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Oil and Office Towers: What Will It Take For Houston’s Office Market to Fully Recover?

Bruce Rutherford, head of JLL’s global energy practice.

HOUSTON – (By Kyle Hagerty for Realty News Report) – Houston’s office sector, which in recent years has been struggling to fill space thanks to a decline in oil prices, is well on the road to recovery thanks to drillers finally increasing production as the price per barrel creeps upward. For Houston to say it’s fully recovered, offshore operations, which are disproportionate users of office space and producers of oil, will need to recover too.

“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,” JLL International Manager Director Bruce Rutherford, who heads up the firm’s global energy practice, told Realty News Report. “Offshore activity has essentially been turned off since November 2014.”

With the price of oil north of $60 a barrel, there’s a reason for optimism. Houston’s office market fundamentals have improved along with the price, according to JLL’s 2019 North America Energy Outlook report. Vacancy is down a further 1.4% from its peak in mid-2018 thanks to positive absorption and job growth. Last year, multiple firms renewed long-term commitments to the Bayou City, including McDermott, Transocean and Occidental Petroleum. The deals continue a trend seen in 2017; 2018 saw a surge in leasing activity from energy tenants, growing 21% year-over-year, according to JLL.

Another positive sign; In 2018, leasing activity was more heavily weighted toward direct space as firms capitalized on the perception that the energy markets had finally hit their bottom, raising the average lease from 61 months to 70 months since 2017, according to JLL.

Despite the optimism, Houston’s direct office vacancy rate registered 20.7% in the first quarter of 2019, according to JLL. Sublease space has come down from its peak of nearly 12 million square feet, but 7.7 million square feet still remains on the market, putting downward pressure on direct rents. Roughly 74.7% of sublease deals have been executed by energy companies looking to lease space at the lowest rate possible, a sign of the energy industries’ increased demand.

Much of the demand in the office and industrial sector is coming from land drillers using hydraulic fracturing techniques to extract oil at far lower break-even points than offshore drilling, creating a boom in activity that’s reshaping global oil markets and the Houston real estate office market.

“The lack of off-shore activity is the reason you’re not seeing a hockey stick rebound,” Rutherford said. “Offshore operations use a disproportionate amount of office space. Deep water drilling requires more engineering and technological support, creating a larger real estate footprint than those operations associated with fracturing wells.”

It’s not just the real estate market, either. The lack of prolific offshore drilling has opened the gate for land drillers to fill the production gap.

“The average land-based well in the U.S. produces only about 54 barrels of oil a day. The best shale well I’ve ever heard of did 6,000 barrels a day. After six months, the well was at 3,000 barrels a day. After a year, the well was around 2,000 barrels a day. That depletion is very characteristic of shale production,” Rutherford explained. “In contrast, there are some offshore rigs, that after 5 years of production, are still producing 220,000 barrels a day,”

With so little offshore production, energy outfits have been forced to rethink their production strategies as well as their real estate strategies as the demand for office space for the legions of employees needed to service the complex rigs dries up.

Instead of putting a massive amount of capital and operating expenditures towards a few high performing offshore rigs, energy firms are learning to do more with less, decentralizing much of the current production support capacity. Land drillers need op centers near wells in the basins, away from Houston. Even the need for those facilities has decreased. The increased use of technology to measure, track and maintain wells has decreased the employee count, further limiting energy companies’ real estate footprints.

Where 500 workers were needed to take measurements and make adjustments and maintain wells, now an outfit can get the same amount done with around 100 workers, according to Rutherford.

“The energy firm real estate strategy of ‘long and large’ leases is obsolete,” Rutherford said.

For now, American drillers are happy to ride the unprecedented shale boom being routed through Texas, but soon oil producers will face pipeline and transportation constraints for their inland operations, particularly at the United States’ largest oil field in the Permian basin of West Texas. Rig counts in the Permian have been declining in recent weeks.

Conversely, offshore rigs are on the rise. There are currently 24 contracted rigs, up from a low of 10 in early 2016, according to Baker Hughes. At the offshore markets peak, nearly 70 offshore rigs were contracted in the United States.

Major oil and gas firms like Chevron, ExxonMobil and BP are all increasing their exploration activity and spending as subsea contracts surge. In recent months, 14 subsea awards have been announced by the Big 3 subsea contractors—TechnipFMC, Schlumberger, and Baker Hughes, according to the Oil & Gas Journal.

With the big offshore rigs ramping up to get back in the game, Houston’s recovery looks set to continue. Still, offshore activity takes years to plan and execute.

“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.

Space City’s road to recovery of its office market is long. If things continue as planned, Houston’s heavy offshore hitters will soon be back in the game. For Houston’s lagging office market, the return of offshore activity can’t come soon enough.

July 15, 2019 Realty News Report Copyright 2019

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