HOUSTON – (By Kyle Hagerty for Realty News Report) – Houston’s office market, long weakened by falling oil prices, is showing clear signs of recovery as drillers raise production and oil prices climb. However, a full recovery for Houston depends on a rebound in offshore activity, which uses a disproportionately large share of office space and contributes significantly to oil output.
“Energy firms are finally starting to hire and expand operations. This change in the industry is not yet complete as the offshore business is still constrained by the lack of higher necessary pricing, and probably won’t happen until we see prices above $72,” said Bruce Rutherford, JLL International Managing Director and head of the firm’s global energy practice. “Offshore activity has essentially been turned off since November 2014.”
With oil trading above $60 a barrel, optimism is growing. JLL’s 2019 North America Energy Outlook reports that Houston’s office fundamentals have improved alongside rising oil prices. Vacancy has fallen another 1.4% from its mid-2018 peak, driven by positive absorption and job growth. Several major energy firms renewed or expanded their Houston commitments last year, including McDermott, Transocean and Occidental Petroleum. Leasing activity from energy tenants surged in 2018, rising 21% year-over-year, according to JLL.
Leasing trends also shifted in 2018 toward direct leases, as companies acted on the belief that the energy downturn had passed. The average lease term increased from 61 months to 70 months since 2017, JLL notes, reflecting renewed confidence among energy tenants.
Despite these gains, Houston’s direct office vacancy rate remained high at 20.7% in the first quarter of 2019, per JLL. Sublease availability has decreased from a peak of nearly 12 million square feet but still totals about 7.7 million square feet, keeping downward pressure on direct rents. Energy firms account for roughly 74.7% of sublease transactions, often seeking the lowest possible rates, which underscores the sector’s influence on the market.
Much of the current demand in both office and industrial sectors stems from land-based drillers using hydraulic fracturing. These operations have far lower break-even costs than many offshore projects, fueling a shale-driven boom that is reshaping global oil markets and altering Houston’s real estate landscape.
“The lack of offshore activity is the reason you’re not seeing a hockey-stick rebound,” Rutherford said. “Offshore operations use a disproportionate amount of office space. Deepwater drilling requires more engineering and technological support, creating a larger real estate footprint than operations associated with fracturing wells.”
The decline in offshore production has opened opportunities for land drillers to fill the shortfall. Rutherford explained the contrast in productivity and longevity: “The average land-based well in the U.S. produces only about 54 barrels of oil a day. The best shale wells may produce thousands of barrels initially—one example did 6,000 barrels a day, dropping to 3,000 after six months and about 2,000 after a year. That steep depletion profile is typical of shale. In contrast, some offshore fields can still produce 220,000 barrels a day after five years.”
With limited offshore output, firms have rethought both production and real estate strategies. Rather than concentrating massive capital and operating expenses on a few high-performing offshore rigs, many companies are decentralizing support operations. Land drillers require operations centers closer to the basins and away from Houston, although overall demand for those facilities has fallen as technology reduces staffing needs.
Advanced monitoring, automation and remote-management tools allow companies to maintain and optimize wells with far fewer personnel. Where 500 workers were once needed to perform measurements, adjustments and maintenance, similar tasks can now be completed with roughly 100 workers, Rutherford said.
“The energy firm real estate strategy of ‘long and large’ leases is obsolete,” Rutherford added.
For the moment, U.S. drillers are benefiting from the shale boom centered in Texas, but inland production faces future constraints related to pipeline capacity and transportation—issues that are especially relevant for the Permian Basin, the nation’s largest oil field. Recent weeks have seen a decline in rig counts in parts of the Permian.
At the same time, offshore activity is gradually returning. Baker Hughes reports 24 contracted offshore rigs, up from a low of 10 in early 2016, though still well below the market peak when nearly 70 rigs were contracted in U.S. waters. Major oil companies—including Chevron, ExxonMobil and BP—are increasing exploration spending and re-engaging with subsea projects. Several large subsea contracts were recently awarded to major contractors such as TechnipFMC, Schlumberger and Baker Hughes, signaling renewed investment in offshore infrastructure.
As big offshore projects ramp up, Houston’s recovery momentum should continue, but renewed offshore production requires years of planning and execution. “We don’t have full-scale offshore exploration and development activity; it will likely take three to five years to have an effect on global production,” Rutherford said.
Houston’s path to a fully recovered office market remains gradual. If current trends hold and offshore players increase activity, Houston’s more space-intensive energy operations will return, easing pressure on the city’s office market. For now, energy-driven leasing and the shale boom are stabilizing fundamentals, but the long-awaited return of offshore activity will be the decisive factor in restoring Houston’s office market to pre-downturn levels.
July 15, 2019 Realty News Report Copyright 2019
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