It’s now trading at $48 per barrel. If those projects were shut down, it would mean a production loss of 7.5 million barrels per day in 2025, equal to 8% of current global demand.
Texas and Saudi Arabia might fare better than other regions due to their “low-cost producer” status, but both economies are heavily dependent on energy. The fallout from cheap oil will manifest itself differently in each region. Here’s a breakdown of what’s at stake:
Texas
For the most part, Texas made it through the Great Recession unscathed. By virtually any measure, the Lone Star state outperformed nationally in terms of GDP, employment, income, tax collection and consumer spending throughout 2008-2009. The Brookings Institute ranked the performance of all metropolitan areas in 2009, and six of the top 10 were from Texas. However, with the price of oil down 60% since June, Texas could become a laggard and a recession is very possible.
Over the last five years, more than two-thirds of the growth in US crude oil output came from Texas. On a nominal basis, Texas accounts for 40% of total US production; up from 25% in 2011.
The situation is actually comparable to 1986, when crude fell 50% over a matter of months. The unemployment rate in Texas jumped 2% higher over the first quarter of 1986. From there, the distress spread from the labor market to housing, and by 1988 Texas home prices had fallen 14% from their peak. The icing on the cake was a banking crisis, as several hundred Texan banks failed during 1988 and 1989.
The chart above shows Texas real estate barely felt the effect of the national housing bubble in 2007-2008. However, now that oil has dropped, expect real estate to cool off. Shorting local home prices is an attractive bet, but it’s hard to find a liquid investment vehicle to target specific geographies.
Instead, bank stocks with heavy exposure to Texas have been under heavy pressure. For example, BOK Financial Corp (ticker: BOKF) is based in Tulsa, OK but 20% (or $2.5 billion) of its total loan portfolio is exposed to energy investments in Texas. The stock is up 150% since the stock market bottomed in March 2009, but has fallen 20% since November 1, 2014. Many Texan oil drillers can temporarily deal with oil prices below $60/barrel, but if prices stay there for a sustained period of time, local banks will pay a heavy price.
Saudi Arabia
Saudi officials have been very open about regaining market share in the oil market by increasing supply and shaking out the weak-handed producers. But at what cost? Since September, the Saudi stock market has been one of the worst performers in the world – down 25%. At one point the index was down 35%, but rallied after the country’s finance minister implied the government would not cut spending on development projects or social benefits in 2015, despite falling oil revenues.
Saudi equities could be very attractive at these levels, as long as oil stabilizes. The opening of Saudi Arabia’s stock market to direct foreign investment is only months away, and demand is expected to be strong. BlackRock (ticker: BLK) even has plans to launch an ETF for Saudi shares sometime next year. However, if oil prices continue to fall, there could be a serious economic crisis.
The Saudi’s have pegged their currency, the Riyal (SAR), to USD since 1986, meaning the rapid appreciation of USD is tightening domestic monetary conditions. 12-month USD/SAR forwards are trading at their highest levels since the financial crisis. If USD continues to rise and oil continues to fall, the country’s monetary policy would be entirely inappropriate, and stocks would suffer.
The government is rapidly trying to diversify the economy because over 90% of its revenues come from oil, but that will take years. While the Kingdom has huge financial reserves to withstand temporary turmoil, a permanent drop in oil prices would be problematic. Few investors have a firm view either way, but Saudi equities are one of the world’s most intriguing markets to watch in 2015.
