big year for job gains in Houston, slowly moving back to trend after that.

Southwest Economy is published quarterly by the Federal Reserve Bank of Dallas. The views expressed are those of the authors and should not be attributed to the Federal Reserve Bank of Dallas or the Federal Reserve System.

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