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Energy and T
the Southwest

he dramatic change in oil prices
during the last twO decades
created much economic turbulence in
the Southwest. As oil prices rose during
the 19705, the economy accelerated;
but when prices fell, the economy faltered. Over the last several years the
energy industry has played a reduced
role in the Southwest. Relying more on
growth in services and manufacturing,
the Southwest is recovering from an energy-induced recession. Looking ahead,
the energy industry will not likely return to ilS former degree of prominence. During the 1990s, however, the
energy industry should capture a growing share of the Soulhwest economy.

on Price volatility

The rise and fall in oil prices was
dramatic (Chart J). After a long stable
period, lhe first big jolt in oil prices
came after the 1973-74 oil embargo.
The next big jump came on the heels
of the II""J.n-lraq war in the late 19705.
Belwcen mid-1973 and early 1981
inflation-adjusted oil prices more than
tripled. In 1980, near the peak in oil
prices, many analysts were forecasling
that oil prices would reach 560 to 570
per barrel by the end of the decade.
BUI beginning in 1981, inflationadjusted oil prices began to slide.
Increased energy conservation,
increased usage of nuclear power and
coal and increased oil production
outside of OPEC caused a price retreat.
In 1986, the downward movemenl in


the oil price accelerated when discontent within OPEC caused excessive
cheating on supply quotas. By mid1986, inflation-adjusted oil prices had
returned to their pre-1974 levels. The
dramatiC change in oil prices during
this period played an important role in
the growth of the energy-producing
states of the Southwest.
Past Performance of the Southwest

Chart 2 shows the percentage of
U.S. output originating from each of the
Southwest's energy-producing states. [n
this chart, an increasing line signifies
that lhe value of the state's output is
growing faster than the nation's. During
the period of rising oil prices, all four
of the energy-producing states in the
Southwest grew faster than the nation.
When prices fell dUring the 1980s,
however, the states grew more slowly
than the nation.

Chart 1
Real Oil Price
(19111 <lobrIo per ba"~)

.. r---~)


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Much of the change in output
growth in the Southwest over the last
two dL'Cades can be directly attributed
to changes in output in oil and gas
extr;K1ion. As shown in Chan 3, oil and
gas extraction was an imponant pan of
the Southwest economies even before
the initial iump in oil prices in 1974.
With the rise in energy prices, oil and
gas extraction captured an increasing
share of the region's economy. By 1981
the share of output from oil and gas
extraction had risen to 30 percent in

Louisiana, 25 percent in New Mexico,
21 percent in Oklahoma and 19 percent
in Texas. Since 1981. however, the
dramatic decline in energy output
reduced these shares to about half of
their peak levels.
TIle large swings in energy's share
of output also played a significant role
in employment growth in the Soulhwest. An earlier study showed that from
1972 to 1982 growth in the energy
industry was responsible for 45 percent
of total employment growth in Texas.'

Chart 2
Stale Output as a Percent
of U.S. Output

Chart 3
Oil and Gas Extraction as a
Percent of Output


, ,

," ,

... ---


LouisiatII ,







1.6 __









UniWI Sll'"










Economic Diversification



as percent
of actual




Changes in the energy industry over
the last [WO decades have affecled economic diversification in the Southwest
(Chart 4).J From 1970 to 1979 Texas
shifted into highly volatile industries
and into industries whose perfonnance
moved together. The shift caused diversification 10 decline. Since 1979, however, the slate has moved to more stable
and more independent industries,
increasing economic diversification.
Much of the change in diversification over this period was the result of
the growth and subsequent decline of




Table 2










Change in employment
(thousands of workers)

Durable manufacturing
Transportation and
public utllities
Wholesale trade
Retail trade
Finance, insurance,
and real estate
Total private
nonagricultural employment

Energy and


Table 1
Importance of Energy to Texas Employment Growth, 1972-82


During this period the energy industry
had a significant effect on employment
growth in every major sector of Ihe
Texas economy (Table 1). For example,
the construction seaor grew by 172,000
workers, and 96,000 of these new jobs
(about 56 percent) were related to the
growth in the energy sector.
[n a related study, two e<:onomislS
looked at the t()(al effect on state employment of a change in the oil price?
Table 2 shows the percentage decrease
in employment resulting from a pennanent 55 per barrel decrease in the oil
price. A $5 decline occurring in 1985
would cause an employment decline of
3.1 percent in Oklahoma, 1.9 percent in
Louisiana, 1.7 percent in Texas and 1.1
percent in New Mexico. These figures
represent significant declines in these
states' employment. The decline in
energy and the growth of ()(her sectors,
however, have decreased the effecl of
an oil price change.

Percent Decreases in Employment
Resulting from a $5 Oil Price Decrease



New Mexico



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Chart 4

TeKas Economic Diversification
(Ind&x: January 1979-100j


the energy sector, A growing share of
the volatile energy sector during the
19705 decreased economic diversification in the Southwest, while a growing
share of other industries during the
1980s increased diversification. During
the last two decades, out of 59 industries, the two most volatile industries in
Texas were oil field machinery manufacturing and oil and gas extraction.
Today's industrial structure in the
Southwest is concentrated more in
manufacturing and services and less in
energy than earlier in this decade,
Because manufacturing and services are
less volatile than energy, today's industrial structure provides a more stable
economic environment. However, if the
energy indusuy returns to its level of
dominance as seen in the early 1980s,
the Southwest could return to a less
stable economy.

on Prices RiseProduction Declines
To estimate the role of energy in the
future of the Southwest, we must first
consider the future demand for oil.
Chan 5 shows estimated paths of oil
consumption to the year 2CXXl for
various oil prices, assuming that world
output grows at a 2.5-percent annual
rate.' The chan also shows current
world oil capaCity. As the chart
indicates, current oil prices are too low
{Q be suslained over the next decade
unless capacity grows sharply.
Oil consumption takes many years

to fully adjust to changes in oil prices.
Much of the decrease in oil consumption during the 1980s was in response
to oil price increases that occurred from
1979 to 1981. Currently, oil consumption is below its long-run equilibrium
and, at current prices, can be expected
to increase, To keep consumption at or
below current world capacity, oil prices
(in 1988 dollars) must rise to at least
535 per barrel by the year 2000. If
capacity rises in the futurc, the oil price
is likely 10 be closer 10 530 per barrel.
Even with growing consumption
and price, the oil industry is unlikely to
regain its fomler prominence in the
Southwest economy beeause the Southwest is running out of oil. Despite
Chart 5

World Oil Consumption at Various Oil Prices

ot barrels PI'" day)



32.81965 1917 1989 1991

1993 1995 1997 1999

Note: Oil f'fiaIs ant 1988 OoIlIrs

sharp increases in oil prices and drilling
activity from 1979101981, proven oil
reserves in the Southwesl failed to tum
around from their long decline.
Oil prodUCtiOn in the Southwest has
also declined since the early 19705. For
example, in 1981, at the peak in oil
prices, crude production in the
Southwest was at its lowest level in 20
years. A continuing depletion of
reserves will limit future oil production.
While a growing demand will likely
drive innation-adjustcd oil prices to
nearly 530 per barrel by the year 2CXXl,
oil production in the Southwest will
likely decrcase by 17 percent. The
combination of a higher price and
lower production will increase slightly

the oil industry'S current share of the
Southwest economy. However, the oil
industry's share will remain significantly
below peak levels reached in the early


The Growing Importance
of Natural Gas
Although oil extraclion's imponance
in the Southwest economy is unlikely
to increase much from recent levels,
natural gas production may become
increasingly impott.1nl. There are four
principal reasons why natural gas is
likely to gain an increasing share of the
Southwest economy.
The first reason is natural gas
deregulation. 111e excess supply of
natural gas over the last several years
has prompted legislation to create a
more competitive environment for the
supply and demand for natural gas.
Legislation reducing the restrictions on
natural gas usage by power plants and
industries, the elimination of federal
price controls on natural gas and new
federal regulations deregulating the
natural gas pipeline industry should
encourage a greater supply and
demand for gas in the future.
The second reason is that the
Southwest has substantial natural gas
resources. It is estimated that at current
produclion levels, the U.S. has up to a
34-year supply of naruml gas. "-lore
than half of these estimated resources
lie in the Southwest. Oil, on the other
hand, is estimated as haVing only a 26year supply and less than 40 percent of
these resources are estimated to be in
the Southwest.$
The third reason is environmental.
The Bush administmtion's proposed
revision of the Clean Air Act is indicative of recent increased environmental
concerns. The burning of natural gas
emits less SO(){, carbon monoxide,
sulfur oxides and other pollutants than
does the buming of other fossil fuels.
Concerns about smog, acid T" and a
warming of the e:H1h's atmosphere
should stimulate the demand for natural
gas in the future.

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The founh reason is technological.
Recent advances have increased the
demand and supply of natural gas.
Developments in highly efficient gasfired turbines have made the cost of
natural gas-generated electricity favorable relative to the use of other fuels.
Also, advances in drilling technology
have increased the production of natural gas from unconventional sources.
As demand increases, the price of
natural gas is likely to rise. The
projected average wellhead price of
natural gas in 1988 dollars is shown in
Chan 6. This forecast was produced by
the U.S. Depanment of Energy and
assumes that the oil price (in 1988
dollars) increases to 528 per barrel by
the year 2000. 6 The rising price of
natural gas reflects increased demand
and the elimination of the excess
supply of natuml gas that has existed in
the market since the early 1980s. By the
year 2000 the inflation-adjusted gas
price should double its 1988 level and
should exceed its early 19805 peak of
about 53 per thousand cubic feet.
Under this scenario, natuml gas production will reverse its long decline, rising
at an annual rJ.te of about 1 percent.

dollars) as much as 561 billion a year to
the Southwest economy. Taking into
accoum declining oil reserves and increasing oil prices, oil will add an 3dditional 532 billion to lhe Southwest
economy. [f lotal real Outpul grows 3
percem annually, oil and gas extraction's share of output in the Southwest
will likely increase from about 9
percem in 1988 to about 14 percem by
the year 2000 (Chart 7).
While energy extmction's share of
the Southwest's output is likely to be
significantly higher than in 1988, it
should remain well below the peak
level of 19S1. By 2000, oil's share of
outpul will increase only slightly and
Chart 7
Energy Extraction as a Percent
of Southwest Output





should be only aboul one-third of its
peak level. The share of OUlput from
natuml gas, however, should increase
slrongly and actually surpass its earlier

Chart 6
Average Wellhead Price o! Natural Gas
(In 1988 OOIIars per thousand <:vljc teet)








See John K. Hill, "Energy's Contribution to the Growth of Employment in
Texas, [972-1982." Fedcml Reserve
Bank of D31las t:C01/omic Review, May
1986, [1-18.
l See S.P.A. Brown :md John K, Hill,
"lower Oil Prices and Slate Employment," Contempomry Policy Issues,
July 1988, 60-66.
J This measure is lhe inverse of the
insl3biHty index presented in Wj]]iam C.
Gruben and Keith R. Phillips, "Diversifying Texas: Recent History and ProspeCl~,· Fedeml Reserve Bank of Dalbs
Economic Review, July 1989, 1-12.
~ This chan was derived from Slephen
P,A. Brown and Keith R. Phillips, "Oil
Prices and Consumption in lhe 1990s,FederJ.1 Reserve Bank of Dallas
Economic Review, January 1989, 1-8.
~ Reserves for oil and g3S include
measured, inferred, indicated and
economically recovemble resources.
See "Eslim:l.les of Undiscovered Convention:J.l Oil and Gas Resources in the
United St:ltes---A Pan of the Nation's
Energy Endowment,~ 1989, U.S. Department of lhe [nlerior. U.S. GeologiC'"J.1
Survey, Management Service,
6 ibid.

The Future of Energy
In the Southwest

[f energy prices increase as projected, oil and gas extraction should
become more important to the Southwest. By the year 2000 the natural gas
industry could add (in inflation-adjusted

will provide significant gains in jobs
and output, il could also reverse much
of lhe recent economic diversification
in the SOllthwest. I3eClUse the energy
industry is more volatile than other
sectors, a growing energy SC(10r ('ould
increase the volalility of the Southwest
economy. As the energy industry
grows, the Soulhwest must provide a
favor:lble business climale to promole
growth in all areas of the economy.
Conlinuing growth in manufacturing
and service industries lhat are not tied
to energy will 3ssure the Southwest of
healthy, stable growth in lhe fulure.
-Keilh R. Phillips

Energy extmction has become a
smaller pan of lhe South\vest economy
in recent years, and oil is not likely to
regain much of its previous imponance.
Gains in lhe demand and price of
natural gas, however, may lead energy
extmction to a more significant role in
the future. Although energy cxtrJ.ction's
share of the Southwest economy m3Y
nOI be 3S large 35 it was in the early
1980s, it should increase from the
depressed level of 1988.
While a growing energy industry

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Beef Prices Expected to Fall with Herd Rebuilding
After seven years of liquidation, Southwest cattle operators
are slowly rebuilding their herds. Beef production is expected
to increase by the end of 1990, pushing down beef prices.


Per Capita Consumption, Retail Weight

SoUlhwest ranchers are concemed about how far beef prices
will fall and that beef may have lost market share as a result of
a decrease in demand for beef because of health concerns.


During the most recent cattle cycle, cattle producers have
been particularly slow to increase their beef inventory in response to positive rerums over cash costs. The cattle industry
has experienced positive returns since 1986. Cattle producers,
however, continued 10 liquidate their inventory, and only now
are they slowly rebuilding their herds.






Cattle Producers Cautious About Rebuilding Herds
several factors may contribute to the cattle operators' cau-

tious approach loward herd rebuilding: drought, debt service,
reduced investment capital. and concerns about price declines
in the future.
Drought decreased cattle producers' relUrns in 1988 and
1989, which discouraged herd rebuilding. Insufficient moisture
increased producers' production cost by reducing water
supplies and increasing the COSt of feed. Moisture conditions
have now improved throughout much of the Southwest.
Debt service may have prevented some cattle operators
from rebuilding their herds. Although returns turned positive
in 1986, producers had experienced negative margins for nine
of the previous twelve years. Some producers had to reduce
debt accumulated during the years of negative margins before
they could begin herd rebuilding.
Tax law changes reduced the availability of investment capital to cattle producers and likely slowed herd rebuilding.
lJmited partnerships, a major source of cattle-based investment
funds, were stimulated by favorable tax treatment in the early
1980s. The 1986 Tax Reform Act, however, eliminated this tax
advantage and reduced the return on these investments.
Uncertainty about beef prices in the future may also explain
why producers are slow to respond to positive returns.
Increasing the cattle supply will place downward pressure on
beef prices. Producers want to be sure that prices wiII remain
high enough to cover the costs of their increased inventol)'.
Producers are worried that concerns about cholesterol have
encouraged consumers to shift their demand away from beef.
This shift would reduce beef prices and the profitability of
cattle production.

Decllning Market ShaJ'e: Prices or Health Concerns?
Beef has lost market share to pork and poultl)' over the last
IS years. (see the chart.) Since 1976, beef consumption declined 25 percent, while consumption of pork and chicken
increased 17 percent and 58 percent, respectively. Though
some of the reduction in market share may be the result of a
shift in consumer demand away from beef because of health
concerns, changes in beef prices strongly suggest that consum-




ers have reduced beef demand be<.'ause of the increasing
relative price of beef.
Beef prices have increased 72 percent since 1976. compared with increases of 37 percent and 43 percent for pork
and chicken, respectively. If consumers were reducing beef
consumption for health reasons, then beef prices would have
fallen relative to chicken prices and demand would have
shifted away from pork, another red meat. Pork consumption,
however. has risen while beef consumption has dropped.
Increases in the relative price of beef have contributed
heavily to reduced beef consumption and have overwhelmed
any reduction in consumption due to health concerns. Beef
prices were most likely rising in response to the decreasing
supply of beef associated with herd liquidation. Although
health concerns affect some consumers' demand for beef,
beef's market share appears to be determined by the relative
price of beef.
-Fiona Sigalla
Texas Agricultural Extension service, Texas Livestock Markel
Comments, August 4, 1989.
U. S. Department of Agriculture, Economic Research service,
Commodity Economics Division, Livestock and Poultry;
Situation Wid Outlook Report, LPS-37, August 1989.

1be Southwest Ecollomy is published six times annually by
the Federal Reserve Bank of Dallas. The views expressed
are those of the authors and should not be attributed to the
Federal Reserve Bank of Dallas or the Federal Reserve
Articles may be reprinted on the condition that the source
is credited and a copy is provided to the Research Department of the Federal Reserve Bank of Dallas.
The Southwest Economy is available withom charge by
Writing the Public Affairs Department, Federal Reserve Bank
of Dallas, Station K, Dallas, Texas 75222 or by telephoning
(214) 65]-6289.

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Economic Commentary
by Haroey Rosenblum
Senior Vice President and Director ofResearch
Federal Reserve Bank ofDallas

The Regional Implications of a National Economic Slowdown
The trend loward slower rates of growth of the U.S. economy
is likely to continue through the end of 1990. But Louisiana, New

Mexico, Oklahoma, and Texas should see improvement relative
to the nation.
National Economy 15 Slowing
The slowdown ohhe national economy can be attributed partly to resource constraints. Capacity utilization is near its highest
level since the early 1970s. The labor market has also tightened.
Substantial increases in nalional economic activity would likely rekindle inflation. But while inflation remains a concern, slower
economic growth coupled with monetary and fiscal policy restraint should alleviate inflationary pressures.
Indeed, preliminary signs indicate thai the inflation rate is
slOWing while the economy expands at a moderate pace. Data released forthe late summer period suggest slightly more economic
growth nationally than is implied by the term "soft landing. "In any
case, a national recession seems unlikely in the near future.
Recovery Underway in the Southwest
An economic recovery is already underway in the Southwest,
despite continued weakness in construction and energy. But the
continued weakness in these two sectors draws attention away
from the emerging health of the remainder of the Southwest
economy. There is no doubt thatlhe Southwest economy was hurt
by downturns in these twO sectors, but now construction declines
have moderated and the energy industry appears to be mending.
More importantly, the region's two largest sectors--services and
manufacturing-are growing at rates dose to that of the nation.

Shifting Economic Forces Favor the Southwest
Economic fortunes are shifting in favor of the Southwest. The
national slowdown is likely to cut unevenly. Some states that
experienced strong economies over the past five years are now
shOWing signs of potential weakness. Far from seeing a soft
landing, some Northeastern states could see a bumpy landing as
the national economy slows. In contrast, the Southwest should
see continued re<:ovety.
Five factors that shaped regional perfonnance in recent
years--energy prices, the value of the dollar, defense spending,
construction, and the financial health of the banking industryare changing, affecting regional economic perfonnance. Overall,
the Southwest should benefit. Some other slates should be
affected adversely. Let's consider each factor in tum.

Energy prices. During much of the 19805, lower energy
prices stimulated emnomic grov.'th in forty states of the United
States while hurting the ten energy-exporting states. The effects
of lower energy prices on economic gro'Mh are behind us,
however. and energy prices can be expected to rise over the next
five to ten years. Other parts of the country. particularly the oilconsuming Slates in the Northeast. will experience reduced
economic gro\\1h while much of the Southwest benefits.
The dollar. The dollar depreciated some 30 percent from
March 1985 to April 1988, stimulating growth in the manufactUring
centers of the Northeast and the Midwest. But with their plants
operating near capacity limits and the dollars recent appreciation,
further gains are unlikely. Any remaining expansion will occur
where resources are available; excess capacity and abundant
labor suggest the Southwest.
Defense spending. National defense spending is declining,
which muld mean problems for the defense-dependent states in
New England. Growth in defense-dependent New Mexico is likely to be hurt as well. For states such as Texas that are not excessively dependent on defense, CUts in defense spending should
impose a lighter e<:onomic burden. The Dallas-Fort Worth metroplex, however, contains an abundance of defense-related manufacturing that will be adversely affected by the anticipated
reductions in defense spending.
Construction. Much of the Southwest suffers from overbuilding. But it is largely a known and quantifiable problem in the
Southwest, and declines in construction over the last few years
have helped reduce the problem. Overbuilding is just now becoming evident in the Northeast and other parts of the country.
A shrinking construction sector in these areas will reinforce other
negative trends.
Banking. Recent events in the Southwest have revealed the
difficulties that problems in the banking industry can cause for
other sectors of the economy. Recapitalization of the banking and
thrift industries with private and federal funds is beginning to
resolve apparent capital shortages in Texas, Oklahoma, New
Mexico, and Louisiana. However. the early signs of banking
problems are now becoming evident in other parts of the country.
I" summary, changes in five critical factors, together with
excess capacity and abundant labor in the Southwest. suggest
continued expansion and the possibility of stronger economic
growth in the Southwest--even as the national economy slows.
In fact, parts of the Southwest may lead the nation in overall
economic performance during the next five years.

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