The war in the Ukraine may seem far away, but consumers are reminded daily not only of its devastating toll on Ukrainians, but of the far-reaching effects globally every time they pull into a gas station to fill up.
The price of oil has almost doubled since the start of the war a month ago and is expected to climb even higher. For example, on March 23, 2021, the price of West Texas Intermediate stood at $61.48 per barrel. On the same day in 2022 it reached $111.75, notes Bruce Rutherford, international director of office tenant representation with commercial real estate services firm JLL.
The question for commercial real estate owners and developers is whether this shift will have an impact on the performance of office buildings in markets reliant on the energy industry.
At the beginning of the year, Houston’s office market was still struggling from the aftereffects of the pandemic. Office vacancy in the city during the fourth quarter of 2021 reached 28.1 percent, according to data from JLL. Net absorption was at negative 2.46 million sq. ft. and both direct asking rents and sublease asking rents were trending down. In Denver, another market with a high concentration of energy firms, total office vacancy averaged 20.6 percent during the same time period, with net absorption at about a negative 2.6 percent and rents remaining flat. With far-reaching constraints on the exports of Russian oil and gas, will these markets see more robust job growth and office expansion?
So far, the rapid increase in prices at the pump has not yet worked its way through the overall economy, Rutherford says. But history tells us the inflationary effect of high oil prices will constrain U.S. and world economies, notes.
The U.S. imported about 8.5 million barrels of crude oil and petroleum products per day in 2021, but only 8 percent of those petroleum products came from Russia, of which just three percent, or about 500,000 barrels per day, was crude oil for refining to gasoline, according to the U.S. Energy Administration.
So why the sharp increase in gas prices at the pump?
“Any geopolitical disruption has an impact on oil prices,” says Rutherford, noting that the world consumes between 97 and 101 million barrels of oil per day, and any reduction in supply pushes prices up worldwide. The price of oil moves so aggressively because oil traders, rather than refineries, originate 80 percent of all contracts to buy and sell oil.
“The proposed sanctions on Russia in theory will impact its ability to produce and deliver what has recently been as much as 10 million barrels per day, and sanctions will definitely hurt that supply more as time goes on,” Rutherford says. The European Union would feel that deficit the most.
The U.S. energy industry is using the war in Ukraine and the need to increase oil production to push the Biden Administration to issue more permits to drill on federal lands, reports The New York Times. But these energy companies are not increasing production nor planning on it, according to Rutherford, because there is uncertainty about how long the high prices will last.
“To increase production the industry must invest more capital and attract qualified employees. But uncertainty is the enemy of new investment, which is especially true in the oil and gas business,” he adds.
What this means for office markets reliant on oil companies
While energy companies have called back some of the workers they laid off during the depth of the COVID-19 pandemic, many other workers have retired or moved on to new careers. In addition, the industry is not attracting enough new workers due to its cyclicality, which young professionals do not like. “As a result, we do not expect any increased demand for office space from energy companies,” Rutherford says.
Office leasing brokers in markets associated with the energy industry are reporting a similar trend among oil and gas tenants as in the general market, with some companies downsizing the amount of space they use and others occupying the same amount of square footage, according to Richard Barkham, global chief economist and head of global research with real estate services firm CBRE. “We aren’t seeing many companies expand their office portfolios, but there may be more activity further out,” he says.
Barham expects an uptick in job growth in energy markets that may increase demand for office space, but he notes that the industry is more cautious and efficient than it was in the past. “Investors have made it clear to oil producers in recent years that they should not sink money into additional drilling in pursuit of the next oil boom. Instead, they want companies to pay back loans and pay out investors, often through dividends,” he says.
Side effects
While many industries, including finance, transportation and retail, are suffering from the high price of oil, it is having a positive impact on others that may increase office occupancy down the road. For example, companies that supply fundamental components of oil production are doing better, according to Rutherford. He notes that international oil engineering firms are benefitting as oil producers around the world try to capitalize on today’s high prices.
Additionally, companies that produce drilling equipment and make pipes, valves and other products used in energy infrastructure are benefiting somewhat, though not as much as would be expected. Rutherford explains that uncertainty has tempered demand for oil field services and products.
“It’ said in oil business, ‘The sure cure for high oil prices is high oil prices,’” he says.