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America’s ongoing energy revolution

Energy & CRE

Billions of dollars invested in unconventional energy exploration has a dramatic impact on commercial real estate activity in the Americas region. Cityscape magazine investigates.

March 2015

The rise in unconventional oil and gas development is shifting the geography of production, so much so that the global supply is now increasingly driven by the Americas region, a region expected to lead production growth through 2040.

Over the past few years the Americas region has emerged as an energy hub, with BP forecasting the U.S. to reach energy independence by 2035.

These shifting dynamics of the global energy industry are reorienting trade and changing the relationship between energy and the broader economy – all of which are affecting real estate requirements in the Americas region. With billions of dollars invested in unconventional energy exploration, there has been a dramatic impact on economic and commercial real estate activity, more especially in key North American exploration hubs.

SHIFTING ENERGY DYNAMICS

The Americas region is leading the global unconventional energy sector. Unconventional reserves refer to production in deep water and ultra-deep-water, oil sands and shale or other tight formations, previously thought uneconomical.

According to CBRE’s Energy Revolution research report, given the location of unconventional resources, global supply is increasingly driven by the Americas region, a region expected to lead the world in production growth of liquids and natural gas through 2040.

“According to ExxonMobil’s most recent Outlook for Energy, North America is expected to shift from a net importer of natural gas to a net exporter by 2020, as production growth from unconventional sources outpaces domestic demand. Latin America, meanwhile, should remain fairly balanced as local demand absorbs local production,” says the report.

The U.S. and Canada are experiencing the impact of the energy boom broadly in support of national output and employment growth.

So, what does this mean for commercial real estate?

According to the report, developers are securing private equity, including partnering with energy companies, to fund real estate projects in exploration markets. “Investors are paying more attention to exploration market opportunities as they understand the long-term play and potential returns,” says the report.

HOUSTON: ENERGY CAPITAL OF THE WORLD

As a result of the energy boom over the last few years, the Americas have become home to several key energy operations markets, more especially Houston, Texas which is now renowned as the’ Energy Capital of the World’ for its concentration of firms and employment across all industry business lines.

According to CBRE the metropolitan area is home to 3,700 energy related establishments, and houses the headquarters or major operations of 20 of the top 25 publicly traded oil and gas exploration and production firms in the U.S., including Shell Oil and ExxonMobil.

“Strength in the energy industry has had a remarkable impact on Houston’s office market, with 4.9 million sq.ft. of net absorption in 2013. This followed net absorption of 4.4 million sq.ft in 2012. Overall vacancy ended 2013 at a post-recession low of 11.8%, with Class A vacancy at 7.3%, its lowest level in over a decade,” says the report.

The energy industry accounted for 64% of the square footage leased in Houston in 2013 but only about one-third of transactions, since energy companies typically require large blocks of space.

CBRE says the western Houston submarkets experienced the market’s most dramatic increases in office space demand, with vacancies dropping below 1% in some areas.

“The majority of new construction in Houston is in response to demand from energy companies, with 14, 2 million sq.ft,” says CBRE.

The current construction in Houston includes the 3.0 million sq.ft ExxonMobil campus, a 1.2 million sq.ft campus for Philips, 620,000 sq.ft in two buildings for Shell, and a 450,000 sq.ft building pre-leased by Technip.

The city has increasingly been met by rising, yet heavily pre-committed, new construction.

CALGARY: ENERGY CAPITAL OF CANADA

Moving further north is Calgary, the ‘Energy Capital of Canada’, because it is home to the major energy industries, including Suncor, Enbridge CNRL, Imperial Oil and TransCanada Corp. International energy firms also have significant presence in Calgary including Shell, BP and Total.

“The energy industry is an essential growth engine for Calgary’s office market. Calgary has seen tremendous growth in the number of head offices over the past 10 years, increasing from 84 in 2003 to 135 in 2012 according to the latest Head Offices Fact Sheet from Calgary Economic Department,” says CBRE.

Of the head offices in Calgary, 74% are from the energy sector, most of which are situated in the central business district. There is also a major cluster of engineering firms dominating the office market along the southern fringe of downtown Calgary.

SOUTH & LATIN AMERICA

In South America key operations markets include Buenos Aires, Caracas, Rio de Janeiro and Sao Paulo.

The variance in performance across markets can be attributed to an office development boom in Latin America as well as limited energy-related activity in markets where the industry presence is tied only to a state-owned firm such as in Mexico City and Caracas.

Buenos Aires is the headquarters of YPF, an Argentinian energy company, and Caracas is the central location of PDVSA’s operations (Petróleos de Venezuela, S.A.), a Venezuelan state-owned oil and natural gas company.

According to CBRE, Brazil’s proximity to offshore production means that energy firm operations and the accrual of more oil production revenue are concentrated in Rio de Janeiro.

“Sao Paulo, the largest city in South America is also considered the financial capital of Latin America and serves as Brazil’s centre of industrial activity. Rio is the headquarters location of Petrobras (Brazilian multi-national energy company) and, in addition to upstream production is home to considerable downstream activity with petrochemical and refining operations,” says the report.

According to CBRE the majority of these energy operations hubs have experienced tightening office market fundamentals since 2010, representing both the global economic recovery as well as the effects of the recent energy boom.

IMPACT OF LOW OIL PRICES

Over the past few months the drop in the oil price has led many raise questions about the volatility in the market.

According to CBRE’s Global Chief Economist Richard Barkham, the economic consequences of falling oil prices are “unequivocally good,” for the economy and for real estate fundamentals of the West.

“The majority of the boost to growth would come through stronger consumption but companies would also benefit from lower input costs. With a lag of 18 months or so we would expect to see higher rents than previously forecast across the board,” says Barkham.

Sarah Rutledge, Director of Research and Analysis at CBRE Texas, says that the recent decline in oil prices is prompting commercial real estate market watchers to focus on the strong-performing Houston office market, which has benefited enormously from the 300% increase in U.S. tight oil production.

She says that Houston’s role as the ‘Energy Capital of the World’, places it in the crosshairs of discussions over the potential impact of lower oil prices.

“Other U.S. energy hubs such as Denver, where one-fifth of the downtown market is occupied by energy tenants, and Pittsburgh to a lesser extent, may also be impacted by energy price movements,” she says.

According to Rutledge, the most important factor to keep in mind regarding oil prices and Houston office market fundamentals is that energy firms employ long-term planning for their exploration.

“If prices continue to fall and are sustained levels well-below breakeven prices, then projects could be delayed or cut, causing a re-evaluation of office space requirements,” she says.

In November last year, Kinder Morgan completed the USD 44 billion merger of its various holding companies into a single, publicly traded company and Halliburton announced the USD 35 billion acquisition of Baker Hughes.

“These two deals rank as the seventh and ninth, respectively, largest energy company mergers in the last century. Merger acquisition activity would likely impact commercial space requirements as well. For example, Halliburton and Baker Hughes, both Houston-based, occupy 2.0 million sq.ft of office space and 2.7 million sq.ft. of industrial space in the market,” concludes Rutledge.

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