"Houston, You Have A Problem" - Texas Is Headed For A Recession Due To Oil Crash, JPM Warns
It was back in August 2013, when there was nothing but clear skies ahead of the US shale industry that we asked "How Much Is Oil Supporting U.S. Employment Gains?" The answer we gave:
The American Petroleum Institute said last week the U.S. oil and natural gas sector was an engine driving job growth. Eight percent of the U.S. economy is supported by the energy sector, the industry's lobbying group said, up from the 7.7 percent recorded the last time the API examined the issue. The employment assessment came as the Energy Department said oil and gas production continued to make gains across the board. With the right energy policies in place, API said the economy could grow even more. But with oil and gas production already at record levels, the narrative over the jobs prospects may be failing on its own accord.... The API's report said each of the direct jobs in the oil and natural gas industry translated to 2.8 jobs in other sectors of the U.S. economy. That in turn translates to a total impact on U.S. gross domestic product of $1.2 trillion, the study found.
Two weeks ago we followed up with an article looking at "Jobs: Shale States vs Non-Shale States" in which we showed the following chart:
And added the following:
According to a new study, investments in oil and gas exploration and production generate substantial economic gains, as well as other benefits such as increased energy independence. The Perryman Group estimates that the industry as a whole generates an economic stimulus of almost $1.2 trillion in gross product each year, as well as more than 9.3 million permanent jobs across the nation.
The ripple effects are everywhere. If you think about the role of oil in your life, it is not only the primary source of many of our fuels, but is also critical to our lubricants, chemicals, synthetic fibers, pharmaceuticals, plastics, and many other items we come into contact with every day. The industry supports almost 1.3 million jobs in manufacturing alone and is responsible for almost $1.2 trillion in annual gross domestic product. If you think about the law, accounting, and engineering firms that serve the industry, the pipe, drilling equipment, and other manufactured goods that it requires, and the large payrolls and their effects on consumer spending, you will begin to get a picture of the enormity of the industry.
Another way of visualizing the impact of the shale industry on the US economy comes courtesy of this chart from the Manhattan Institute which really needs no commentary:
The Institute had this commentary to add:
The jobs recovery since the 2008 recession has been the slowest of any post recession recovery in the U.S. since World War II. The number of people employed has yet to return to the 2007 level. The country has suffered a deeper and longer-lasting period of job loss than has followed any of the ten other recessions since 1945.
There has, however, been one employment bright spot: jobs in America’s oil & gas sector and related industries. Since 2003, more than 400,000 jobs have been created in the direct production of oil & gas and some 2 million more in indirect employment in industries such as transportation, construction, and information services associated with finding, transporting, and storing fuels from the new shale bounty.
In addition, America is seeing revitalized growth and jobs in previously stagnant sectors of the economy, from chemicals production and manufacturing to steel and even textiles because of access to lower cost and reliable energy.
The surge in American oil & gas production has become reasonably well-known; far less appreciated are two key features, which are the focus of this paper: the widespread geographic dispersion of the jobs created; and the fact that the majority of the jobs have been created not in the ranks of the Big Oil companies but in small businesses, even more widely dispersed.
Fast forward to today when we are about to learn that Newton's third law of Keynesian economics states that every boom, has an equal and opposite bust.
Which brings us to Texas, the one state that more than any other, has benefited over the past 5 years from the Shale miracle. And now with crude sinking by the day, it is time to unwind all those gains, and give back all those jobs. Did we mention: highly compensated, very well-paying jobs, not the restaurant, clerical, waiter, retail, part-time minimum-wage jobs the "recovery" has been flooded with.
Here is JPM's Michael Feroli explaining why Houston suddenly has a very big problem.
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- In less than five years Texas’ share of US oil production has gone from around 25% to over 40%
- By some measures, the oil intensity of the Texas economy looks similar to what it was in the mid-1980s
- The 1986 collapse in oil prices led to a painful regional recession in Texas
- While the rest of the country looks to benefit from cheap oil, Texas could be headed for recession
The collapse in oil prices will create winners and losers, both globally and here in the US. While we expect the country, overall, will be a net beneficiary from falling oil prices, two states look like they will bear the brunt of the pain: North Dakota and Texas. Given its much larger size, the prospect of a recession in Texas could have some broader reverberations.
By now, most people are familiar with the growth of the fossil fuel industry in places like Pennsylvania and Ohio. However, that has primarily been a natural gas story. The renaissance of US crude oil production has been much more concentrated: over 90% of the growth in the past five years has been in North Dakota and Texas; with Texas alone accounting for 67% of the increase in the nation’s crude output over that period.
In the first half of 1986, crude oil prices fell just over 50%. At the end of 1985, the unemployment rate in Texas was equal to that in the nation as a whole; at the end of 1986 it was 2.6%- points higher than the national rate. There are some reasons to think that it may not be as bad this time around, but there are even better reasons not to be complacent about the risk of a regional recession in Texas.
Geography of a boom
The well-known energy renaissance in the US has occurred in both the oil and natural gas sectors. Some states that are huge natural gas producers have limited oil production: Pennsylvania is the second largest gas producing state but 19th largest oil producer. The converse is also true: North Dakota is the second largest crude producer but 14th largest gas producer. However, most of the economic data as it relates to the energy sector, employment, GDP, etc, often lump together the oil and gas extraction industries. Yet oil prices have collapsed while natural gas prices have held fairly steady. To understand who is vulnerable to the decline in oil prices specifically we turn to the EIA’s state-level crude oil production data.
The first point, mentioned at the outset, is that Texas, already a giant, has become a behemoth crude producer in the past few years, and now accounts for over 40% of US production. However, there are a few states for which oil is a relatively larger sector (as measured by crude production relative to Gross State Product): North Dakota, Alaska, Wyoming, and New Mexico. For two other states, Oklahoma and Montana, crude production is important, though somewhat less so than for Texas. Note, however, that these are all pretty small states: the four states where oil is more important to the local economy than Texas have a combined GSP that is only 16% of the Texas GSP. Finally, there is one large oil producer, California, which is dwarfed by such a huge economy that its oil intensity is actually below the national average, and we would expect it, like the country as a whole, to benefit from lower oil prices.
As discussed above, Texas is unique in the country as a huge economy and a huge oil producer. When thinking about the challenges facing the Texas economy in 2015 it may be useful, as a starting point, to begin with the oil price collapse of 1986. Then, like now, crude oil prices collapsed around 50% in the space of a few short months. As noted in the introduction, the labor market response was severe and swift, with the Texas unemployment rate rising 2.0%-points in the first three months of 1986 alone. Following the hit to the labor market, the real estate market suffered a longer, slower, burn, and by the end of 1988 Texas house prices were down over 14% from their peak in early 1986 (over the same period national house prices were up just over 14%). The last act of this tragedy was a banking crisis, as several hundred Texas banks failed, with peak failures occurring in 1988 and 1989.
How appropriate is it to compare the challenges Texas faces today to the ones they faced in 1986? The natural place to begin is by getting a sense of the relative energy industry intensity of Texas today versus 1986. Unfortunately, the GSP-by-industry data have a definitional break in 1997, but splicing the data would suggest a similar share of the oil and gas sector in Texas GSP now and in 1985: around 11%. Employment in the mining and logging sector (which, in Texas, is overwhelmingly dominated by the oil and gas sector) was around 3.7% in 1985 and is 2.7% now. This is consistent with a point we have been making in the national context: the oil and gas sector is very capital-intensive, and increasingly so. Even so, as the 1986 episode demonstrated, there do seem to be sizable multiplier effects on non-energy employment. Finally, there does not exist capital spending by state data, but at the national level we can see the flip side of the increasing capital intensive nature of energy: oil and gas related cap-ex was 0.58% of GDP in 4Q85, and is 0.98% of GDP now.
Given this, what is the case for arguing that this time is different, and the impact will be smaller than in 1986? One is that now, unlike in 1986, natural gas prices haven’t moved down in sympathy with crude oil prices, and the Texas recession in 1986 may have owed in part also to the decline in gas prices. Another is that, as noted above, the employment share is somewhat lower, and thus the income hit will be felt more by capital-holders – i.e. investors around the country and the world. Finally, unlike 1986, the energy industry is experiencing rapid technological gains, pushing down the energy extraction cost curve.
While these are all valid, they are not so strong as to signal smooth sailing for the Texas economy. Financially, oil is a fair bit more important than gas for Texas, both now and in 1986, with a dollar value two to three times as large. Moreover, while energy employment may be somewhat smaller now, we are not talking about night and day. The current share is about 3/4ths what it was in 1986. (Given the higher capital intensity, there are some reasons to think employment may be greater now in sectors outside the traditional oil and gas sectors, such as pipeline and heavy engineering construction).
As we weigh the evidence, we think Texas will, at the least, have a rough 2015 ahead, and is at risk of slipping into a regional recession. Such an outcome could bring with it the usual collateral damage that occurs in a slowdown. Housing markets have been hot in Texas. Although affordability in Texas looks good compared to the national average, it always does; compared to its own history, housing in some major Texas metro areas looks quite dear, suggesting a risk of a pull-back in the real estate market.
The national economy performed quite well in 1986, in spite of the Texas recession. We expect the US economy will perform well next year too , though some regions – most notably Texas – could significantly underperform the national average.
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So perhaps it is finally time to add that footnote to the "unambiguously good" qualified when pundits describe the oil crash: it may be good for everyone... except Texas which is about to enter a recession. And then Pennsylvania. And then North Dakota. And then Colorado. And then West Virginia. And then Alaska. And then Wyoming. And then Oklahoma. And then Montana, and so on, until finally we find just where the new equilibrium is following the exodus of hundreds of thousands of the best-paying jobs created during the "recovery" offset by minimum-wage waiters, bartenders, retail workers and temps.
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