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HoustonBusiness A Perspective on the Houston Economy FEDERAL RESERVE BANK OF DALLAS • HOUSTON BRANCH Houston’s Midyear Outlook: Positive Growth Ahead Factors have fallen into place for a resumption of job growth this year and for potentially strong job growth next year. But there are substantial risks to job growth if current positive trends falter. H ouston’s economic patterns have largely followed the nation’s for the past three years. A broad view of Houston’s performance can be seen in the coincident index of economic activity. This index is based on employment, unemployment rates, real wages and real retail sales, and its movements should reflect the broad path of the local economy. Figure 1 shows the index and the slowdown that began in April 2000. Unlike the nation, which recovered from recession in late 2001 but then saw the recovery turn sluggish, Houston experienced declines that were more modest but that have lingered since early 2001. Houston is waiting for three potentially positive factors to weigh in and spur local growth. First, prospects brightened at the beginning of 2003 with higher oil and natural gas prices and a cold winter. The rig count, which had already • JULY 2003 begun to increase as natural gas prices reached $4 per thousand cubic feet and oil approached $30 per barrel, accelerated through the winter and into 2003 (Figure 2 ). The rig count is currently 32 percent higher than its most recent trough, set in August 2002. Despite increased drilling activity, energy prices have remained relatively firm, and the sector has been adding jobs since February. A second factor is the recent and dramatic weakening of the dollar relative to our trading partners. Weighted against a basket of world currencies, the dollar has declined 10 percent since last year, wiping out all of the dollar’s runup since 2000. Finally, Houston is waiting for a stronger national economy to stimulate local growth and provide further support for energy prices. This article looks more closely at the national economy, energy markets and the tradeweighted value of the dollar and assesses their effects on local job growth for the rest of 2003 and 2004. Factors have fallen into place for a resumption of job growth this year and for potentially strong job Figure 1 Coincident Index of Economic Activity for Houston, 1981 to Present Figure 3 Retail Sales Drive Economy; Industrial Production Is a Drag Index, July 1992 = 100 118 Index, 1997 = 100 Billions of real dollars 174 180 172 116 Industrial production 170 160 168 114 166 140 112 120 164 162 110 160 108 100 158 Real retail sales (six-month moving average) 106 156 80 154 104 152 2000 60 ’81 ’83 ’85 ’87 ’89 ’91 ’93 ’95 ’97 ’99 ’01 2001 2002 2003 SOURCES: Census Bureau; Bureau of Labor Statistics; Federal Reserve; authors’ calculations. ’03 SOURCE: Authors’ calculations. have dominated U.S. economic growth in recent years. One is the endurance of U.S. consumers and their willingness to push up real retail sales at a near 5 The National Economy percent annual rate. The other If you focus on real ecois the double-dip behavior of nomic activity, it is difficult to the U.S. industrial sector. Alargue that much has changed though the most recent data recently in the U.S. economy. offer hope of recovery — a 0.1 Sluggish growth remains the percent increase in industrial norm. Real gross domestic production and a purchasing product (GDP) growth in the managers index that has pulled first quarter of this year was at back to near breakeven — it is a 1.4 percent annual rate, and too soon to declare that the the most recent employment economy has reversed course. data indicate little acceleration Another sharp dichotomy in in the economy since. Growth the national economic data — since the recession ended in and perhaps another way to the last quarter of 2001 has look at the same issue — comes averaged only 2.6 percent. in the current difference beFigure 3 shows two of the tween real economic activity most important trends that that remains sluggish and various financial Figure 2 and expectations Houston Mining Employment and Drilling Activity measures that have in the United States turned positive. Real Thousands of employees Number of rigs economic activity 1,400 66 Employment indicators such as 1,300 65 average weekly fac1,200 64 tory hours, vendor 1,100 63 performance, new 1,000 62 orders and initial un900 61 employment claims 800 60 have all been flat or 700 59 negative, while con600 58 sumer expectations, 500 57 Drilling activity stock prices, interest 400 56 rate spreads and ’89 ’90 ’91 ’92 ’93 ’94 ’95 ’96 ’97 ’98 ’99 ’00 ’01 ’02 ’03 money growth have SOURCES: Bureau of Labor Statistics; Baker Hughes, Inc.; seasonally adjusted growth next year. But there are substantial risks to job growth if current positive trends falter. by authors. 2 consistently provided good news in recent months. Two factors probably explain the difference in news from the real economic and financial arenas: robust productivity growth and a strong dollar. Productivity growth simultaneously increases profits, raises stock prices and improves the general business outlook while restraining weekly hours worked and boosting initial claims for unemployment compensation. Productivity also has allowed real wages to grow, underpinning retail consumption. The strong dollar spurs imports, discourages exports and produces a disproportionate negative impact on domestic goods sectors. Resumption of stronger U.S. growth, then, depends on two things: corporate balance sheets and business confidence rising to the point where we see robust business investment, and a continued decline in the tradeweighted value of the dollar, which has fallen steadily throughout 2003 (Figure 4 ). Table 1 shows estimates of U.S. economic growth in 2003 and 2004 from the Federal Reserve’s latest Monetary Policy Report to the Congress. The figures are an average of estimates submitted by members of the Board of Governors and Figure 4 Trade-Weighted Value of the Dollar, 1990 to Present from a seasonally above normal. This was when adjusted peak of the price briefly fell under $2. 135 1,272 working rigs For the current cycle, stor130 (see Figure 2 ). By age more than price again 125 August 2002, 16 seems to drive drilling decimonths later, the sions. Despite high natural gas 120 number of rigs had prices in 2002, drilling was 115 fallen to 807, a 37 slow to pick up. Prices moved 110 percent decline. The back over $3 per thousand 105 setback lasted two cubic feet in March and only 100 months longer than briefly fell under $3 through the previous rig the summer. Drilling did not 95 count drop in 1998 – bottom out and begin to turn, 90 ’90 ’91 ’92 ’93 ’94 ’95 ’96 ’97 ’98 ’99 ’00 ’01 ’02 ’03 99, but it was mildhowever, until the price firmed er; the 1998 – 99 near $4 in the second half. SOURCE: Federal Reserve Bank of Atlanta; seasonally adjusted by authors. downturn reached Despite excellent cash flows, 48.3 percent from producers refused to be conpeak to trough. vinced that high prices would Reserve Bank presidents, and When the rig count began persist, probably because high they are quite optimistic. They its latest descent in April 2001, gas inventories were flashing a agree with assessments of natural gas prices were in the strong caution signal: Before many other analysts who view range of $4 – $5 per thousand projects are completed, the recent financial data, especially cubic feet, $3 for much of the price could collapse. Caution the rebounds in corporate following summer, $2 by fall by producers has been a hallearnings and the stock market, and briefly under $2 in Octomark of this drilling cycle, as a signal that strong growth ber. Still, for all of 2002, daily measured not just by the numis ready to return in the second spot prices at the Henry Hub ber of projects undertaken but half of 2003. The Fed figures averaged a healthy $3.36. also by producers’ unwillingshow real GDP growth at 2.5 to Drilling activity in recent ness to undertake risky or ex2.75 percent in 2003. With years has reacted more to gas pensive projects. probable GDP growth near 1.5 storage data, perhaps as a preAll warning signals disappercent for the first half of the dictor of gas prices, than to the peared briefly last winter, howyear, this implies a rate of 3.5 gas price itself. Figure 5, for ever, when storage fell 50 perpercent or better in the second example, shows storage levels cent below the five-year average half, possibly accelerating to during 2000 – 01 compared with in March and April and spot more than 4 percent in 2004. their average levels over the prices briefly moved over $10 Given the long pause in growth previous five years. The price per thousand cubic feet in Febsince early 2001, even this optisurged to double digits during ruary. So far this year, spot mistic estimate would leave extraordinarily cold winter prices have averaged $5.91, significant slack in the econweather, and by late March and and the domestic rig count omy, keeping the door open to early April 2001, incontinued low inflation and ventory was 33 perlow interest rates. Figure 5 cent below average. Deficit or Surplus of Natural Gas Refill of this storage, Upstream Energy (Relative to 5-year average, October to October) however, was exIn April 2001, drilling began Percent 20 tremely rapid, and by to decline in the United States late July 2001 10 inventories 2000–01 Table 1 0 were back on Federal Reserve Economic Projections – 10 track and equal Percent to the five-year 2002–03 – 20 2003 2004 average. By – 30 Real GDP growth 2.5–2.75 3.75–4.75 October and Inflation 1.25–1.50 1.0 –1.50 – 40 the beginning Unemployment rate 6.0–6.25 6.0–6.25 of the heating – 50 NOTE: Changes are fourth quarter to fourth quarter. The central tendency is season, storage reported here. Inflation figures are based on personal consumption – 60 was 8 percent deflator. Oct. Dec. Feb. Apr. June Aug. Oct. Index, 1995 = 100 SOURCE: Monetary Policy Report to the Congress, July 15–16, 2003. 3 SOURCES: Energy Information Administration; authors’ calculations. Figure 6 Drilling Activity in Gulf of Mexico, 1980 to Present Number of rigs 250 200 150 100 50 0 ’80 ’82 ’84 ’86 ’88 ’90 ’92 ’94 ’96 ’98 ’00 ’02 ’03 SOURCE: Baker Hughes, Inc. continued to surge through May. Signs of producer caution have persisted, however, as the number of rigs working in the Gulf of Mexico has remained below 110. Gulf operations provide a good example of the complex and risky ventures operators have continued to avoid (Figure 6 ). In 2001, Gulf drilling averaged 148 rigs. This year’s count has yet to rise from 2002 lows. The last two months have seen a flattening out and pause in the number of active U.S. rigs. Allowing for seasonal factors, there has actually been a small decline in drilling. This pullback coincides with a sudden and unexpected rapid refill of natural gas inventories. April figures showed gas storage 50 percent below the five-year average; by early July, inventories were only 15 percent below the norm. Cool weather in the Northeast and Midwest resulted in a series of record injections into gas storage. Although the gas price has remained at extremely profitable levels near $5 per thousand cubic feet, suddenly the storage indicator light is again flashing yellow. Producers quickly applied the brakes in fear that this could be 2000 – 01 all over again. What happens ahead? Many consulting firms, investment researchers and oil company analysts believe there is a fundamental shortage of natural gas reserves and production capacity in the United States and that recent high prices simply reflect too little investment in domestic exploration in recent years. Even if this is true, a mild summer could mask this shortage and bring lower prices, just as the extraordinarily cold winter of 2002 – 03 may have exaggerated it. Three months remains to close the 15 percent storage deficit before the heating season begins on Oct. 1, and continued rapid refill of storage could easily take a significant bite out of the domestic rig count. Alternatively, an August heat wave, pushing up air-conditioning loads in the Northeast and Midwest, would signal more increases in drilling activity. Either way, a significant piece of the Houston economy now depends on this summer’s weather. Downstream Manufacturing Many Gulf Coast industries are built on the premise that natural gas is a surplus commodity that sells at a substantial discount relative to oil. Important industries like metha4 nol, ammonia and the olefins depend on cheap natural gas feedstocks. These industries face severe financial distress when natural gas priced at $5 or more per thousand cubic feet now sells at an energyequivalent premium to oil at $30 per barrel. Many facilities are cutting back sharply on production, some are closing temporarily, and others are announcing or accelerating permanent closures. Global competitors to the Texas and Louisiana petrochemical industry generally rely on oil to produce petrochemicals, and historically cheap gas has provided an important cost advantage to U.S. plants. Now oil has the advantage, and one of the most important Texas export industries finds itself at a significant competitive disadvantage vis-à-vis the rest of the world. Olefin plants along the Gulf Coast are currently operating at minimal levels, hurt by a lack of export markets and weak demand at home. This is not the first time feedstock prices have risen this high, a fact that has led to widespread speculation that the days of cheap, surplus natural gas in the United States may be over. If this is true, it represents a fundamental threat to much of the Gulf Coast’s industrial base. While the announced closures so far have been confined to older facilities, no one is currently betting on the future of the industry, and investment has fallen to very low levels. This is seen in the low number of hydrocarbon-processing projects announced on the Gulf Coast since the recession began in 2001 (Figure 7 ). The few new projects are largely confined to more profitable refining, with little or no interest in petrochemical expansion. Excess capacity, no prof- Table 2 Employment Growth in Houston a strong second half that must overcome the Total new jobs weakness Houston exPercent (in thousands) perienced in the first 2003 2004 2003 2004 half, including about Scenario 1 1.04 1.95 22 41 2,000 net lost jobs yearScenario 2 1.2 2.3 26 49 Scenario 3 .56 .43 12 9 to-date. The second scenario represents all NOTE: Changes are fourth quarter to fourth quarter. the pieces falling into SOURCE: Authors’ calculations. place for Houston. It produces even more Looking Forward growth for the current year and A simple model of the return to Houston. A realistic predicts more than 25,000 net Houston economy provides look at the three key driving new jobs, enough to regain all insight into the prospects for factors for Houston, however, of the employment lost since employment growth. It examshows significant risks to a April 2000. The final scenario ines the forces that most influquick return to normal or even represents a return to the stagence this region’s economy: the faster job growth. Natural gas nant growth seen since midU.S. economy, energy markets storage levels are approaching 2001, when the national econand the value of the dollar. their five-year average, which omy was in recession. Should Table 2 shows the outcome could signal cooling in the this occur, Houston would of three possible scenarios. The energy sector. Timing the comlikely still see positive growth, first assumes that growth in ing upturn in the U.S. economy but closer to 0.5 percent, or energy markets and the U.S. has stumped the experts time 12,000 new jobs, for the cureconomy and weakness in the and again, including this busirent year. dollar continue at current rates. ness cycle. Productivity has The main differences in the The second, more optimistic increased in the industrial secmodel’s projections do not scenario assumes that the rig tor, which translates into appear in 2003 but rather in count increases, the dollar slower job growth. Finally, the 2004. The reason lies in what weakens substantially more dollar has strengthened somehas already occurred so far this and the U.S. economy strengthwhat against its trading partyear with the expanded rig ens beyond its current pace. ners in recent weeks. Even if count and falling dollar. The The third, more pessimistic scethe dollar’s value simply stays first scenario predicts a return nario assumes that the rig at current levels, the weakento more normal growth rates, count reverses, the U.S. econing trend of the past year has near 2 percent, beginning next omy slows and the dollar rebeen broken, at least for the year; this amounts to about gains strength. time being. 41,000 new jobs. The more The first scenario provides A best guess for job growth optimistic second scenario prean annual growth rate of just in Houston the rest of this year dicts that by the end of 2004, over 1 percent, or 22,000 net probably falls somewhere Houston would enter a period new jobs in the metro area, for between the low and middle of growth approaching that all of 2003. This translates into scenarios — less than 1 percent, seen during much perhaps near 18,000 jobs. Next of the 1990s, closer year’s prospects could be much Figure 7 New Hydrocarbon Processing Announcements in Texas and to 2.5 percent, or better if the U.S. economy Louisiana, 1986 to Present 49,000 new jobs by finally picks up, moving Hous80 year-end. The more ton’s job growth above 2 perAnnouncements pessimistic third cent to about 45,000 jobs. 70 scenario, on the 60 other hand, would — Timothy K. Hopper 50 return Houston to Robert W. Gilmer 2001 growth rates 40 12-month average Hopper is a senior economist in the and further stagna30 Houston Branch of the Federal tion. its and now extraordinary feedstock costs have halted investment in these plants, removing an important source of heavy construction activity from the Texas and Louisiana economies. The possibility of permanently higher natural gas prices could end this construction for good. 20 10 0 ’86 ’88 ’90 ’92 SOURCE: Hydrocarbon Processing. ’94 ’96 ’98 ’00 ’02 ’04 Conclusion It is apparent that job growth will 5 Reserve Bank of Dallas. Gilmer is senior economist and vice president. Houston H ouston’s coincident index of economic activity shows the local economy continuing to tread water through May, with no significant gains or losses. The cumulative declines in the local economy since early 2001 are still less than 2 percent. Advances in drilling, a falling dollar and an improving U.S. economy would give Houston some positive impetus in the second half of this year — if all three remain on a positive track. Retail and Auto Sales It has been a difficult year for retailers, whose sales have trailed expectations by 5 percent or more. Early July seemed to bring improved sales, although promotions remain necessary to drive traffic through the stores. Inventories are now well under control, and costs have been brought into line with job reductions in some cases. Auto sales have also faced a difficult environment in Houston. Sales have lagged throughout 2003 despite numerous manufacturer and dealer incentives. Sales were off 7 percent in June compared with a year earlier and are down 7 percent for the first half of 2003. Real Estate Recent local real estate trends show few surprises. Both new and existing home sales were up strongly in May. Weakness continues in the apartment market, with occupancy rates dragged down by a weak job market and renters drawn by low interest rates to the singlefamily market. The office BeigeBook market is still looking for a bottom, although the rate of decline has slowed. Weakness remains concentrated in the central business district and Galleria areas. Oil and Natural Gas Crude prices remained in a narrow range in recent weeks — near $30 for West Texas Intermediate — and the price of gasoline and heating oil largely followed the price of crude. Supporting oil prices have been low inventories for both crude and gasoline, the start of the summer driving season and substitution of oil for expensive natural gas by industrial users. Natural gas prices weakened in recent weeks, falling from over $6 per thousand cubic feet to near $5. Storage injections proceeded at record levels, trimming the gas storage deficit from 50 percent of the five-year average in March to only 15 percent by early July. Cool weather and reduced air-conditioning loads in the Northeast speeded the inventory refill. Drillers seemed to take note of the storage data, because the rapid climb in the domestic rig count slowed sharply. Exploration did not start to increase last year until every signal was flashing green, and now this one caution light seems to have slowed the advance. International activity remains strong. Canada, hesitant to get started July 2003 this year after the annual thaw, has roared back in recent weeks. Refining and Chemicals Refiners saw margins weaken in recent weeks, probably marking the end of the period of very good profits spurred by last winter’s extreme cold. Profits remained good — comparable with last summer’s — but down sharply from this spring’s earnings. Capacity utilization on the Gulf Coast also fell back from recent months’ highs, partly because of several refinery outages. Pain continues in the petrochemical industry. High natural gas prices have forced gas-intensive users of methanol, ammonia and olefins to cut back. Weak domestic and export demand has further reduced production. The Gulf Coast’s bellwether olefin industry is operating at minimal levels, and the outlook is generally bleak. Prices are falling for ethylene and propylene as well as for plastics such as polyethylene, polypropylene, bottle resins, polyvinyl chloride and polystyrene. For more information or copies of this publication, contact Bill Gilmer at (713) 652-1546 or bill.gilmer@dal.frb.org, or write Bill Gilmer, Houston Branch, Federal Reserve Bank of Dallas, P.O. Box 2578, Houston, TX 77252. This publication is also available on the Internet at www.dallasfed.org. The views expressed are those of the authors and do not necessarily reflect the positions of the Federal Reserve Bank of Dallas or the Federal Reserve System.
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