By Nick Cunningham
Posted on Wed, 13 January 2016 22:53 | 0
Low crude oil prices since the second half of 2014 have created a boon for consumers as the cost to fill up at the pump has plunged. The extra cash in the pockets of millions of motorists is often likened to an unexpected tax cut, which could help stimulate the economy.
Leaving aside the true extent of such a stimulus, which is debatable, there is a flip side to that coin. The collapse in crude oil prices is a huge blow to areas where oil extraction and associated industries are the bread and butter of the economy.
As petro-economies suffer from the bust in crude prices, the effects are showing up in the housing market.
Take North Dakota, for example, which was on the front lines of the oil boom between 2011 and 2014. In fact, North Dakota is probably the most vulnerable to a downturn in housing because of low oil prices. The economy is smaller and thus more dependent on the oil boom than other places, such as Texas. The state saw an influx of new workers over the past few years, looking for work in in the prolific Bakken Shale. A housing shortage quickly emerged, pushing up prices. With the inability to house all of the new people, rent spiked, as did hotel rates. The overflow led to a proliferation of “man camps.
Now the boom has reversed. The state’s rig count is down to 53 as of January 13, about one-third of the level from one year ago. Drilling is quickly drying up and production is falling. “The jobs are leaving, and if an area gets depopulated, they can’t take the houses with them and that’s dangerous for the housing market,” Ralph DeFranco, senior director of risk analytics and pricing at Arch Mortgage Insurance Company, told CNN Money.
New home sales were down by 6.3 percent in North Dakota between January and October of 2015 compared to a year earlier. Housing prices have not crashed yet, but there tends to be a bit of a lag with housing prices. JP Ackerman of HouseCanary says that it typically takes 15 to 24 months before house prices start to show the negative effects of an oil downturn.
According to Arch Mortgage, homes in North Dakota are probably 20 percent overvalued at this point. They also estimate that the state has a 46 percent chance that house prices will decline over the next two years. But that is probably understating the risk since oil prices are not expected to rebound through most of 2016. Moreover, with some permanent damage to the balance sheets of U.S. shale companies, drilling won’t spring back to life immediately upon a rebound in oil prices.
There are some other states that are also at risk of a hit to their housing markets, including Wyoming, West Virginia and Alaska. Out of those three, only Alaska is a significant oil producer, but it is in the midst of a budget crisis because of the twin threats of falling production and rock bottom prices. Alaska’s oil fields are mature, and have been in decline for years. With a massive hole blown through the state’s budget, the Governor has floated the idea of instituting an income tax, a once unthinkable idea.
The downturn in Wyoming and West Virginia has more to do with the collapse in natural gas prices, which continues to hollow out their coal industries. Coal prices have plummeted in recent years, and coal production is now at its lowest level since the Reagan administration. Shale gas production, particularly in West Virginia, partially offsets the decline, but won’t be enough to come to the state’s rescue.
Texas is another place to keep an eye on. However, Arch Mortgage says the economy there is much larger and more diversified than other states, and also better equipped to handle the downturn than it was back in the 1980s during the last oil bust.
But Texas won’t escape unscathed. The Dallas Fed says job growth will turn negative in a few months if oil prices don’t move back to $40 or $50 per barrel. Texas is expected to see an additional 161,200 jobs this year if oil prices move back up into that range. But while that could be the best-case scenario, it would still only amount to one-third of the jobs created in 2014. “The biggest risk to the forecast is if oil prices are in the range of $20 to $30 for much of the year,” Keith Phillips, Dallas Fed Senior Economist, said in a written statement. “Then I expect job growth to slip into negative territory as Houston gets hit much harder and greater problems emerge in the financial sector.”
After 41 consecutive months of increases in house prices in Houston, prices started to decline in third quarter of 2015. In Odessa, TX, near the Permian Basin, home sales declined by 10.6 percent between January and October 2015 compared to a year earlier.
Most Americans will still welcome low prices at the pump. But in the oil boom towns of yesterday, the slowdown is very much being felt.
What does this mean for note investing? Be very cautious on what the loan to value is. Adjust what one is paying for a note based on the potential risks on the horizon.