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DALLASFED
FOURTH QUARTER 2012

Southwest
Economy

}

Determining Creditworthiness
and Texas’ Case for a Top Rating
PLUS
ffBrutal Drought Depresses Agriculture, Thwarting U.S.
and Texas Economies

ffBooming Shale Gas Production Drives Texas
Petrochemical Surge

ffOn the Record: Increased U.S. Energy Supply Helps
Offset Tight Global Conditions

ffSpotlight: Dollar-Sensitive Mexican Shoppers Boost
Texas Border Retail Activity

President’s Perspective

T

our elected
}Asofficials
struggle to
reboot economic
competitiveness without
encumbering future
generations with debt,
perhaps they should
look to the economic
laboratory that is Texas.

exas has a long tradition of outperforming the
nation in job creation—a trait that is matched
only by our long-standing reputation for modesty.
Over the past two decades, the state has added
jobs at more than double the pace of the U.S. This year,
employment growth is above 3 percent, compared with less
than 1.5 percent for the nation.
Texas’ fiscal position is also strong relative to the U.S.,
as Jason Saving notes in this issue of Southwest Economy.
The state falls just short of a consensus top bond rating
from the three major credit ratings agencies. The evaluation
is based on the state’s outstanding performance in many
areas of the economy.
In a reflection of our strong economy, the state continues to attract significant numbers of new residents. Net
domestic in-migration averaged more than 80,000 annually
in Texas from 1991 to 2011, in contrast with outmigration of
192,000 from California and 187,000 from New York. People
come here for opportunity.
To be sure, employment growth should not be the only
criterion for evaluating a state’s performance, and as Saving
makes clear, Texas is not without its challenges. It’s important that we remember, however, that economic growth
is the foundation for the other goals and aspirations of a
society.
Neither Texas nor the U.S. can pay for social services,
education or infrastructure without the tax revenue to do
so. And there is no tax revenue without sources from which
to collect it. The best source of revenue is a citizenry that is
gainfully employed and an economy that is growing and
prosperous.
Managing the tradeoffs between fiscal responsibility
and social and environmental stewardship is perhaps the
greatest challenge our nation confronts. It’s important to
remember that, as President Dwight D. Eisenhower said
in his farewell address, “We cannot mortgage the material
assets of our grandchildren without risking the loss also of
their political and spiritual heritage. We want democracy to
survive for all generations to come.”
If you believe people vote with their feet, the balance
our state has struck between economic dynamism and
government services seems appropriate enough to attract a
diaspora from other states. As our elected officials in Washington struggle to reboot economic competitiveness without encumbering future generations with debt, perhaps
they should look to the economic laboratory that is Texas.

Richard W. Fisher
President and CEO
Federal Reserve Bank of Dallas

Determining Creditworthiness
and Texas’ Case for a Top Rating
By Jason Saving

J

ratings agencies,
}TothetheAAA-rated
states
share one important
trait: fiscal capacity, a
superior ability to raise
revenue within their
borders to cover fiscal
obligations.

ust as individual consumers’ credit scores determine
the availability and cost of
borrowed funds, states’ credit
ratings assess their presumed ability
to repay bond investors often decades
into the future.
Eight states carry the highest, AAA
bond grade from the country’s three
major credit ratings agencies. The “elite
eight” are Delaware, Georgia, Iowa,
Maryland, Missouri, North Carolina,
Utah and Virginia. Texas narrowly misses
inclusion, with a top rating from two of
the three agencies.1
The significance of credit ratings
has been underscored in recent public
debate regarding the rising federal debt
and one firm’s decision to withdraw its
AAA assessment of the United States. The
rating is important because top marks
generally allow governments to borrow
money at lower interest rates, thereby
enabling their residents to spend less
money servicing public debt. States issue
debt for a wide variety of reasons, including the construction and maintenance
of roads, bridges and schools and even
day-to-day liquidity needs.
The eight states are an outwardly
varied group. They aren’t clustered in
a particular region, benefiting from a
vibrant geographic location, nor do they
have similar industrial compositions.
Demographically, they’re also dissimilar.
Utah is among the youngest and least
diverse states, while Iowa is older and
Georgia and Maryland are relatively
more diverse.
To the ratings agencies, AAA-rated
states share one important trait: fiscal
capacity, a superior ability to raise
revenue within their borders to cover
fiscal obligations. This doesn’t, in and
of itself, guarantee that those states
will meet their commitments. It does,
however, signal that they are wellpositioned to do so absent significant,

unexpected economic or political
developments.
Texas’ credit rating is just below a
consensus AAA but better than the national average. The state has advantages
that include rapidly growing industries
and extensive in-migration by people
seeking better economic opportunity.
It consistently ranks high among states
with the best business climates. In addition, employment has grown about 1
percentage point faster in Texas than the
nation—and faster than in each of the
eight states with top credit ratings.
Texas’ standing begs the question: What factors help determine fiscal
capacity and a state’s underlying ability
to repay bondholders in a timely fashion,
through good times and bad?
Industrial diversification, type of tax
system, “rainy day” savings, population
growth, business opportunity and employment levels all matter, as does investment in education and social services.

A Measurement of Risk
Simply put, a state’s credit rating
measures how much risk is associated
with any given bond issuance. The better
the rating, the better the terms on which
credit will be provided.
The three major credit-rating issuers
in the United States are Moody’s Investors Service, Fitch Ratings and Standard
& Poor’s. Potential bond issuers are rated
on a scale that ranges from AAA/Aaa for
top-quality borrowers to B3/B- for borrowers whose paper carries a fair amount
of risk (Table 1).2 The ratings firms don’t
always agree— for example, Texas
holds a AAA/Aaa rating from Fitch and
Moody’s but an AA+ from S&P. Generally, the ratings are similar because each
company uses some of the same data to
assess essentially the same proposition
—the underlying risk associated with
loaning money.
When a state’s fiscal capacity is

Southwest Economy • Federal Reserve Bank of Dallas • Fourth Quarter 2012

3

Table

1

Moody’s
Aaa
Aa1
Aa2
Aa3
A1
A2
A3
Baa1
Baa2
Baa3
Ba1
Ba2
Ba3
B1
B2
B3

Agencies’ Credit Ratings
and What They Mean
S&P
AAA
AA+
AA
AA–
A+
A
A–
BB+
BBB
BBB–
BB+
BB
BB–
B+
B
B–

Fitch
Quality level
AAA
Prime
AA+
AA
High grade
AA–
A+
Upper medium
A
grade
A–
BB+
Lower medium
BBB
grade
BBB–
BB+ Noninvestment
BB
grade/
speculative
BB–
B+
Highly
B
speculative
B–

high, it has the means to raise adequate
revenue for new spending programs
without compromising existing obligations. Most importantly, a superior fiscal
capacity helps reassure investors that a
state can make full and timely repayment
of interest on its bonds.3 When a state’s
fiscal capacity is low, it cannot easily
raise revenue to meet new obligations
and may face greater skepticism from
investors, who demand higher interest
rates on the state’s debt to compensate
for the greater perceived risk.

Evaluating Creditworthiness
Among the most relevant factors determining creditworthiness is the overall
configuration of a state’s economy.
Decades ago, Texas largely centered on
“cotton, cattle and oil” at a time when the
Midwest and Northeast were diversifying
into a more modern economic environment. When an economy is heavily
dependent on one particular sector,
its sudden downturn—which occurs
periodically—can dramatically worsen
state fiscal health, imperiling timely
repayment of obligations. In contrast,
diversification helps minimize the fiscal
impact of sectoral downturns, much as
individual investors incur less risk with a
mutual fund than a specific stock.
The Texas economy has grown more
similar to the well-diversified national
economy. Chart 1 plots the degree to
which some of the largest states mirror the national employment profile;

complete resemblance equals 1. The
trend was interrupted during the energy
booms of the early 1980s and today,
which temporarily boosted the size of
the energy sector and made the state
economy somewhat less diversified
than it would otherwise be. On the other
hand, energy booms also swell state
coffers and create significant disposable income for Texas residents, helping
offset the mild increase in credit risk that
would ordinarily be associated with a
temporary diversification diminution.
Of course, diversification does not
entirely eliminate risk. Recent events
have shown that when large parts of the
overall economy falter simultaneously,
even a well-diversified “portfolio” of
industries cannot fully overcome fiscal
pressures, leading many states to cut
spending, raise taxes and borrow more.
Still, a diverse mix to some degree guards
against this and helps a state meet its obligations even during difficult economic
times.
State tax systems can significantly
shield government treasuries from the
stresses of the overall business cycle—
or amplify those stresses. Individual
incomes typically rise faster than consumption during economic expansions
as people find themselves better able
to find jobs and obtain raises. They also
fall faster than consumption during

Chart

1

recessions as people seek to maintain
a reasonable standard of living even as
layoffs rise and job opportunities fall
away. Thus, states heavily dependent on
income taxes are more likely to ride the
business cycle than other states, reaping
outsized revenue gains during good
times but suffering sizable revenue contractions during recessions. Conversely,
states that primarily tax consumption
won’t receive windfalls during economic
booms but will experience more stable
revenue over time, offering hope to creditors that their debt-repayment promises
are more likely to be respected even if an
unanticipated downturn occurs.
Here, too, the Texas economy
compares relatively favorably with its bigstate peers (Chart 2). For instance, California’s reliance on procyclical taxes such
as an unusually progressive income tax
ensures its revenue swings strongly with
the business cycle, growing relatively
rapidly in the boom years of 2003–06 but
falling steeply during the 2007–09 period.
Texas revenue remained more stable
during both the boom and the bust as
sales (consumption) taxation caused it
to miss out on the early-decade income
boom but also on the late-decade bust.
Another means by which a state
can insulate itself during difficult times
is an economic stabilization fund (ESF),
better known as a rainy-day fund.

Texas’ Economic Diversity Rises Over the Years

Similarity index, U.S. = 1

1
California

.98

Texas

.96

.94
New York

.92

.90
1975

1980

1985

1990

1995

SOURCE: Bureau of Labor Statistics.

4

2000

2005

2010

NOTE: The index measures the similarity of a state’s industry mix with the nation’s—a reading of 1 indicates the state
has the same share of jobs in each industry sector as the nation, while 0 suggests that its mix differs to an extreme.

Southwest Economy • Federal Reserve Bank of Dallas • Fourth Quarter 2012

Chart

2

Tax Revenue Growth More Stable in Texas than California

Real dollars, year/year percent change

15
10
California
5
0
Texas

–5
–10
–15
2003

2004

2005

2006

2007

2008

2009

2010

2011

SOURCES: Census Bureau; Bureau of Labor Statistics.

Chart

3

Alaska and Texas Have Highest Rainy-Day Fund Balances

Dollars (billions)

12

11.07

10
8
6

5.04

4
2
0

1.38

AK

TX

MA

1.21

NY

than its peers is an additional factor
determining future creditworthiness.
States offering more favorable business
climates and better availability of land
tend to grow relatively quickly, making
them a better bet for stronger economic
growth down the road. And as a state
grows faster, it increases its fiscal capacity
to repay debt without compromising
other policy goals.
Texas employment has over the last
several decades grown about 1 percentage point per year faster than the U.S. as
a whole (Chart 4). The reasons include a
low cost of living, ready labor availability, low corporate taxes and an education system that—while not among the
nation’s strongest—is sturdier than its
southern neighbors.4 Absent a change in
one or more of these factors, this general
trend is expected to continue.
Moreover, independent assessments of the state business climates
almost invariably rank Texas as among
the nation’s most hospitable (Chart 5).
These ratings analyze factors such as
the regulatory climate, access to capital,
cost of living and labor availability to
produce a comprehensive assessment
of the extent to which a state is “open for
business.” Taken together, these factors
suggest Texas is likely to outperform its
peers in the near future.

Future Challenges
.66

.65

.62

.57

.45

.44

WV

LA

MD

WY

GA

IA

NOTE: Data from 2011.
SOURCE: National Association of State Budget Officers.

During ordinary times, the fund receives
a portion of annual state revenue, sometimes from specific taxes earmarked for
this purpose. When unforeseen fiscal
pressures emerge—often because a
state has entered recession and revenue
unexpectedly lags behind projections—
the state can draw from the fund until
the situation improves. In essence, the
ESF acts as a silo in which a state can
store money in anticipation of adverse
economic shocks down the road.
Thirty-eight states have rainy-day
funds, but most of the sums are quite
small. Preparing for an unforeseen

downturn often takes a backseat—for individuals and states—because it reduces
available funds in the near term for other
priorities that may at the time seem more
pressing. Only two states, Alaska and
Texas, have maintained rainy-day fund
balances exceeding $2 billion over the
last decade, in part because of unexpectedly strong energy production revenue
(Chart 3). Texas’ rainy day fund is expected to reach at least $8 billion by next
August (the end of fiscal 2013), putting it
in a relatively strong position to weather
a future recession.
A state’s likelihood to grow faster

Education is among several factors
that could potentially pare Texas’ future
fiscal capacity. The state has gradually reduced the role of local property
taxes, a relatively stable revenue source
dedicated primarily to schools, in favor
of general-revenue funding by the state.
This has been met with increasing legal
pressure on Texas to increase aggregate
funding for education. While a better
education system would be almost universally welcomed, new general-revenue
spending attenuates the state’s fiscal
capacity. Of course, a better-funded education system might improve productivity and thereby put Texas on a stronger
economic growth path. If this were the
end result, more education funding
would eventually increase fiscal capacity
and make Texas a better credit risk.
Social services spending, notably on

Southwest Economy • Federal Reserve Bank of Dallas • Fourth Quarter 2012

5

Chart

4

Texas Outperforms Other Big States, Nation in Employment

Index, 1970 = 100

350
Texas

300
250

California
200
U.S.
150
New York

100
50
1970

1975

1980

1985

1990

1995

2000

2005

2010

2015

SOURCE: Bureau of Labor Statistics.

Medicaid, poses another challenge for
Texas (and many other states). Payments
for Medicaid, the shared federal–state
program that funds medical services to
the poor, were once relatively steady in
Texas but have grown rapidly in recent
years with no clear sign of leveling out.
If Medicaid continues to increase as a
share of the state’s overall budget, funding for other programs will have to be cut
or taxes will have to rise.
These examples illustrate the
limitations of fiscal capacity as it relates
to credit ratings. While fiscal capacity

Chart

5

plays an important role in their determination, willingness to meet fiscal obligations is also important. While a state that
has no further resources to tap cannot
meet new fiscal obligations no matter
how fervently it might wish to do so, it
also may choose not to fund the obligations even if it can.
One area where this comes into
play is state pension systems, whose
promised benefits generally exceed policymakers’ willingness to save on their
behalf. Pension obligations are perhaps
the largest single liability confronting

states, and a significant number of states
have failed to fund them at the 80 percent threshold generally recommended
by pension analysts. Like any private
pension system, a state that saves too
little for its retirees during their working
years will find itself strapped for cash
as retirements occur, especially when
accompanied by declining population
growth and increasing life expectancy.
While this day of reckoning may
not occur for a while, forward-looking
investors will on average demand more
of a premium to purchase bonds from
states whose fiscal capacities will predictably decline over time. Conversely,
they will demand less from states that
have maintained an 80 percent-or-better funding ratio and can more readily
pay the remainder from general revenue
without overly straining their fiscal
capacities. Texas exceeds that threshold
(Chart 6), with enough set aside to cover
82 percent of pension liabilities. But that
still leaves a sizable gap for which additional appropriations could pressure
general revenue down the road.
Another area where this willingness
comes into play is overall revenue and
expenditure levels. States such as Texas
have historically opted for a relatively
low level of per capita spending (Chart
7), with most going to the core state government functions of education, criminal justice, infrastructure and health.

Texas Ranks Highest for Business Climate in 2012

Points

1,800
1,600
1,400
1,200
1,000
800
600
400
200
TX
UT
VA
NC
ND
NE
SD
CO
GA
W
Y
M
N
IA
IN
ID
KS
TN
W
I
OR
NH
AR
W
A
AZ
OK
M
T
OH
IL
M
O
M
A
FL
PA
M
D
SC
M
I
NY
M
E
KY
NM
AL
VT
CA
NJ
LA
DE
CT
NV
M
S
AK
W
V
HI
RI

0

NOTES: CNBC assigns points over a range of factors that include cost of doing business and access to capital. Other organizations publish business-climate lists that use different sets of measures.
SOURCE: CNBC.

6

Southwest Economy • Federal Reserve Bank of Dallas • Fourth Quarter 2012

Chart

6

fairly well funded and offers constitutional protections to bondholders that
interest payments will occur in a full and
timely fashion. The state also offers a
favorable business climate and is among
the biggest destinations for migrants in
the country, both of which strengthen
the state’s fiscal capacity. Yet, Texas also
faces challenges involving education and
Medicaid that, depending on how they
are handled, could diminish that capacity down the road.
While noneconomic factors play
a role in a state’s individual circumstances, ratings are heavily influenced
by each state’s policy environment and
how well that environment responds to
the economic shocks with which states
(or other entities) are regularly confronted. Decisions made by lawmakers
and other officials can position a state
to rise to a better credit rating—or fall
to a lower one.

Texas Pension Funding Exceeds Recommended
80 Percent in 2008–09

Less than 80% funded
At least 80% in 2008, less than 80% in 2009
At least 80% funded
SOURCE: Pew Center on the States

Chart

7

Texas on Low End of Per Capita State Spending

Real dollars

Saving is a senior research economist
and advisor in the Research Department of the Federal Reserve Bank of
Dallas.

7,000
New York

6,500
6,000
5,500

California

5,000

Notes

4,500

1

4,000
Texas

3,500
3,000
2,500
2,000
2003

2004

2005

2006

2007

2008

2009

2010

SOURCES: National Association of State Budget Officers; Bureau of Labor Statistics; Census Bureau.

This stance has been cited as a major
reason Texas has grown faster than the
nation. This has enabled the state to
keep taxes low, fostering a businessfriendly climate, but it also precludes
some options that other states might
pursue to more easily meet their fiscal
obligations. Illinois, for example, recently improved its fiscal capacity by raising
some fees and taxes, although its large
and growing pension liabilities continue
to influence its credit ratings.
It’s also important to note that
Texas emphasizes the importance of
debt vis-à-vis other areas of the budget.

The Texas constitution prioritizes state
debt repayment above ordinary discretionary spending, which helps ensure
spending reductions necessary over
the course of the business cycle will not
affect bondholders (and, therefore, the
state’s credit rating).

Ratings agencies base their evaluations on different
sets of criteria, and this can cause ratings to vary.
2
Below these are C-rated “junk” bonds that carry a
significantly greater risk of default.
3
The same is true at the national level.
4
Scores from the National Assessment of Education
Progress rank Texas 34th out of 50 states. Arkansas
placed 41st, Oklahoma 46th, Louisiana 47th and New
Mexico 48th.
5
Reflecting the state’s greater diversification, oil and
natural gas production taxes were the No. 6 and
No. 7 sources of revenue in 2011, collectively
accounting for just under 7 percent of total state revenue.
That is a bigger share of revenue than a few years ago
but still not large enough to have much of an impact on
Texas’ overall creditworthiness.

Texas in Perspective
Texas has one of the nation’s higher
credit ratings, reflecting its relatively
diversified economy, comparatively
stable tax system, large rainy-day fund
and consistently strong growth rate.5 Its
pension system—a key obligation—is

Southwest Economy • Federal Reserve Bank of Dallas • Fourth Quarter 2012

7

On the record
A Conversation with Michael Plante

Increased U.S. Energy
Supply Helps Offset
Tight Global Conditions
As world crude oil prices remain persistently elevated, along with
those for many other commodities, Dallas Fed research economist
Michael Plante explores the reasons why and the prospects for lower
costs, including those at the pump. He offers a cautionary note
about U.S. advances toward energy independence and the era of
inexpensive natural gas.
Q. Amid disappointing U.S. economic growth, the European
recession and slowing in emerging
markets, oil prices seem high.
Why? What’s the outlook for 2013?
Although economic growth in many
industrialized countries has been lackluster in recent years, the world economy
has grown and global oil consumption
has slowly, but surely increased. The
world consumed about 1 percent more
oil in 2011 than in 2010, and demand is
expected to expand by just less than 1
percent this year.
Meanwhile, supply has struggled
to keep pace with demand. Unexpected
supply disruptions are partly to blame.
Libya went offline in 2011 during its
revolution, and in 2012, there have been
problems in Syria, South Sudan and the
North Sea. Moreover, apart from Canada
and the U.S., non-OPEC output growth
has been poor.
World supply in 2011 rose just 0.3
percent from 2010 levels, an increase
insufficient to keep up with demand.
The situation improved this year, with
supply climbing more than 2 percent.
That has been just enough to keep pace
with demand growth. So, upward pressure on oil prices hasn’t been surprising. Crude oil averaged $80 per barrel
in 2010, $111 in 2011 and is expected to
average $112 this year.
The world economy is likely to continue growing at a subdued pace next
year, as is demand for oil. The Energy

8

Information Administration (EIA) is
currently penciling in about a 1 percent
consumption increase for 2013. Supply
is expected to expand by about 1.1 percent, and this should help ease pressure
in the market. The EIA predicts Brent
crude oil prices will average about $103
a barrel, a modest decline from 2012.

Q. Prices for other commodities,
such as corn and soybeans, are
near record highs too. Is there
anything they share with oil markets?
These commodities and crude oil
have all benefitted from burgeoning
demand over the past decade or so.
Much of it reflects economic growth in
the developing world, especially China.
For example, China’s soybean consumption roughly tripled from 2000 to
the present and now accounts for about
30 percent of world consumption, up
from 15 percent in 2000. If you look
at the data for corn, China consumes
almost 70 percent more than it did in
2000. The country, which had been a
corn exporter, became a net importer
in 2009. Meanwhile, China’s crude oil
consumption has doubled since 2000.
As with oil, rapid growth in
demand for other commodities has
created a situation where any supply
problems prompt rapid price increases;
for example, poor U.S. harvests in 2010
and 2012 caused corn and soybean
prices to spike.

Q. There are different types of
oil, and they command different
prices. It used to be that the price
of West Texas Intermediate (WTI)
and North Sea Brent crude were
roughly in line. Why isn’t that true
anymore?
Crude oil varies from place to place
and thus sells for different prices. Brent
and WTI, both light sweet crude, should
sell for roughly the same amount. Since
early 2011, however, WTI has been
much cheaper than Brent crude. WTI
has sold for about $20 less than Brent
crude in recent months.
This reflects a crude-oil production boom in Canada, North Dakota
and parts of Texas that has flooded the
Midwest and midcontinent markets.
This has led to a bottleneck in Cushing,
Okla., a key distribution hub. Crude oil
is usually shipped by pipeline, but there
is just not enough capacity to move it to
other parts of the U.S. or Canada where
it could fetch higher prices.
Given the price disparity and the
lack of pipelines, people have shipped
crude by truck, rail and barge to get
it to areas where it will sell for higher
prices. Refineries in the Midwest and
the Rocky Mountain regions have taken
advantage of the disparity by running
at full capacity. These refiners can sell
gasoline at world prices but pay significantly lower input costs than competitors elsewhere.
Pipelines are eventually going to
be built that will deal with this situation. Once that happens, Brent and WTI
prices will converge.

Q. You note that U.S. oil production has increased after many
years of decline. Have oil imports
declined as a result? Is North
American energy independence a
realistic and desirable goal?
New technology has led to surging
U.S. production since 2009, reversing
a decline that began in the mid-1980s.
As a result, crude oil imports have
declined for the past several years. Imports are expected to continue falling in
the near future as production grows.
If “energy independence” means
that the U.S. produces all of the crude

Southwest Economy • Federal Reserve Bank of Dallas • Fourth Quarter 2012

more oil when it makes business
}“Producing
sense is a good thing. But energy independence
for energy independence’s sake is probably not as
desirable as one might expect.”

oil that it consumes, then that seems
unlikely in the foreseeable future. The
EIA predicts that net imports of oil
products should level out to below
40 percent of total consumption after
2020. Even under the most optimistic
assumptions, net imports still remain
above 20 percent of total consumption
in the long run.
Producing more oil when it makes
business sense is a good thing. But
when it comes to oil, energy independence for energy independence’s sake
is probably not as desirable as one
might expect. For example, energy
independence in crude oil would not
protect the U.S. from price spikes in
the oil market even when caused by
events outside the U.S. Crude oil and
oil products trade on a world market.
So U.S. consumers and firms would
continue paying the same price as
everyone else. Independence would
only have a particular benefit in some
sort of catastrophic situation where the
U.S. literally could not purchase crude
oil on the world market. However, that
seems unlikely, and even then we have
the strategic petroleum reserve to deal
with such a supply disruption.

Q. What are the costs that feed
into gasoline prices at the pump?
Are high oil prices the reason we
are seeing near-record gasoline
prices? Why do these prices vary
across states?
Crude oil made up about 68 percent
of the retail price of gasoline in 2011,
EIA data show. Federal and state taxes
contributed about 11 percent to the
final price, while another 11 percent was

due to the cost of refining the oil into
gasoline. Finally, about 9 percent went to
distribution costs through retail outlets.
While these percentages can
change over time, the cost of crude oil
is always the largest component behind
U.S. retail prices. Thus, if oil prices are
high, gasoline prices will also be high; if
they are low, then gasoline will be less
expensive.
Retail prices vary significantly
between countries and across different
parts of the U.S. This is generally due
to differences in taxes and distribution
costs. For example, European retail
prices for gasoline are often much
higher than those in the U.S. because
of higher taxes. In the U.S., prices tend
to be lower on the Gulf Coast than in
many other parts of the country since a
lot of gasoline is produced on the coast
and distribution costs are therefore
lower.
Gasoline prices can also vary due
to environmental considerations. California, reflecting air pollution concerns,
mandates strict regulations regarding
gasoline formulations. California gasoline is produced in limited quantities
and is thus relatively more expensive.
Not surprisingly, prices tend to be
higher in California than elsewhere in
the U.S.

Q. Most commodity prices are at
high levels, but natural gas is low.
Why? If U.S. natural gas production is expanding, can that excess
capacity be exported or used in
some other way, such as for powering motor vehicles?
The supply of natural gas in North
America has rapidly grown in recent
years because of the shale-gas revolution, which has driven down gas prices
to very low levels in the U.S. On the
other hand, natural gas remains fairly
expensive elsewhere in the world.

While many commodities can be easily
shipped from one location to another,
this is not true for natural gas in the U.S.
That helps explain why prices can be
low here but higher elsewhere.
Of course, once prices diverge
between markets, there will be a natural
tendency for someone to figure out how
to make money off of the difference.
One possibility would be exporting U.S.
natural gas as liquid natural gas (LNG)
to other countries. However, this is a
costly and time-consuming process
to get started. Another is to use the
natural gas domestically to produce
other goods that can then be exported.
Petrochemicals are a good example of
this. An additional possibility is increasing domestic demand to absorb surplus
supply—for example, in power plants
generating electricity or as fuel for natural gas vehicles.

Q. With rising natural gas supplies
increasingly contributing to the
production of electricity, what is
happening to coal? What are U.S.
coal producers doing with their
supplies?
U.S. power plants took advantage
of collapsing natural gas prices earlier
this year by increasing gas use at the
expense of coal. As a result, coal producers were forced to look elsewhere
for possible buyers. This contributed to
sharply declining prices for steam coal,
the type used to produce power.
U.S. coal exports are predicted
to break records in 2012, paced by
increased exports of steam coal to
Europe. While natural gas is cheap
compared to coal in the U.S., it is relatively pricier than coal in Europe. This
has led some European power plants
to produce more electricity using coal,
some of it from the U.S., instead of from
natural gas.

Southwest Economy • Federal Reserve Bank of Dallas • Fourth Quarter 2012

9

Brutal Drought Depresses Agriculture,
Thwarting U.S. and Texas Economies
By Emily Kerr

}

10

The drought’s effects
significantly suppressed
U.S. economic growth in
2012. Sharply lower farm
inventories subtracted
0.2 and 0.4 percentage
points from already
weak real GDP growth
in the second and third
quarters, respectively.

A

griculture has rarely made
the difference between an
expanding U.S. economy and
one that is stalling. It may,
however, have had such a pivotal role
this year, as severe drought depressed
the nation’s farm output, taking a toll
on broader economic growth. Texas,
with more acreage devoted to farming than any other state, confronts the
direct impact of two consecutive dry
years.
The drought’s effects significantly
suppressed U.S. economic growth in
2012. Sharply lower farm inventories
subtracted 0.2 and 0.4 percentage
points from already weak real GDP
growth in the second and third quarters, respectively.
The agricultural sector directly accounts for just 1.2 percent of GDP and
1.6 percent of employment, although
its overall impact on the U.S. economy
is much larger because it is linked to
a variety of industries. These include
processing, manufacturing and exporting, as well as inputs used in farming,
such as machinery and fertilizer. The
U.S. Department of Agriculture (USDA)
estimated that farm and farm-related
employment represents roughly 14
percent of total U.S. employment.1
The U.S. exported $140 billion
in agricultural products during 2011,
representing nearly 10 percent of total
exported goods. Agricultural sales
abroad in 2012 will certainly be adversely impacted by drought-reduced
crop production.

broilers (chickens raised for meat production). Farm receipts totaled nearly
$375 billion in 2011.2
The composition of the Texas
sector differs from the U.S. as a whole.
Cattle and cotton remain king in Texas
with their very large farming presence.
More than three-quarters of the
state’s total land area is dedicated
to agriculture, and a disproportionate share of it—about two-thirds—is
pastureland, largely used for raising
cattle. Texas boasts the largest cattle
industry among the states, bringing in
more than $11 billion in annual farm
receipts. Cattle, the state’s No. 1 agricultural commodity, accounts for half
of Texas farm receipts, compared with
17 percent for the U.S. overall.
Cotton is Texas’ second-most
prominent agricultural item, and
the state produces 30 percent of
the nation’s crop. Texas is the No. 1
cotton-exporting state, and the crop is
responsible for more than one-third
of the state’s $6 billion in agricultural
exports.3
Cattle are raised throughout the
state, though in greater numbers in the
west; grains such as corn, wheat and
sorghum are grown mostly in the temperate north and north-central regions;
cotton is produced expansively in the
high and low plains; vegetables and
fruits are mostly grown in the subtropical south. Although Texas has the most
farm acreage of all the states, the land
is less productive than in many parts of
the U.S.4

Farming in U.S., Texas

Drought Déjà vu for Texas

Nearly 40 percent of the nation’s
total land area is dedicated to agriculture, about equally split between
cropland and pastureland. The top five
U.S. agricultural commodities are corn,
cattle, dairy products, soybeans and

Nearly two-thirds of the contiguous U.S. was in drought as of October
2012, compared with only 30 percent a
year earlier, when drought conditions
were confined to the Southwest.5 The
Great Plains have been hit the hardest

Southwest Economy • Federal Reserve Bank of Dallas • Fourth Quarter 2012

Chart

1

Drought Conditions Most Severe in Great Plains

SOURCE: U.S. Drought Monitor, released Oct. 23, 2012. The U.S. Drought Monitor is produced by the National Drought Mitigation Center at the University of Nebraska–Lincoln, the U.S.
Department of Agriculture and the National Oceanic and Atmospheric Administration.

by the 2012 drought, with states such
as Nebraska and Kansas experiencing
widespread exceptional drought—the
most severe classification (Chart 1).
The latest Texas conditions follow
a much more severe and localized
drought last year. 2011 was the driest
year in Texas since records began in
1895. Conditions have since eased only
slightly, and two-thirds of the state
experienced a second year of drought
this year.

Crops, Livestock Suffer
The successive droughts are profoundly and distinctly affecting national
and local agricultural sectors. Unusually hot and excessively dry weather
has taken a toll on this year’s U.S. crop
production. The USDA’s September estimates project the smallest U.S. corn crop
in six years, with production down 13
percent from 2011. Soybean production
is expected to decline 14 percent.
Agricultural commodity prices
climbed sharply during the summer on
diminished yield expectations (Chart 2),

with corn and soybean prices reaching
inflation-adjusted levels not seen since
the 1980s.
In states such as Nebraska and Kansas, where grain and soybeans account
for 90 percent of farm output, higher
prices largely offset reduced production.
In Texas, where cotton predominates,
fewer farmers benefit from bullish grain
and soybean prices amid diminished
yields. Cotton prices were high last year
but have since declined 25 percent due
to weak demand and record global cotton inventories.
Ranchers also face difficult conditions. Much of the pastureland used to
support cattle herds withered under the
hot, dry conditions, causing ranchers to
feed grain to their herds—a very costly
alternative in light of high grain prices.
Hay, another food source, skyrocketed
amid limited supply and very strong
demand, with some ranchers paying
double or triple last year’s prices.
In response, ranchers sold their
cattle earlier—bringing in less income
due to lower animal weights—and

two-thirds of the
}Nearly
contiguous U.S. was in
drought as of October
2012, compared
with only 30 percent
a year earlier, when
drought conditions
were confined to the
Southwest.

Southwest Economy • Federal Reserve Bank of Dallas • Fourth Quarter 2012

11

Chart

2

Drought Pushes Up Grain and Soybean Prices

Dollars per bushel*

18
Soybeans

16

as the 2012
}AsU.S.much
drought affected
crop and pasture
conditions, Texas
confronted a far more
calamitous situation in
2011.

14
12
10

Wheat

8

Corn

6
4
2
0

2009

2010

2011

2012

*Nominal prices received by farmers.
SOURCE: U.S. Department of Agriculture.

in larger quantities than usual. Cattle
prices softened in July because of the
abundance of animals going to market,
although prices remained high relative
to the previous 10 years. Many cattlemen
were forced to sell off breeding herds that
took decades to develop. Texas felt the
effect more acutely because cattle make
up a disproportionately large portion of
the state’s agriculture sector.

2011 Texas Drought Severity
As much as the 2012 U.S. drought
affected crop and pasture conditions,
Texas confronted a far more calamitous situation in 2011. Resulting Texas
agricultural losses were estimated at a
record $7.6 billion in 2011,6 far exceeding the previous $4.1 billion record, in
2006, and representing more than 40
percent of the state’s average agricultural receipts. Main components of the
loss were livestock, $3.2 billion; cotton,
$2.2 billion; hay, $750 million; and corn,
$736 million. Livestock losses reflected
increased feeding costs and market
losses due to lower animal weight and
suppressed market prices. Crop losses
stemmed mainly from high abandonment and low yields.
Only 57 percent of planted crop
acreage in Texas was harvested in
2011—meaning 43 percent of acreage
was abandoned due to crop failure. A
comparison between the U.S. in 2012

12

and Texas in 2011 reveals the relatively
tougher blow Texas farmers sustained
(Table 1).
Texas corn production fell 55 percent in 2011 from the prior year, while
the current drought is expected to lower
U.S. corn production by only 13 percent.
Texas cotton also sustained a 55 percent
production loss last year, whereas U.S.
cotton production is expected to increase
10 percent this year. In Texas and the
U.S., crop insurance payouts largely offset the impact of higher crop abandonment and lower crop yields on farmers’
incomes. Livestock producers, however,
weren’t covered as extensively by insurance and continue struggling with high
feed costs.

Severe Cattle Industry Impact
As ranchers culled or completely
liquidated herds under the strain of very
poor pasture conditions and limited
water availability, the Texas cattle population dropped by 1.4 million head from
January 2011 to January 2012 (Chart
3)—an 11 percent decline, the sharpest
in more than 75 years, leaving inventory
at its lowest level since 1968. Texas still
holds the largest number of cattle among
the states, but its share of the national
population is at a 25-year low of 13 percent. Outside of Texas, the cattle population declined 0.6 percent during 2011 as
the overall U.S. inventory continued its

Southwest Economy • Federal Reserve Bank of Dallas • Fourth Quarter 2012

Table

1

Dueling Droughts: Impact on Texas vs. U.S.
Corn

Soybeans
U.S.
Texas
2012
2011
2
45

Cotton
U.S.
Texas
2012
2011
16
59

U.S.
2012
9

Texas
2011
28

Crop yields (percent change, drought year
vs. prior year)

–17

–36

–15

–37

–1

–23

Crop production (percent change, drought
year vs. prior year)

–13

–55

–14

–69

10

–55

Crop abandonment (percent)

cattle
}Declining
inventories have put

NOTE: 2012 U.S. figures are estimates based on forecasts as of September 2012.
SOURCES: U.S. Department of Agriculture Crop Production 2011 Summary, January 2012 (Texas data); U.S. Department of
Agriculture Crop Production report, September 2012 (U.S. data).

gradual decline. The national herd has
been trending down since 1975, largely
a result of the beef industry raising fewer
but heavier cattle.
Declining cattle inventories have
put upward pressure on future retail beef
prices, although the recent influx of supply eased short-term prices. Beef prices
are expected to rise in 2013, a trend likely
to continue amid less supply to meet
domestic and global demand. Restocking herds is a gradual process, particularly since female cattle produce only
one offspring per year. Restocking is also
expensive, and not all ranchers will have
the ability to buy back into the business.
Also, downstream feedlots—which fatten
cattle in preparation for slaughter—are
hesitant to expand operations in the face
of high feed grain prices, which squeeze
margins.

Outlook: Drought to Persist
The Great Plains drought is
expected to persist or even intensify
through year-end, although conditions
are likely to improve in the eastern
Midwest, according to the National
Oceanic and Atmospheric Administration.
Drought is certainly nothing
new—farmers and ranchers have
always faced periodic dry spells of
varying severity. But in an economy
struggling to gain momentum, the
current episode brings an unwelcome
drag on growth.

Kerr is an associate economist in the
Research Department of the Federal
Reserve Bank of Dallas.

upward pressure on
future retail beef prices,
although the recent
influx of supply eased
short-term prices.

Notes
1
U.S. farm and farm-related employment, 2002,
Economic Research Service, U.S. Department of
Agriculture, Washington, D.C.
2
State Fact Sheets: United States, as of Sept. 13,
2012, Economic Research Service, U.S. Department of
Agriculture, Washington, D.C.
3
All figures are from State Fact Sheets: Texas, as of Sept.
13, 2012, Economic Research Service, U.S. Department
of Agriculture, Washington, D.C.
4
This is discussed further in “Agriculture: Sector’s Share
of GDP Smaller in Texas than in U.S.,” by Emily Kerr,
Federal Reserve Bank of Dallas Southwest Economy,
Second Quarter, 2012.
5
Figures are from the U.S. Drought Monitor, produced
by the National Drought Mitigation Center at the
University of Nebraska–Lincoln, the U.S. Department of
Agriculture and the National Oceanic and Atmospheric
Administration, http://droughtmonitor.unl.edu.
6
“Updated 2011 Texas Agricultural Drought Losses Total
$7.62 Billion,” by Blair Fannin, AgriLife Today, Texas
A&M AgriLife Extension Service; March 21, 2012.

Chart

3

Texas Cattle Inventory Drops Sharply in 2011

Millions

Millions

175

18
16

Texas

150

14
125

12
U.S.

100

10
8

75

6

50

4
25
0
’50

2
’60

’70

’80

’90

’00

’10

0

SOURCE: Cattle Report, National Agricultural Statistics Service, U.S. Department of Agriculture.

Southwest Economy • Federal Reserve Bank of Dallas • Fourth Quarter 2012

13

NoteWorthy
Construction: Employment Improves Across Texas During 2012

C

onstruction employment grew at an annualized 6.7 percent rate through the first 10 months of
the year, making the sector—which includes residential, commercial and industrial building—the
second-fastest growing in the Texas economy after mining and logging, according to Bureau of
Labor Statistics (BLS) data adjusted by the Federal Reserve Bank of Dallas. Nationally, construction jobs
declined 0.2 percent over the same period. Nevada, still recovering from a severe housing bust, recorded
an 11 percent construction employment drop during the period.
Despite robust growth, Texas construction employment remains 11 percent below its May 2008 peak.
Nationally, it’s down 28 percent from the April 2006 peak, at the height of the housing boom.
Residential building is helping the construction jobs recovery in Texas. Building construction employment increased 6 percent year to date through October in Texas, but is down 0.8 percent in the U.S.
In Texas, residential builders report that shortages of framers, plumbers and electricians are delaying the
completion of new homes. Texas construction laborers were paid 5 cents more per hour in 2011 than in
2010, compared with a decline of 23 cents nationally, according to the BLS’s Occupational Employment
Statistics. Since 2006, Texas hourly construction wages are up 10 percent in inflation-adjusted terms
versus a 2.3 percent U.S. decline.
—Christina Daly

Compensation: Texas Income, Earnings Mixed in Latest Census Report

T

exas median household income fell in 2011, while median earnings for workers rose for a second
consecutive year, according to new Census Bureau estimates. Texas median household income
fell to $49,392 in 2011 from $50,010 in 2010, a 1.2 percent decline, smaller than the 2.2 percent drop
in 2010. Nationally, median household income fell 1.5 percent to $50,054 from $50,831. Among Texas
metropolitan areas, Houston matched the statewide decline, while Dallas–Fort Worth and Austin–Round
Rock–San Marcos slipped by less than 1 percentage point. Falling household income can be attributed
in part to a shrinking labor force and the loss of well-paying jobs in government and finance and real
estate—the latter especially occurring in Dallas–Fort Worth in the aftermath of the 2008–09 recesssion.
Still, Texas workers earned more. Median earnings rose 1.4 percent to $28,015 in 2011 from $27,620
in 2010, while nationally they fell 2.5 percent. Although Texas numbers look good compared with the rest
of the country, the estimates continue to reflect a trend of the “hollowing out” of the middle class. Between 2010 and 2011, the share of Texas households with incomes between $35,000 and $100,000 shrank
to 54.1 percent from 55 percent.
Furthermore, Texas’ poverty rate rose to 18.5 percent in 2011 from 17.9 percent in 2010, continuing a
trend of increasing poverty that has persisted since the recession.
—Melissa LoPalo

POLLUTION: More Natural Gas, Less Coal Pace CO2 Emissions Drop

C

arbon dioxide (CO2) emissions in the U.S. in first quarter 2012 were at the lowest level for any first
quarter in 20 years. Data from the Energy Information Administration (EIA) show that U.S. CO2
emissions from energy consumption totaled 1,340 million metric tons (mmt) in first quarter 2012,
an almost 8 percent decrease from first quarter 2011. First-quarter emissions have not been this low since
1992, when they roughly totaled 1,339 mmt.
The mild winter, a decline in coal-fired electricity generation in favor of natural gas-fired power, and
reduced gasoline demand combined to lower emissions at the beginning of the year. CO2 emissions are
usually highest in the first quarter each year due to heating demand, according to the EIA.
Using cheaper natural gas to generate electricity is particularly important in emissions reductions.
Natural gas produces the lowest CO2 emissions of any fossil fuel, making it a much cleaner energy source
than coal. Increasing supplies of gas, mainly shale gas, sent natural gas prices to a historical low in 2012.
Shale gas is accessible through hydraulic fracturing, or fracking.
A reduction in emissions is good news for the U.S., but there are caveats. Global CO2 levels are still
rising, and natural gas price increases could reverse emissions drops if coal use increases. Additionally,
fracking has raised environmental concerns, some involving groundwater contamination.
—Amy Jordan

14

Southwest Economy • Federal Reserve Bank of Dallas • Fourth Quarter 2012

spotlight

Dollar-Sensitive Mexican Shoppers Boost
Texas Border Retail Activity
By Roberto A. Coronado and Keith R. Phillips

M

exican citizens logged 70
million border crossings into
Texas in 2011. While some
came for work, school or
family reasons, many traveled to border
cities to shop.
Cross-border retail trade is crucial to
border-city economies. Mexicans spend
more than $4.5 billion annually on food,
clothing, auto parts and other retail items
in these cities, primarily El Paso, McAllen, Brownsville and Laredo, Federal
Reserve Bank of Dallas research shows.
Geographic proximity, border-crossing
cards that expedite movement, attractive
prices and broad product selection are
among the draws.
But shoppers’ purchasing power
matters, too. On that count, Texas border
retailers struggled to attract business
during the second half of last year and
the first part of 2012 because peso
weakness (dollar strength) made goods
relatively more expensive. In recent
months, the peso has strengthened and
lifted retail sales.
Since the 1970s, border scholars
have attempted to estimate the size
of cross-border retail trade. Because
Mexicans’ shopping transactions on the
U.S. side are mostly in cash, valuing the
volume of activity is difficult. To obtain
an estimate, we assume that individuals spend a fixed proportion of their
income on consumption, or in this case,
retail sales.1 In essence, we estimate the
purchasing power of local residents. If
an area’s retail sales exceed what locals
are spending, Mexican visitors’ shopping
likely accounts for the difference.
The results suggest that Mexican
trade represents a significant share of
Texas border-city retail activity, ranging from 40 to 45 percent in Laredo,
35 to 40 percent in McAllen, 30 to
35 percent in Brownsville and 10 to
15 percent in El Paso. While El Paso
relies mostly on shoppers from its
sister border city, Ciudad Juárez, Rio
Grande Valley communities draw to a

greater extent from interior cities such
as Monterrey.
Peso–dollar exchange rate fluctuations significantly influence crossborder shopping activity (see chart). For
instance, the peso began losing value in
third quarter 2008, falling from roughly
10 pesos per dollar to almost 15; in turn,
border city retail sales contracted almost
15 percent. Conversely, when the peso
rose against the dollar during 2009–11,
Texas border retail sales quickly inched
up.
When the peso lost ground again
against the dollar in the first half of this
year, Texas border cities—particularly in
the Rio Grande Valley—felt the pinch, as
evidenced by weak growth in retail-dependent employment. A high crime rate
in northern Mexico also likely affected
border retail activity. Reports of crime
along the highways connecting Monterrey to McAllen and Laredo deterred
Mexican shoppers’ travels, according to
anecdotal evidence.
The good news is that the peso has
strengthened almost 10 percent against

Principal Texas Border Cities
El Paso

Laredo

McAllen
Brownsville

the dollar since June, and some headway
has been made on public security. Given
these improvements, Mexican shopping in Texas should increase in coming
months.
Note
“Cross-Border Retail Activity Along the Texas–Mexico
Border,” by Roberto A. Coronado, Keith R. Phillips
and Eduardo Saucedo, Federal Reserve Bank of Dallas
Working Paper, forthcoming 2013.
1

Border Retail Sales React to Exchange Rate Changes
Index, fourth quarter 2007 = 100*

105

Pesos per dollar

15

Border Sales**
Texas border retail

Brownsville

100

14

15%

95
90

McAllen
35%

El Paso
37%

13

Laredo
13%

12

85

11
Exchange rate

80

10

75

9

70

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

8

*Real, seasonally adjusted.
**Reflects each city’s estimated share of total sales in the four largest Texas border cities.
SOURCES: Texas Comptroller of Public Accounts; Banco de México.

Southwest Economy • Federal Reserve Bank of Dallas • Fourth Quarter 2012

15

Booming Shale Gas Production Drives
Texas Petrochemical Surge
By Jesse Thompson

A

highly profitable petrochemical industry has reemerged in
Texas from the boom in U.S.
shale oil-and-gas exploration,
creating an internationally competitive
sector that can produce a variety of products including plastics at a lower cost.1
Advances in the exploration of
shale, the source rock from which oil
and gas have seeped for millions of
years, have brought to market new supplies of oil, natural gas and natural gas
liquids (NGLs) such as ethane, a key
petrochemical feedstock or input. This
modern-day gusher was made possible
by hydraulic fracturing (also known as
fracking) and horizontal drilling in the
United States.
These technologies have helped
reduce the price of natural gas, which
was once in line with oil, and led to
the production of lower-cost NGLs
(Chart 1). Because U.S. petrochemical
firms commonly use NGLs for feedstock, their input costs have fallen and
they have gained an export advantage
over competitors in other parts of
the world that heavily rely on much
pricier oil-based naphtha.
At the epicenter of the shale boom
is Texas, a significant player in the U.S.
petrochemical industry and home to
some of the nation’s most productive shale areas. The state is reaping
economic gains from the petrochemical resurgence that include increases in
construction, jobs and exports.

Changing Hydrocarbon Industry
Ethane and propane are key NGLs
in ethylene—an intermediate petrochemical used in polyethylene, polyvinyl chloride, some polyesters and other
substances. Those substances become
components of products such as PVC
pipe and an array of plastics and industrial products.

16

Chart

1

Oil Prices Rise, While Gas Falls on Higher Supplies

Price of oil relative to natural gas*

12
10
8
6
4
2
0

’74 ’76 ’78 ’80 ’82 ’84 ’86 ’88 ’90 ’92 ’94 ’96 ’98 ’00 ’02 ’04 ’06 ’08 ’10 ’12

* Refiners’ acquisition cost of imported crude relative to wellhead price of natural gas.
SOURCES: Energy Information Administration; author’s calculations.

Globally, the growth rate for ethylene production slowed in the decade
before the recent recession. After
averaging 5 percent annually from
1990 to 2000, the rate declined, almost
matching global gross domestic product growth of 2.5 percent from 2000 to
2009.2 Demand for petrochemicals was
increasingly concentrated in emerging markets where U.S. manufacturers
couldn’t overcome a strong dollar and
international transportation costs. As
a result, U.S. petrochemical firms confronted a steadily eroding outlook that
left little justification for investment in
new facilities.
The unlocking of hydrocarbons
within shale and the resulting decline
in natural gas prices—from $6.25 per
thousand cubic feet (Mcf ) in 2007 to
$2.40 in the first half of 2012—changed
the petrochemical industry.3
Shale fracking and horizontal
drilling technologies in the early 2000s
yielded discoveries in the Barnett Shale

in North Central Texas before spreading to the Eagle Ford in South Texas;
the Haynesville in Arkansas, Louisiana
and East Texas; and the Marcellus in
the Northeastern U.S.
These technologies not only led
to the initial natural gas finds, but also
proved successful at extracting oil and
other liquids.
The Eagle Ford is expected to produce more than 90 million barrels of oil
and 51 million oil-equivalent barrels of
natural gas in 2012 after yielding less
than 10 million barrels of both in 2009.
Total annual Texas oil production,
which fell steadily for decades and
bottomed out in 2007 at 391 million
barrels, may reach 712 million barrels
this year—an 82 percent increase over
five years.4
When global commodity prices
spiked in 2008, natural gas prices
soared to $10.79 per Mcf and oil
reached a high of $127.77 per barrel. Both tumbled amid the global

Southwest Economy • Federal Reserve Bank of Dallas • Fourth Quarter 2012

economic recession, with natural gas
falling to $3.70 per Mcf and oil sliding
to $36.84 per barrel in early 2009. Gas
prices rebounded to $5.69 per Mcf by
January 2010, only to begin a sustained
decline that just recently showed signs
of abating. Oil, meanwhile, hovered
between $70 and $80 per barrel in 2010
and has stood at around $100 since
March 2011.
Fracking expanded the U.S. production of natural gas and NGLs far
more rapidly than the market could
absorb them or export them, unwinding more than a decade of rising input
costs for U.S. petrochemical firms. Natural gas prices this year reached their
lowest levels since 1975, adjusted for
inflation. Ethane and propane tumbled
40 percent to their lowest prices in at
least two decades.5
The Eagle Ford, with its significant amounts of oil and NGLs and a
network of pipelines and plants, feeds
Texas refining and petrochemical facilities.6 Overall, Texas accounts for 72
percent of U.S. ethylene capacity.

A Boon to U.S. Competitiveness
While the U.S. petrochemical
industry primarily uses NGLs (mostly
ethane) to make ethylene, other areas
of the world (outside the Middle East)
heavily rely on naphtha (Table 1).
Naphtha has followed oil prices higher.
Underscoring the impact of diverging oil and natural gas prices, it cost 60
cents to produce a pound of ethylene
with nearly 12 cents worth of ethane
in September 2012; alternatively, one
pound of ethylene required $1.37 of
naphtha. While the NGL-based product
was clearly profitable, the oil-based version was not (Chart 2).
From May 2011 to September
2012, the difference in the feedstock
costs rose fivefold.

Investing in New Capacity
The U.S.—with Texas at the
forefront—has become a highly costeffective place to invest in new petrochemical plants, even if the market
for that new production is in emerging economies.7 Ethylene capacity is
poised to increase almost 33 percent

by 2017, pending completion of all new
plants, expansions, enhancements and
restarts of shutdown facilities that have
been announced in the U.S. (Table 2).8
Obtaining permits for these new
projects can take more than two years,
with individual facilities representing
an investment of $350 million to $1.7
billion. The regional economic impact
of the construction alone should be
significant, with Gulf Coast crews
earning from $25 an hour for experienced personnel to $40 an hour for
the slightly more than 10 percent of
the workforce with specialized skills.
Machining and fabrication of pipes,
fittings, valves and other specialty components for these facilities could provide more work for U.S. firms. Moreover, these new and revamped facilities

Table

1

U.S.—with Texas
}The
at the forefront—has
become a highly costeffective place to invest
in new petrochemical
plants.

U.S. Favors Natural Gas Liquids in Ethylene Production;
Other Nations Use Oil-Based Naphtha
Nameplate capacity, 2011*

Area
Asia Pacific
Middle East
United States
Western Europe
Rest of the world

Million tons/year
29.2
24.1
27.6
24.4
38.9

Feedstock mix, 2011 (percent)**
NGL
21
75
59
20
47

Naphtha
76
21
30
71
45

Other
3
4
11
9
8

*Nameplate capacity refers to the theoretical maximum output in a given year under ideal conditions.
**Percent of capacity reporting feedstock usage in each region: Asia Pacific, 82 percent; Middle East, 46 percent; U.S.,
99 percent; Western Europe, 89 percent; rest of the world, 56 percent.
SOURCES: 2012 International Survey of Ethylene Steam Crackers; author’s calculations.

Chart

2

Profit Margins Grow for Ethylene Made from Ethane

Cents/pound

60
50

Ethane

40
30
20
10
0
–10
–20
Naphtha

–30
–40

1998

2000

2002

2004

2006

2008

2010

2012

SOURCES: Muse, Stancil and Co.; author’s calculations.

Southwest Economy • Federal Reserve Bank of Dallas • Fourth Quarter 2012

17

Table

2

is a leading
}Texas
exporter, accounting
for 17 percent of all
U.S. exports in 2011,
including 24 percent
of chemicals and 12
percent of plastics and
rubber products—
categories that include
resins for pipes, toys,
plastic cups and
antifreeze.

Shale Gas Spurs Investment in Ethylene Capacity

Company
ExxonMobil Chemical
Chevron Phillips Chemical
Dow Chemical
Shell
Formosa Plastics
Dow Chemical
LyondellBasell
Williams
Westlake Chemical
Westlake Chemical
INEOS

Project
New cracker
New cracker
New cracker
New cracker
New cracker
Restart
Expansion
Expansion
Expansion
Expansion
Debottleneck

Capacity
Location
Cost
Start-up
1.5m tons
Baytown, TX
n.a.
2016
1.5m tons
Cedar Bayou, TX
n.a.
1Q 2017
>800,000 tons
U.S. Gulf Coast
n.a.
2016-17
>800,000 tons
U.S. Northeast
n.a.
2016-17
800,000 tons
Point Comfort, TX
$1.7bn
2016
390,000 tons St. Charles Parish, LA
n.a.
End 2012
386,000 tons
La Porte, TX
n.a.
2014
272,158 tons
Geismar, LA
$350m–$400m
3Q 2012
113,399 tons
Lake Charles, LA
n.a.
2014
108,863 tons
Lake Charles, LA
n.a.
Midyear 2012
115,000 tons Chocolate Bayou, TX
n.a.
End 2013

NOTES Crackers are plants that refine ethane into ethylene. The entry “n.a.” denotes that the project cost was not available.
SOURCE: ICIS.

of chemicals and 12 percent of plastics
and rubber products—categories that
include resins for pipes, toys, plastic
cups and antifreeze.
The value and tonnage of Texas
petrochemical exports have grown
over the last decade on strong global
activity. More recently, shipments have
soared on cost advantages and foreign
markets’ relative attractiveness. This
is particularly true for two ethylenebased products—polyethylene and vinyls. Polyethylene has been an increasingly important export over the last
20 years, doubling its share to nearly
half of all ethylene-related chemicals
and resins sent abroad (Chart 3).10
Polyethylene is used for such items as
plastic lids and containers, packaging
for consumer products, televisions and

will require highly skilled personnel to
monitor and maintain plant systems.
To take advantage of export opportunities, ethylene must be sent to other
new or expanded chemical facilities
that will transform it and other intermediate products into consumer goods
and components for further manufacturing. The construction and expansion
at this stage is similarly valuable. For
example, Chevron Phillips has announced two polyethylene facilities
in addition to a new ethylene plant in
Southeast Texas, representing an estimated $5 billion total investment.9

Building Export Trade
Texas is a leading exporter, accounting for 17 percent of all U.S.
exports in 2011, including 24 percent

Chart

3

Exports of Major Ethylene Products Soar

Thousands of tons (polyethylene, vinyls)

Thousands of tons (HDPE, PVC)

350

1,000
900
800
700

Polyethylene
Vinyls
PVC (pipes)
HDPE (pipelines, Tupperware)

300
250

600

200

500
150

400
300

100

200

50

100
0

’90

’92

’94

’96

’98

’00

’02

’04

SOURCES: International Trade Commission; author’s calculations.

18

Southwest Economy • Federal Reserve Bank of Dallas • Fourth Quarter 2012

’06

’08

’10

’12

0

cell phones. Vinyls make up a similar
share of ethylene-related chemical
exports and are overwhelmingly tied
to construction-related products such
as the large pipes used in municipal
water operations. As U.S. construction
tumbled at the outset of the recent
recession, sales abroad of polyvinyl
chloride pipe, also known as PVC,
increased.
Overall, greater domestic ethylene
production capacity will significantly
outstrip projected domestic demand
growth over the next several years. As
a result, U.S. petrochemical exports,
particularly from Texas, will expand
significantly.

Robust Outlook for U.S. Firms
U.S. producers of ethylene-based
petrochemicals have gained a significant cost advantage and greater global
competitiveness because of relatively
inexpensive and plentiful NGLs from
hydraulic fracturing of shale. Projects
capitalizing on the shale boom will
drive a wave of construction as plants
are built and pipeline infrastructure
and storage capacity are expanded
along the Gulf Coast over the next five
years.
The extent of the construction
depends on several factors, including
regulatory constraints.11 Whatever the
outcome, cheaper raw material inputs
are likely to uniquely benefit Texas
firms for some time, and petrochemicals will become an increasingly important component of already expanding Texas exports.12

3
See “Oil Boom in Eagle Ford Shale Brings New
Wealth to South Texas,” by Bill Gilmer, Raúl Hernandez
and Keith R. Phillips, Federal Reserve Bank of Dallas
Southwest Economy, Second Quarter 2012.
4
Projection based on the average monthly increase in
Texas production in 2012 through August.
5
Mont Belvieu and Conway NGL spot prices from
Bloomberg.
6
Data from the 2012 International Survey of Ethylene
from Steam Crackers.
7
Ethylene plants are also referred to as “crackers,” a
term that describes the process of breaking up—or
cracking—feedstock into smaller units such as ethylene.
8
“ExxonMobil Brings Total U.S. C2 Expansions to over
33 Percent of Capacity,” by Joseph Chang, ICIS, June
1, 2012, www.icis.com/Articles/2012/06/01/9566472/
exxonmobil-brings-total-us-c2-expansions-to-over-33of.html.
9
“Chevron Phillips Chemical Chooses Old
Ocean, Texas, Site for New Polyethylene Plants,”
by Bernardo Fallas, Platts, April 30, 2012, www.
platts.com/RSSFeedDetailedNews/RSSFeed/
Petrochemicals/6243222.
10
The data presented were limited to resins and
chemicals within the ethylene chain that make up
the bulk of export tonnage, and largely excluded
end products. Examples of included substances are
vinyl chloride (chloroethylene), ethylene dichloride,
trichlorethylene, vinyl acetate and polymers, PVC and
polymers, HDPE (high-density polyethylene), linear lowdensity polyethylene, low-density polyethylene, other
polymers of ethylene, ethylene copolymers, etc.
11
Many considerations are not addressed in this article,
including the potential environmental impact of these
facilities and of hydraulic fracturing, the effects on
property taxes and the potential impact of a capacity
overbuild.
12
See “U.S. LNG Exports Truth and Consequence,”
by Kenneth B. Medlock, James A Baker III Institute for
Public Policy, Rice University, Aug. 10, 2012, http://
bakerinstitute.org/publications/US%20LNG%20
Exports%20-%20Truth%20and%20Consequence%20
Final_Aug12-1.pdf.

greater
}Overall,
domestic ethylene
production capacity will
significantly outstrip
projected domestic
demand growth
over the next several
years. As a result, U.S.
petrochemical exports,
particularly from Texas,
will expand significantly.

Thompson is a business economist in
the Houston Branch of the Federal
Reserve Bank of Dallas.
Notes
1
“Petrochemical” refers to a group of substances that
are ultimately derived from oil or natural gas. The term
is usually applied to substances such as ethylene,
propylene and their byproducts, which are used to make
plastics, among other things. “Petroleum product”
usually refers to substances with molecular properties
such as those of gasoline and diesel.
2
See “Petrochemicals: Preparing for a Supercycle,”
Morgan Stanley Blue Paper, Oct. 18, 2010, www.
morganstanley.com/views/perspectives/preparingfor_
supercycle.pdf.

Southwest Economy • Federal Reserve Bank of Dallas • Fourth Quarter 2012

19

Federal Reserve Bank of Dallas
P.O. Box 655906
Dallas, TX 75265-5906

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Snapshot Mexico’s Economic Expansion Slows

M

exico’s economy appears to have slowed. Thirdquarter real gross domestic product grew at an
annual rate of 1.8 percent on a quarter-over-quarter
basis, down from 3.3 percent in the second quarter and
5.4 percent in the first quarter. In third quarter 2012,
goods-producing industries (including manufacturing,
construction, utilities and mining) expanded at a 2.9 percent annualized rate. Service-related activities (including
trade, transportation, services and government) grew 3
percent on an annualized basis from the previous quarter.
Agricultural output fell 2.2 percent. Exports fell, while employment, industrial production and retail sales advanced
in September.
Inflation is still running above target but fell for the
second month in a row, down to 4.2 percent in November,
after increasing for five consecutive months. The exchange
rate of 12.8 pesos per dollar is up about 7 percent against
the dollar since the beginning of the year. Aware of the economic slowdown but leery of inflation, Banco de México

DALLASFED

Mexico Gross Domestic Product
Percent annual growth rate

15
10
5
0
–5
–10
–15
–20
–25
–30

2007

2008

2009

2010

2011

2012

SOURCE: Instituto Nacional de Estadística y Geografía.

has not changed its monetary policy stance, holding the
benchmark interest rate at 4.5 percent since July 2009.
—Adapted from the Mexico Economic Update,
Federal Reserve Bank of Dallas

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
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Articles may be reprinted on the condition that the
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