Tierra Grande - April 2015

APRIL 2015 ™

JOURNAL OF THE REAL ESTATE CENTER AT TEXAS A&M UNIVERSITY

NON-PROFIT ORG. U.S. POSTAGE PAID HOUSTON, TEXAS PERMIT No. 4126 COLLEGE STATION, TEXAS 77843-2115

In This Issue Housing Market and Oil Downturn Land Markets Vacation Home Rentals Texas Triangle Corpus Christi Industrial Growth Surface vs. Mineral Rights Texas GDP Since Recession

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APRIL 2015 ™

JOURNAL OF THE REAL ESTATE CENTER AT TEXAS A&M UNIVERSITY

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TIERRA GRANDE

APRIL 2015

VOLUME 22, NUMBER 2 ™

TIERRA GRANDE

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JOURNAL OF THE REAL ESTATE CENTER AT TEXAS A&M UNIVERSITY

Director, GARY W. MALER Chief Economist, MARK G. DOTZOUR Senior Editor, DAVID S. JONES

14 Weathering the

Managing Editor, NANCY MCQUISTION Associate Editor, BRYAN POPE

Drilling Decline

Assistant Editor, KAMMY BAUMANN

Corpus Christi Industries Diversify

Art Director, ROBERT P. BEALS II

Five years ago, forward-thinking Corpus Christi leaders set out to attract global industries that use natural gas and natural gas liquids as raw materials. Today, over $28 billion in new projects are under construction or in final permitting.

BY HAROLD D. HUNT

Graphic Specialist/Photographer, JP BEATO III Circulation Manager, MARK BAUMANN Lithography, RR DONNELLEY, HOUSTON ADVISORY COMMITTEE: C. Clark Welder, San Antonio, chairman; Russell Cain, Port Lavaca, vice chairman; Mario A. Arriaga, Conroe; Jacquelyn K. Hawkins, Austin; Doug Jennings, Fort Worth; Walter F. “Ted” Nelson, Houston; Doug Roberts, Austin; Kimberly Shambley, Dallas; Ronald C. Wakefield, San Antonio; and Bill Jones, Temple, ex-officio representing the Texas Real Estate Commission.

TIERRA GRANDE ™ (ISSN 1070-0234) is published quarterly by the Real Estate Center at Texas A&M University, College Station, Texas 77843-2115.

Telephone: 979-845-2031.

SUBSCRIPTIONS free to Texas real estate licensees. Other subscribers, $20 per year. Subscribe online at www.recenter.tamu.edu/store VIEWS EXPRESSED are those of the authors and do not imply endorsement by the Real Estate Center, Mays Business School or Texas A&M University. The Texas A&M University System serves people of all ages, regardless of socioeconomic level, race, color, sex, religion, disability or national origin.

PHOTOGRAPHY/ILLUSTRATIONS: Real Estate Center files, pp. 1, 6, 17, 18, 19, 22, 24–25, 26 (bottom left), 27 (top right); Robert Beals II, 2-3, 11; Harold Hunt, pp. 8, 26 (top left); Kari Rives, p. 9; JP Beato III, pp. 14–15, 26–27 (top center/bottom center), 27 (bottom right); Judon Fambrough, p. 21. © 2015, Real Estate Center. All rights reserved.

2 Oil Change Housing Thrived in Fluctuating Market A Center researcher reports Texas’ housing markets did surprisingly well even when oil prices were lower than those in 2013 and the first half of 2014. That’s because so many other factors — credit availability and employment growth in nonenergy sectors, for example — are influential as well.

BY JAMES P. GAINES

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Land Markets

The Waiting Game Last year was a good one for Texas land prices, which hit record highs. But this year is a big old question mark, as markets are expected to reflect goings-on in the oil industry.

BY CHARLES E. GILLILAND, RYAN McGOUGH AND MARTIN STEINBRING

9 Vacation Home Rentals Recent Tax Developments ON THE COVER Dianthus (Sweet William) adorn Lake Austin landscape.

PHOTOGRAPHER JP Beato III

APRIL 2015

In a 2014 tax court case, a taxpayer who rented out a vacation home learned a lesson about record keeping. The gist is that to deduct losses on the property, owners must keep meticulous records on exactly how they spend repair and maintenance time at the home.

BY JERROLD J. STERN

10 Texas Triangle

Economic Engine of the Southwest Research shows that rather than competing, Texas’ largest metro areas complement each other, essentially functioning as one large economic unit.

BY ROBERT W. GILMER AND SAMUEL REDUS

20 Surface Tension

Accommodation of the Estates Doctrine Landowners who own surface rights but not mineral rights are sometimes unpleasantly surprised to learn how little legal protection they have when problems arise with oil companies entering their property. The accommodation of the estates doctrine offers some relief.

BY JUDON FAMBROUGH

24 Aftermath

Texas GDP Expands Post Great Recession Texas emerged from the Great Recession in a much stronger position than the rest of the nation’s economy. The upward trend in Texas’ share of U.S. GDP is expected to continue.

BY ALI ANARI

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Texas Economy

Housing Thrived in Fluctuating Market

By James P. Gaines

Outlook for Texas’ Economy Lower oil and energy prices, while not all that good for Texas’ economy, positively impact the U.S. economy. Lower gasoline prices, lower fuel oil costs, lower transportation costs to move goods to market and lower energy costs to run industrial facilities create greater economic activity, better profit margins, higher GDP and, generally, more employment. Texas benefits from an active and growing national economy even in the face of a declining energy sector.

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Everyone remembers the energy bust of the 1980s in Texas, but there are numerous reasons to believe that the current price downturn is different — at least that is the hope. First, the state’s economic diversification over the past three decades included other, growing economic segments such as health care, technology, trade and professional services that should help offset some of the negative effects from the energy sector decline.

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Figure 1. West Texas Intermediate Spot Oil Price FOB Cushing, Oklahoma

120 Dollars per Barrel

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exas’ tie to the energy industry continues to play a highly significant role in the state’s overall economic health and outlook. Starting in 2005, unprecedented highs in oil and natural gas prices fueled an energy boom in exploration and drilling using hydraulic fracturing. As a result, Texas was not impacted by the 2007 recession as severely as other states.

Today, some of the early bloom is off the rose.

The price of WTI crude closed at $107.95 on June 20, 2014, then tumbled to around $50, a 55 percent decline, by midMarch 2015. This precipitous downward trend in oil prices casts a shadow over Texas’ 2015 economy and housing market (Figure 1).

With the recent fall in oil prices and the continued low price for natural gas, the number of active rigs in the state is beginning to slip significantly (Figure 2).

100 80 60 40 20 0 1990 1994 1998 2002 2006 2010 2014 Sources: Energy Information Administration and Real Estate Center at Texas A&M University TIERRA GRANDE

Perhaps even more importantly, expectations during the past few years have not led to excessive overbuilding or overspending as was the case in the 1980s. Oil price expectations, this time, were not based on maintaining $100/barrel (bbl) or more levels, thus reducing the potential negative impact on the economy, especially in housing and commercial real estate. As many people have noted, “we’ve seen this cycle before, so we’re not as carried away with the good times.”

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Figure 2. Change in Texas Rotary Rig Count

30 0 –30 –60 –90 –120 –150 1990 1994 1998 2002 2006 2010 2014 Sources: Baker Hughes and Haver Analytics APRIL 2015

Also, the state’s banking sector is not as seriously exposed or vulnerable as it was in the 1980s, when more than 700 banks and savings and loans failed. erhaps the best case scenario for Texas in 2015 is a slowdown in the economic growth rate rather than an absolute decline. Employment losses in mining and energy and oil field services should be offset by growth in the many nonenergy sectors and enhanced improvement in the national economy. Texas’ total employment expanded by roughly 3.3 percent in 2014, considerably faster than the overall 2.1 percent employment growth for the United States. The Texas growth rate for 2015 may more closely follow or slightly lag the U.S. rate — a much slower expansion than the past several years but still positive job gains. One potentially positive result of lost jobs in drilling and exploration would be the relocation of many workers back into residential and nonresidential construction, where labor shortages have been acute.

Capital investment in exploration and production will not come to an absolute halt. Most oil producers operating today hedged against falling oil prices in the futures market and are better able to withstand short-term price declines without severely impacting operating revenues. Consequently, many of the potentially negative impacts can be planned for and may not occur until the second half of 2015 or even into 2016. A prolonged slump in prices, therefore, may be more impactful in 2016 than in 2015.

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The slowdown in job growth would likely lead to a slowdown in domestic population inmigration, but that is not likely to be noticeable for a couple of years.

Texas’ Housing Markets and Oil Prices Texas’ housing markets surged in 2014 along with the state’s general economy and employment. Home sales in 2014 reached 285,000 transactions, the second-highest level ever recorded at somewhat less than the 2006 peak of 292,805. The statewide median home price set another record high for the fourth year in a row, reaching $183,700. Inventory of homes listed for sale fell to new lows relative to the pace of monthly home sales, reflecting the tight residential markets across the state as population and employment gains coupled with low interest rates fueled home purchase demand. ingle-family building permits in 2014 rebounded to 102,000, close to the 105,000 average permits issued between 1995 and 2012. Even at that level, they were still unable to offset the increase in demand. Multifamily building permits for the year reached 65,700, a total not exceeded since 1985, the last year of the last oil boom. The rapid increase in population in the past several years, especially young singles and young married families coming to the state for employment opportunities, fueled a strong rental housing market.

Texas’ housing market for 2015 will not be exclusively based on the price of oil. Local metropolitan markets experience different levels of influence from oil prices and energy sector activity over the year, depending on how closely tied they are to that sector. Several other factors will affect home sales, home prices and home construction around the state. The major housing market influences besides oil prices include ease of credit and availability for first-time homebuyers, employment growth in nonenergy economic sectors, population growth and immigration, and continued very low mortgage interest rates.

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The negative economic impacts of low oil prices should be at least partially offset by positive impacts from nonenergy economic activity. The uncertainty about how low prices will go and how long they will stay low makes 2015 estimates extremely difficult. No doubt there will be some job losses and a reduction in the job growth rate, which will impact the housing sector. Equally significant, though, may be any negative psychological impact on buyer and seller expectations and behavior if the nonenergy positive impacts are not sufficiently offsetting. he national economy continues to gain strength and show greater improvement in job growth, income, productivity and GDP. Lower oil prices will stimulate the national economy even further, with lower inflation effects, lower transportation costs and lower gas prices providing greater spendable income. It appears the Federal Reserve will be cautious about letting interest rates increase too soon or by too much, and coupled with a heavy inflow of foreign investment capital, a climate of low interest rates should continue to prevail.

The first-time buyer and first-time move-up housing market in Texas declined significantly the past several years because of tight mortgage credit underwriting, which limits buying opportunities, and low-growth household incomes. Statewide, sales of homes priced under $160,000 fell about 18 percent and even more in the major metropolitan areas. This same decline affected the national housing market, prompting political leaders and the director of the Federal Housing Finance Agency to call for looser credit underwriting for first-time and lowerincome buyers to stimulate homeownership. The Federal Housing Administration (FHA), Fannie Mae and Freddie Mac have initiated efforts to lower costs and support lower down payment mortgage financing, but lenders have done little to make such loans available.

Last November, a Metrostudy Inc. blog post reported a “sweet spot” in oil prices between $55 and $90/bbl that

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Figure 4. Texas Single-Family Permits and WTI Price/BBL Monthly, January 1995 to Current

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Single-Family Permits (Thousands)

Monthly Home Sales (Thousands)

Figure 3. Texas Monthly Home Sales and WTI Price/BBL May 1987 to Current 28 22 16 10 4 $0

$30 $60 $90 $120 WTI Spot Price FOB Cushing, Oklahoma

Sources: Energy Information Administration and Real Estate Center at Texas A&M University

4

$150

18 15 12 9 6 3 0

$0

$30 $60 $90 $120 WTI Spot Price FOB Cushing, Oklahoma

$150

Sources: Average Monthly WTI Spot Price FOB Cushing and Real Estate Center at Texas A&M University TIERRA GRANDE

Home construction should show some improvement as it “produces the highest demand for housing in the Houston has not fully recovered from the 2007 recession. However, the market.” The data presented showed quarterly housing starts lack of finished, developed land, financing for first-time buyers tended to be higher within that range of oil prices. and the shortage of construction labor may keep any marked State and local home sales and single-family permit data expansion in check. indicate that demand (sales) and supply (permits) tend to maxiome prices will continue to rise but at a slower rate, mize within an identifiable “optimum range” of WTI oil price. probably around 5 to 7 percent. A rate of price increase The sales and permits depict a notable negative correlation to closer to a long-term norm (around 4.5 percent) would exceptionally low or high prices. Both sales and building perbe a desirable outcome to avoid affordability issues, especially mits fall when oil prices are in excess of $90/bbl and similarly within the low- to moderate-priced housing sector, but the lack at prices below $50/bbl. Residential construction, as measured by single-family permits, falls even more distinctly as the price of supply relative to demand should keep prices higher.

If the WTI price stabilizes at a significantly lower level and of oil exceeds $80/bbl (Figures 3 and 4). the multiplier effect of energy job losses spurs even greater Home prices exhibit a distinct positive correlation with oil employment decline, the housing market could fare much prices within a broader range ($30 to $110) but also show a disworse. Sales and construction activity could decline by 10 to tinct falloff at much lower oil prices (less than $30/bbl) and at 20 percent or more. The level extremely high oil prices (more of increase in the median price than $110/bbl) (Figure 5).

Figure 5. Texas Median Home Price and WTI Price/BBL could be severely restricted or Houston, Dallas-Fort Monthly, January 1990 to Current possibly fall. The more intense Worth, San Antonio and 210 negative psychological effects Austin home sales and single190 of a more significant economic family building permits 170 decline on the market would fursimilarly tend to be highest ther depress the housing sector. within the same oil price 150 If, on the other hand, the “optimum range,” even 130 repercussions of lower oil though each metropolitan prices are not as pronounced market has different con110 Correlation coefficient of 0.86 or prices stabilize at a higher nectivity to oil- and energy90 level, the housing market related industries. could fare much better.

The key to estimating 70 Already, a 30-year fixed the Texas and major metro 50 mortgage interest rate of less market areas’ 2015 housing $0 $30 $60 $90 $120 $150 than 4 percent is stimulatmarket focuses on how low Monthly WTI Price/Barrel ing demand. Since mortgage oil prices go and how long Sources: Average Monthly WTI Spot Price FOB Cushing, Oklahoma and Real Estate Center at Texas A&M University industry regulators and politithey stay there. The current cians have eased entry-level WTI price of around $45/bbl financing by lowering required down payments, making these falls just below the historical “optimum range” for home loans Qualified Mortgages, the volume of sales and starts could sales and building permits, but generally not enough below to indicate a major decline in either. The possibility remains be stimulated to even greater levels than last year.

For more data on this subject, see Center publication “Texas that WTI oil prices could fall further, perhaps stabilizing 2015 Housing Market and the Price of Oil” at recenter.tamu. for some time in the $35 to $40/bbl range, or lower. Such a edu/pdf/2092.pdf. prospect would not necessarily be catastrophic for the Texas housing market but would definitely cause sales and home Dr. Gaines (jpgaines@tamu.edu) is a research economist with the Real Estate construction to constrict from 2014 levels. Again, the timCenter at Texas A&M University. ing of such impacts may be more in the second half of the year and into 2016.

THE TAKEAWAY ssuming the prevailing annual WTI oil price for 2015 stabilizes between $40/bbl and $50/bbl, home sales The price of Texas oil and the upstream energy sector is a statewide could potentially equal or, more likely, be 5 prime cause of concern for Texas’ 2015 economy and housto 10 percent less than the 2014 level. The state most likely ing market. But history shows that Texas’ housing does not will not set another record sales high, but the decline would depend on high oil prices. In fact, the state’s housing marnot be overwhelming. The overall shortage in the supply ket has thrived at prices within a wide range of oil prices of homes available for sale will similarly limit a significant lower than those in 2013 and the first half of 2014. expansion in overall sales.

Median Home Prices (Thousands)

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5

Land Markets

Land Markets The Waiting Game

By Charles E. Gilliland, Ryan McGough and Martin Steinbring

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2,400

Figure 1. Texas Rural Land Prices Nominal Real or Deflated

2,000 Dollars Per Acre

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n 2014, commodity prices retreated.

From a February 2013 high, corn prices dropped 51 percent by September 2014. By year’s end, cotton prices fell 29 percent from an August 2013 high.

In October, oil prices began a slide that continued into 2015.

Despite these headwinds, Texas land buyers shrugged off negative sentiments to propel land prices to record highs.

Fueled by strong demand for recreational properties and cropland, buyers dismissed bearish farm income forecasts.

Statewide land prices soared 9 percent, settling at $2,354 per acre (Figure 1).

That was a five-year increase of 33 percent and a ten-year appreciation of 125 percent. From 1966, Texas land prices took 38 years to top $1,000 per acre. By 2013, a mere nine years later, the statewide per-acre price exceeded $2,000 for the first time, reaching $2,160. The 2014 price was a new record. The median size for a Texas rural tract sold was 118 acres, down from 120 acres in 2013.

With the exception of the West Texas and Far West Texas areas (Figure 2), regional market prices moved up, mirroring the statewide trend. South Texas posted the greatest percentage increase with a regional price nearly 16 percent higher than 2013. The Northeast Texas region followed closely with a more than 12 percent increase. he Gulf Coast–Brazos Bottom and Panhandle and South Plains each rose approximately 10 percent.

The Austin–Waco–Hill Country region expanded by 9 percent. However, the West Texas region contracted more than 2 percent from 2013 price levels.

Far West Texas sales registered a sizable decline. However, because that region frequently sees a limited number of highly individualized transactions, this price drop does not accurately reflect broad market realities. In this case, observers indicated that few good-

1,600 1,200 800 400 0 1966

1974

1982

1990

1998

2006

2014

Note: Real prices in 1966 dollars.

Source: Real Estate Center at Texas A&M University

quality properties reached the market in 2014, hinting that the price change resulted from an unusually large number of lesser-quality land sales in the lowest priced locales of the region.

With 4,546 reported sales, the 2014 Texas land market finally Figure 2. exceeded the level of activity Land Market Regions Panhandle posted in 2007, amounting and to a 10 percent increase over South 2013. However, the median Plains tract size dropped from 120 acres to 118 acres with an overall volume of West Texas Northeast Texas 1,446,827 acres, 65 percent greater than Austin-Wacothe 2009 total of Hill Country Far West Texas 875,536 acres and Gulf Coast6 percent more acres Brazos Bottom than 2013.

Separately, rural markets for small properties South Texas recorded a price increase of 4 percent after a 19 percent growth in 2013 (Figure 3). The 2014 price for small tracts was $5,018 per acre, surpassing the 2008 peak price by 23 percent.

This was an all-time high for Texas small Source: Real Estate Center at Texas A&M University property prices.

Taken together, these indicators paint a portrait of an active 2014 market with

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robust prices in all segments. Prices surged ahead as investors competed with recreational buyers and agricultural producers. The explosion of wealth from

Dollars Per Acre

of listings. Some farmers have begun to demand rent reductions or threaten to drop leased property altogether. In addition, the dramatic reversal of oil prices cooled recreational buyers, especially those with Figure 3. Small Property income from the energy Texas Rural Land Prices industry.

5,000 Nominal Deals in the works Real or Deflated ground to a halt in Decem4,000 ber and January as potential buyers waited for oil 3,000 prices to settle, ending the uncertainty gripping the 2,000 market. As potential buyers brace for possible nega1,000 tive impacts on oil-based incomes, this apprehensive 0 2000 2002 2004 2006 2008 2010 2012 2014 mindset clouds prospects Note: Real prices in 2000 dollars. for market activity in the Source: Real Estate Center at Texas A&M University coming months. Oil field service suppliers are likely Eagle Ford Shale production spurred a going to reduce prices for their services wave of buyers seeking ranches. Develto avoid widespread layoffs. Companies opments in urban areas spiked upward as may announce plans to curtail drilling in the Texas economy expanded, promptthe coming year until oil prices stabilize. ing land purchases for future housing As Texas faces a reversal of oil prices, subdivisions. In short, 2014 was a robust two possibilities emerge for the path of land market. future economic development. Some As the fall progressed and turned the prognosticators, recalling the carnage in corner into 2015, prospects for continu1986, foresee challenging times ahead ing market progress dimmed. Weakened for the entire economy. Others, citing commodity prices finally caused woulddiversification of the Texas economy and be cropland investors to pull back, and less vulnerable financial institutions, brokers reported a growing inventory insist that this time is different from the

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1980s. These observers expect a modest slowdown, but they do not foresee major challenges ahead. The prospects for land markets in 2015 critically depend on which of these scenarios emerges in the coming months.

Analyses of past land price developments suggest that a 50 percent cut in the Texas personal income growth rate will result in a sizable but noncatastrophic drop in overall land prices over the coming two years. A downturn inflicting greater declines in Texas personal income with weak oil prices will obviously inflict a more painful retreat in land prices. The uncertainty about which path the economy will likely follow has many potential buyers adopting a wait-and-see attitude.

For the complete Texas Land Price Index, see “2015 Texas Land Markets Taking a Breather?� at recenter.tamu. edu/pdf/2095.pdf.

Dr. Gilliland (c-gilliland@tamu.edu) is a research economist and McGough and Steinbring research assistants with the Real Estate Center at Texas A&M University.

THE TAKEAWAY Statewide per-acre prices set a record high in 2014, with all regions except West Texas and Far West Texas registering price increases.

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Income Taxes

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ecent stock market gains and low mortgage interest rates are enabling more individuals to purchase vacation homes. In addition to offering personal enjoyment, vacation homes can be rented out to help offset expenses and reduce the owners’ taxes.

But beware. A 2014 tax court case highlights how poor record-keeping and the manner in which days are spent in connection with repairing a vacation rental home may eliminate eligibility to deduct losses. Furthermore, a new 3.8 percent surtax on unearned income (introduced in 2013) could produce a higher tax cost when selling income-producing real estate, including vacation rental homes. The court case and surtax are discussed here, following a summary of key vacation rental home rules.

Typical expenses associated with vacation rental homes include mortgage interest and real estate taxes, which are deductible under any circumstances. In addition, if the property is rented more than 14 days, a proportionate amount of expenses such as rental management company fees, utilities, maintenance and tax depreciation may also be deductible. The latter expenses can generate a tax loss (deductible against nonrental income) if the number of personal-use days does not exceed the greater of 14 days or 10 percent of the number of rental days.

The taxpayer must maintain careful records, such as a logbook of how time was spent while at the property along with receipts for all expenses. A 2014 tax case focuses on how to assess whether days are considered personal use. If the property is rented for 14 days or less, the rental income and related expenses are ignored for tax purposes. ssume the taxpayer uses the residence as a vacation home for 16 days and rents to others for 100 days.

Both the 14-day personal-use test is met (16 days are greater than 14), and the 10 percent test is met (16 days are greater than 10 percent of 100 days, or 10 days). Consequently, rental property expenses are still deductible but only up to the amount of rental income. If expenses exceed rental income, the resulting net loss can be deducted in a future tax year but only to the extent that future rental income exceeds future rental expenses. However, if the rental period is 170 days (10 percent of which equals 17 days), then all expenses allocable to the rental period are deductible and they are allowed to generate a deductible tax loss that can reduce taxes on nonrental income.

A 2014 court case illustrates that the IRS assesses personal-use days very carefully when days are spent repairing or maintaining

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the property.

In the case, the concern was whether tax losses could reduce nonrental income. The taxpayer spent 24 days in connection with making repairs and performing maintenance on the vacation home and classified the days as nonpersonal (and nonrental).

However, even though the taxpayer endeavored to maintain adequate records, the IRS and the court counted some of the 24 days as personal because they contained a combination of personal use (that is, relaxation) and repairs. Also, some of the taxpayer’s records were suspect. As a result, the number of personal days identified by the court was sufficient to preclude the deduction of tax losses against nonrental income. eparate from the court case is the issue of taxation of the gain from a subsequent sale of the property. If the taxpayer sells the property at a gain, the larger of the gain or total tax depreciation deducted during the holding period is taxable. In 2013, the tax rate on the taxable gain (and other investment income) was increased by 3.8 percentage points for high-income taxpayers — generally, marrieds filing jointly with adjusted gross income (AGI) more than $250,000 — and singles with more than $200,000 AGI. The rules and tax-planning strategies for a vacation home are complex if the home is rented. Vacation homeowners are advised to consult with a tax accountant or tax attorney to maximize the tax benefits from vacation home rentals.

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Dr. Stern (stern@indiana.edu) is a research fellow with the Real Estate Center at Texas A&M University and a professor of accounting in the Kelley School of Business at Indiana University.

THE TAKEAWAY Vacation home rentals can decrease income taxes under certain circumstances. However, a 2014 court case demonstrates how the personal use of a rental vacation home can decrease tax benefits. A new 3.8 percent surtax on unearned income may increase taxes when vacation rental homes are sold.

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Texas Economy

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ex ∆s ri∆ngle

By Robert W. Gilmer and Samuel Redus

Economic Engine of the Southwest

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he Texas Triangle is outlined by Dallas-Fort Worth (DFW), Houston and San Antonio, with Austin just inside the Dallas-San Antonio line. These four metro areas are the economic heart of Texas, holding 68 percent of its jobs and earning 73 percent of its income.

The four Texas Triangle cities come together to form a great economic engine that serves Texas and much of the southwestern United States. These cities are best understood as one economic entity that is divided by history and geography. Although miles apart, they remain physically close enough that mutual competition has forced them to seek out different and complementary economic roles. This engine has four cylinders that work in close coordination to power the Texas economy.

Largest Metropolitan Areas

definition. To the DFW MSA, for example, the CSA definition adds smaller cities such as Mineral Wells, or to Houston, cities such as Brenham and Huntsville. The CSA definition squeezes out a little more industry-level information in defining the economic role of each Texas Triangle metro.

San Antonio and Austin are the 25th and 35th largest MSAs by population in 2012. Neither is part of a CSA, but their ranking as metro areas place them in impressive company. San Antonio’s population ranks with Portland or Orlando, while Austin is similar to Nashville or Indianapolis.

Looking at MSA rankings, New York is first with 19.8 million, followed by Los Angeles with 13 million, and Chicago with 9.5 million. Then population falls to 6.7 million in DFW and 6.2 million in Houston. Although Texas holds these next two places, the Gulf Coast somehow seems cheated out of a great megalopolis. The impression is more pronounced by looking at the CSA rankings.

There is a solid case for fixing this apparent anomaly by simply adding Houston and DFW together. It is not that they

Table 1 shows the largest metropolitan areas in the United States ranked by population and identified by their largest central cities. The ranking on the left uses the better-known Metropolitan Statistical Area (MSA) definition, which is a group of counties with a central place of 50,000 or more residents, and Table 1. Metropolitan Areas Ranked by 2012 Population with surrounding counties that Under Different Metro Definititions have economic or social cohesion.

Rank Metropolitan Area Rank Combined Metropolitan Area The Combined Metropolitan Area 1 New York 19,837,753 1 New York 23,368,541 on the right uses the Combined 2 Los Angeles 13,037,045 2 Los Angeles 18,213,775 Statistical Area (CSA) definition, 3 Chicago 9,514,059 3 Chicago 9,891,237 which begins with a significant 4 Dallas-Fort Worth 6,702,801 4 Washington, D.C. 9,334,630 MSA and adds adjacent metropoli5 Houston 6,175,466 5 San Francisco 8,364,559 6 Philadelphia 6,019,533 6 Boston 7,991,835 tan or micropolitan areas, if there 7 Washington, D.C. 5,862,594 7 Philadelphia 7,129,715 is economic integration within the 8 Miami 5,763,282 8 Dallas-Fort Worth 7,097,014 larger group.

9 Atlanta 5,454,429 9 Miami 6,375,718 For the benefit of Texas bragging 10 Boston 4,642,095 10 Houston 6,369,855 rights, the MSA definition works 11 San Francisco 4,454,159 11 Atlanta 6,088,358 better, placing DFW in fourth 25 San Antonio 2,234,494 n.a.

San Antonio 2,234,494 35 Austin 1,835,110 n.a.

Austin 1,835,110 place with 6.7 million people and Texas Triangle 16,947,871 Texas Triangle 21,768,793 Houston’s 6.2 million in fifth.

This article relies on the CSA Source: Bureau of Economic Analysis, Regional Economic Information System

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would count as a single metro under federal definito the square of the distance between tions but that Texas history and geography conspired them. to separate Dallas and Houston 170 years ago. Today, Table 2 shows intense economic economic and social integration is extensive, and — as interaction among Texas Triangle will be shown — the two economies strongly complement cities and limited relations with other each other. In fact, it can be argued that nearby San Antonio major U.S. metros. The figures are and Austin could be added on similar grounds, and the Texas scaled so that the interaction between Triangle treated as a very large and highly coordinated ecoHouston and DFW is 100.0. The stronnomic system. gest interaction in the Texas Triangle dding these metropolitan areas together brings scale. is between San Antonio and Austin A combined Houston and DFW ranks just behind Los at 137.2, and the weakest is between DFW and San Antonio at Angeles if the MSA definition is used and ahead of Los 27.5. Triangle city interactions are large compared with interacAngeles under the CSA ranking. The combined Texas Triangle tions with other major U.S. metros. Only three combinations metros are second only to New York on either list. But more are as much as one-tenth of the DFW-Houston linkage: Chicago than size matters here. These cities — especially Houston with DFW and Houston, and Atlanta with Houston. and DFW — often think of themselves as economic rivals.

How do the Triangle cities earn their living? To define their But this idea fails if each economic role, economists takes a different economic focus on the metro area’s Table 2. Strong Economic Interaction Among Triangle Metros role, providing a distincsales of goods and services (Gravity Model Scaled at Houston/Dallas = 100) tive group of goods and to places outside the local Dallasservices to other Triangle area. These sales generAustin Fort Worth Houston San Antonio cities. In this case, instead ate new income for the Austin – 44.6 90.2 137.2 of rivals, the success or area, in contrast to many Dallas-Fort Worth 44.6 – 100.0 27.5 failure of any one city is inherently local activiHouston 90.2 100.0 – 74.3 an event shared by the ties such as laundries, San Antonio 137.2 27.5 74.3 – entire region. dry cleaners and grocery Atlanta 2.5 8.3 11.2 2.6 stores. These businesses Proximity, History, Boston 0.5 1.4 1.8 0.5 provide critical services Chicago 2.9 10.3 10.5 3.1 Geography but bring no new income Los Angeles 2.6 5.9 7.0 3.3 into the community.

Simple proximity drives a Miami 1.2 3.1 5.3 1.4 Table 3 shows selected high degree of economic New York 2.3 6.8 8.0 2.5 sectors that sell goods or Philadelphia 0.8 2.6 3.2 0.9 interaction among the Phoenix 1.6 3.5 4.1 2.1 services from each Texas Texas cities. Economists San Francisco 0.6 1.4 1.5 0.7 metro to other regional, often use a “gravity Washington, D.C. 1.0 3.1 3.8 1.1 national or global cusmodel” to measure the Sources: Google Maps and authors’ calculations tomers. It shows the perlikely interaction among centage share of income different places. Gravity from that sector that is derived from external sales. If no defines the attraction between two objects as directly pronumber appears, less than 12 percent of the sector’s income portional to their mass and inversely related to their distance is from exports, and the industry is local or relies on imports squared. The economic analogy is that attraction between two to fill the community’s needs. The positive numbers are places is proportional to their population and inversely related

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Table 3. Percent of Sector Income Derived from Metro-Level Exports Austin

DallasFort Worth

Houston

San Antonio

Texas Triangle

Energy

the list of sectors that Oil Producers 39.8 79.6 91.3 47.4 85.7 drive local growth. Exports Oil Services 62.8 89.3 80.2 from these Texas Triangle Fabricated Metals 45.9 16.0 cities fall into six groups: Machinery 64.0 33.3 energy, transportation, techRefining 83.2 62.0 Chemicals 47.4 15.3 nology, finance, tourism and Pipelines 50.0 32.3 77.6 84.8 government.

Utilities 55.4 Table 3 does a good job Transportation of describing these local Wholesale Trade 23.7 22.5 economies. Austin, for Water 65.2 example, began as a planned Air 62.5 46.2 capital, with Mirabeau B. Truck 21.3 18.0 20.6 14.5 Lamar choosing the site Warehousing 20.0 Transport Support 14.5 48.7 28.6 for its natural beauty and Repair and Maintenance 23.1 24.8 1.4 23.1 interior location. It would Technology struggle against isolation Computer Manufacturing 76.9 32.4 18.0 and Indian attack for many Electronic Equipment Manufacturing 19.4 years to secure its political Telecommunications 46.2 14.5 and economic role. Until ISP and Data Processing 30.1 56.7 75.5 40.1 the 1960s, its economy was Finance based on being a state capital Banking 34.2 15.3 and home to the University Real Estate 20.0 31.0 18.0 of Texas. In recent years, a Administrative Services 21.9 13.8 large technology industry has Tourism developed, defined by comAccommodations 13.8 puter and electronics manuEating/Drinking Places 16.7 27.0 facturing. This basic story is Gasoline Stations 17.4 confirmed by the data in the Government first column of Table 3, with State 48.7 Federal Civilian 43.8 tech and state government Federal Military 71.7 sectors standing out. Strength in eating and drinking places Sources: Bureau of Economic Analysis and authors’ calculations (as well as several retail secThe DFW area has evolved into the primary distribution tors not listed) can be attributed to the large state university. point for Texas, Oklahoma, Arkansas and other surrounding ouston is about energy, transportation to move energy, states. Goods flow into the metro area by rail, truck and air and the Port of Houston. Oil exploration and producto be broken down for further distribution to towns and cities tion, oil services, refining and petrochemicals operate throughout Texas and beyond. Goods from Asia arrive by rail on a world-class scale, supported by pipelines, machinery and from the west coast to join the flow of domestic goods for fabricated metal. Houston’s port is the second largest in the distribution. If the Trinity River had been navigable as far as nation by tonnage, and nearly 80 percent of that tonnage is DFW, combining this central distribution point with deep energy related. water access, Houston probably would not be a major port today.

In DFW, there are three key clusters: transportation, techDFW has its own tech sector, built on a history of aircraft nology and finance. Dallas was founded in 1841 as the only production, defense electronics and telecommunications. Dalnatural ford on the Trinity River, with no access to the sea las has become the state’s financial center. Since the crash of except by moving goods to the Mississippi River. The railroads the 1980s and the loss of most of the Texas banking system, arrived after the Civil War, opening the Blackland Prairie and out-of-state banks have concentrated activity in Dallas. giving DFW a key inland location. Fort Worth began as a barSan Antonio was 100 years old before the Texas Revolurier against Indian attack and later was an important railhead tion, part of the Mexican presidio and mission system. Today for the cattle industry.

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it remains strongly tied to South Texas and Mexico, both culturally and economically. San Antonio stands out as a highly diversified city, providing a wide array of goods and services, mostly to the South Texas region. Again, Table 3 shows a transportation cluster, this one serving the Texas border cities and the maquiladora industry in northern Mexico. There is regional banking and insurance, a thriving tourist industry indicated by the concentration of bars, restaurants and gasoline stations, as well as a large military presence.

At first glance, there is substantial overlap — and potential competition — in oil, tech, and transportation industries, but the work of the Texas Triangle in fact has been neatly divided up. Oil producers are found in all four cities, for example. But Houston’s energy market is national and global in scope, serving a market that extends far beyond Texas. In contrast, the other cities are regional service centers: Fort Worth serves the Panhandle, Oklahoma and North Texas; San Antonio focuses on South Texas; and Austin serves the Giddings area and the Gulf Coast.

Similarly, transportation activities divide into those related to the Port of Houston, the distribution of goods from DFW to Texas and surrounding states, and San Antonio’s truck and warehouse services for the border cities. Tech divides between the computer-related manufacturing in Austin and telecommunications in DFW. As hypothesized, proximity and competition has split up the work of the Texas Triangle, with limited head-to-head competition among the cities.

shared among Triangle cities only — air or water transportation in DFW and Houston, for example — but are not part of larger national markets. The remaining Triangle exports are heavy on energy. Houston’s national and global exports are included, of course, but the regional oil centers also reach well outside the Triangle to other states and cities. Similarly, all the transportation hubs serve larger surrounding areas, meaning they count as Triangle exports; tech industries sell to larger markets from both Austin and DFW. ne concern about the Triangle economy revealed by Table 3 is the weakness of the service sector. For example, banking disappears when the four metros are combined, implying that the DFW financial industry has no significant reach beyond the other Texas cities. Professional, business and scientific services show up as a potential export only in Austin, and there is no evidence that these higherorder, white-collar services are exported to the rest of the United States. Urban economists often point to these highly skilled professional services as the hallmark of a successful global city, and the Triangle cities — alone or combined — seem to fall short.

Spreading the population across the state offers more livable places — less congestion and cheaper housing, for example — but one cost associated with the loss of that single megalopolis may be the lack of scale needed to justify the highest-order urban functions.

On their own, the Triangle cities may simply lack the size and gravitas to justify a global financial center like London, a communications center like New York, or the high-end retail of Los Angeles’ Rodeo Drive.

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The combined population of the Triangle metro areas puts them in the same class as New York, Los Angeles and Chicago.

Exports from Triangle Cities

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s seen in Table 1, the combined population of the Triangle metro areas puts them in the same class as New York, Los Angeles and Chicago. These Texas cities share intense economic interaction, are highly integrated, and essentially function as a single large metro. The cities are anything but rivals, providing a shared group of goods and services that contributes to their mutual success.

As a single economic entity, what is the bigger role of the Texas Triangle as a key part of the state or nation? The rightmost column in Table 3 adds the Texas Triangle cities together and shows the exporting sectors from the combined metros.

Some local activities disappear from this list because they are APRIL 2015

Dr. Gilmer (rwgilmer@Central.UH.edu) is director of regional forecasting at Bauer College of Business at the University of Houston and Redus is an associate with Rand Group of Houston.

THE TAKEAWAY Texas’ four largest metros (Dallas-Fort Worth, Houston, Austin are San Antonio), function as one large economic entity with each playing complementary roles. Together, they represent 68 percent of Texas jobs and 73 percent of the state’s income.

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Texas Economy

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This is not the 1980s. The world has turned, and many local economies in Texas may be impacted quite differently by the downturn in crude oil prices this time around.

The Corpus Christi region stands out as an area that anticipates a net positive economic impact from reduced upstream oil and gas activity.

Its massive level of new industrial development offers Texas real estate professionals a look at how economic diversity can help bolster local real estate markets during periods of economic uncertainty.

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Plan for Diversification

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bout five years ago, with the Eagle Ford shale region in its infancy, the City of Corpus Christi and the Corpus Christi Regional Economic Development Corporation (CCREDC) began to identify and court global industrial firms that used natural gas and natural gas liquids (NGLs) as a feedstock. Already home to crude oil refineries, the thought was that the region’s proximity to the Eagle Ford placed it in a strong position to benefit from the play’s oil and gas production.

“We thought that increasing downstream industrial development based on cheap natural gas would help us weather future price drops and also diversify our economy,” says Judy Hawley, chair of the Port of Corpus Christi Commission. “It’s looking like our plan was a good one.”

Over $28 billion in new projects are under construction or in final permitting.

A number of factors appealed to companies that are locating new facilities in Corpus Christi.

A well-positioned 45-foot-deep port to handle larger ship traffic and access to cheap, plentiful natural gas were often at the top of the list. However, being in attainment for air quality (meeting government regulations) has also been a huge advantage. Corpus Christi is currently the largest industrial area in the country in air attainment.

“Companies looking at Corpus discover that the permitting process for new industrial facilities is much less onerous in an area that is in attainment,” says Corpus Christi Mayor Nelda Martinez.

The existing harbor bridge, built in 1959, is also being replaced with a much taller structure to provide more clearance for bigger ships. The new bridge, scheduled to be completed by 2020, will offer 67 more feet of vertical clearance at 205 feet from the waterline.

New Projects Coming to Town The bulk of new development and expansions in the region are related to downstream oil and gas activities (see table). Projected construction

Publicly Announced New Industrial Projects or Facility Expansions in Corpus Christi Region (Last Five Years)

Company Name TPCO America (Phase I)

Facility Type Pipe Finishing

TPCO America (Phase II)

Pipe Manufacturing

Cheniere

LNG Exports

Cheniere

Condensate Distribution

OxyChem

Propane Exports

OxyChem

$ Investment Total $1.3 bil.

Construction Start

(Approximate) Construction End

Oct. 2011

Nov. 2014

Permanent Jobs Total of 800

Feedstock

Finished Products

Iron ore

Green seamless pipe

Green seamless pipe

Finished and threaded pipe

Aug. 2014

Year-end 2016

Mid-2015

2018

200

Natural gas

Liquified natural gas

$500 mil.

Unknown

Unknown

50

Condensate

Condensate

$60 mil.

Sept. 2014

2015

60

Propane

Propane

Ethylene Production

$1.3 bil.

Dec. 2014

2017

140

Ethane

Ethylene

M&G Resins

PET plant

$1.1 bil.

Nov. 2014

2016

220

Ethylene glycol

Plastic PET pellet catalysts

Voestalpine Texas

Steel Production

$770 mil.

Apr. 2014

2016

150

Iron ore pellets

High purity hotbriquetted iron (HBI)

Castleton Commodities International

Condensate Splitter

$400 mil.

Mid-2015

2016

35

Condensate

LPG, naptha, kerosene, gasoil, fuel oil

Magellan Midstream

Condensate Splitter

$400 mil.

Jan. 2015

2016

105

Condensate

LPG, naptha, kerosene, gasoil, fuel oil

TexStar Midstream Services

Gas Fractionator

$100 mil.

Feb. 2014

Year-end 2015

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Wet gas

Ethane, propane, butane, condensate

Trafigura

Storage Tanks/Distribution

2013

2015

Unknown

Oil & condensate

Oil & condensate

Plains Marketing

Storage Tanks/Distribution

2013

2015

Unknown

Oil & condensate

Oil & condensate

Martin Midstream

Storage Tanks/Distribution

2013

2015

Unknown

Oil & condensate

Oil & condensate

Eagle Materials

Frack Sand Distribution

$22 mil.

Mid-2012

2013

40

Raw frack sand

Graded frack sand

LyondellBasell

Petrochemical Production

$500 mil.

Nov. 2014

Year-end 2015

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Ethane

Ethylene

Flint Hills Resources

Refinery

$250 mil.

2012

2014

N/A

Crude oil

Refined petroleum products

Valero

Refinery

$650 mil.

2012

2014

N/A

Crude oil

Refined petroleum products

Superior Weighting Products

Drilling Products

$18 mil.

Mid-2014

Mid-2015

20

Barium sulfate

Barite for drilling fluids

Celanese

Methanol Production

$750 mil.

Early 2015

2017

45

Natural gas

Methanol

Celanese

Compounding Facility

$150 mil.

Mid-2015

2017

106

Polystyrene

Assorted engineered polymers

$11 bil.

Total $800 mil.

Source: Corpus Christi Regional Economic Development Corporation

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CORPUS CHRISTI ALREADY HAD crude oil refineries, so community leaders actively sought out and recruited other industries related to downstream oil and gas activities. The goal was to take advantage of opportunities offered by the then-booming Eagle Ford Shale, and to allow for economic stability during petroleum industry downturns.

completion dates extend out to 2018. By the time the dust settles, more than 2,000 new direct permanent jobs will be created. ne of the earliest arrivals was TPCO America’s pipe-processing plant. The facility is east of Gregory, Texas, across U.S. 181 from Port Corpus Christi’s La Quinta Trade Gateway site. The 1.6 million-square-foot plant is the largest single investment in a U.S. manufacturing facility by a Chinese company.

The TPCO America facility will produce about 500,000 metric tons of four-inch through 10¾inch seamless steel pipe annually, primarily for use in the energy industry around the world.

Another new company is Voestalpine Texas.

The world’s largest manufacturer of specialty steel, Voestalpine Texas will use natural gas, which is more environmentally friendly than traditional petroleum coke, to reduce impurities in iron ore pellets imported from Brazil. No hazardous byproducts are produced in the purification process.

The hot iron will be poured into palm-sized bricks known as hot-briquetted iron or “HBI.”

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About half of the plant’s production will be shipped to Austria to develop a wide variety of steel products, including oilfield pipe, steel rails and flat steel for vehicle manufacturing.

By far, the most expensive project in the region will be Cheniere Energy’s $11 billion liquefied natural gas (LNG) export facility. The natural gas liquefaction plant will be constructed on one of Cheniere’s existing sites originally permitted to import LNG back when when natural gas was thought to be a declining resource in the United States.

The Cheniere site is located on the La Quinta Channel on the northeast side of Corpus Christi Bay in San Patricio County. The facility will have an export capacity of 2.1 billion cubic feet of LNG per day when completely built out. Cheniere is completing the federal and state permitting process, and the project is tentatively slated for completion in 2018.

Cheniere has also closed on approximately 485 acres in Ingleside for a condensate distribution facility. Plans include two marine docks capable of handling mid-sized crude oil tankers

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for shipping condensate overseas and barges for domestic delivery. ast summer, the export of condensate outside the United States became legal under very limited conditions. The expectation is that the limitations on condensate exports will be further loosened over time. Cheniere is positioning itself to handle increased exports as the need arises.

M&G Chemicals, a privately owned Italian company, is constructing the world’s largest PTA/PET chemical plant in Corpus Christi with its investment of more than $1 billion.

Purified terephthalic acid (PTA) is a raw material used in making highperformance multi-purpose plastics.

Also, polyester fibers based on PTA improve synthetic fabric performance, both alone and in blends with natural and other synthetic fibers.

Polyethylene terephthalate (PET)

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is a plastic resin made from PTA. PET is used to make synthetic fibers and clear, strong, lightweight plastics widely used for packaging foods and beverages such as soft drinks, juices, cooking oil and water.

The facility will be located on Port Corpus Christi’s Inner Harbor. With access to three Class I railroads at the port, M&G Chemicals will be a major rail user, shipping an estimated 15,000 carloads of product per year. PTA can be produced from a variety of petrochemical feedstocks such as ethylene or propylene.

Occidental Chemical Corp. (OxyChem) is working with Mexican petrochemical company Mexichem to build a $1.3 billion ethylene cracking plant in Ingleside. The processing or “cracking” of ethane feedstock turns it into the petrochemical

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ethylene. The majority of the plant’s production will be sold to Mexichem to produce PVC resin and piping. The most popular uses for ethylene are polyethylene plastic products or ethylene glycol (antifreeze).

LyondellBasell has also broken ground on a major expansion of their Corpus Christi ethylene cracking facilities. The expansion should almost double their current production of ethylene. Constructing a new plant could have taken five years

or more, so the company instead chose to expand existing facilities to take advantage of cheap, plentiful ethane.

Finally, Flint Hills Resources LP and Valero Energy have spent hundreds of millions of dollars to expand their Corpus Christi refineries’ capacity to handle more light Eagle Ford crude. As a bonus, state-of-the-art pollution controls in the new facilities are actually expected to reduce emissions below what is required by regulatory agencies.

CCREDC expects to see additional development and permanent employment stemming from all the basic industries locating in the region. Much like the automotive assembly sector, an array of different suppliers and service companies are needed now and will be needed to provide maintenance, engineering, logistics, testing expertise and other critical ancillary goods and services to these plants.

Tight Labor Markets

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ll the new construction will require a significant skilled labor force, something that continues to be in short supply across Texas. However, industry and workforce officials think that any downturn in the upstream oil and gas sector could work out well for Corpus Christi.

“Corpus Christi will need thousands of craft workers in the next three years,” according to Mayor Martinez. “We need truck drivers, welders, TIERRA GRANDE

fabricators, scaffolding builders, electricians and site preparation folks. The list goes on.” The Corpus Christi MSA’s overall unemployment rate has dropped from 8.4 percent in November 2010 to 5 percent in January 2015.

The upstream oil and gas sector pulled a lot of skilled labor out of many communities in Texas, and Corpus Christi is no exception. “We are hoping that many of the laborers who left Corpus Christi to work in drilling operations will be willing to come back to work at home in the construction sector,” says John Plotnik, executive vice president of CCREDC.

The Future City and county leaders remain proactive when it comes to keeping up with infrastructure, education, security and housing needs.

The port, the City of Corpus Christi and local industries recently pitched in to hire water consultants. The region has plentiful water and several of the new industries have chosen to desalinate bay water for their use. But a cost-benefit analysis of all possible sources of water, including wastewater recycling and desalination, is being carried out to refine future needs.

The region is also looking out another five years to find the next key industry. One possibility showing great promise is unmanned aircraft systems or “drones.”

In December 2013, the Federal Aviation Administration selected six public institutions to conduct APRIL 2015

research using drones to incorporate the technology into the national airspace for public and private purposes. Texas A&M University Corpus Christi (TAMUCC) was one of the six.

Known as the Lone Star Unmanned Aircraft Systems Initiative (LSUASI), the program is a statewide economic development initiative being led by TAMUCC. Uses for drones are expected to burgeon in the coming years according to TAMUCC officials.

Some possibilities beyond the obvious varieties of surveillance work include locating and assessing distressed vessels at sea and land surveying. A whole new wave of manufacturers could come for the technology transfer with TAMUCC as well.

“We’re always on the lookout for that next new sizzle,” says Plotnik.

Dr. Hunt (hhunt@tamu.edu) is a research economist with the Real Estate Center at Texas A&M University.

THE TAKEAWAY Throughout Texas, people are concerned about the oil industry downturn, fearing another 1980s bust. But the Corpus Christi area is an example of how economic diversification creates employment opportunities that may counter the decline in the drilling sector.

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Legal Issues

SURFACE Surface Tension

TENSION Accommodation of the Estates Doctrine

BY JUDON FAMBROUGH

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o the surprise of many Texas landowners, the mineral estate is dominant over the surface when it comes to mineral exploration and production. Simply put, an oil company (mineral lessee) has the automatic (implied) right to use as much of the physical surface and substances belonging to the surface owner as is reasonably necessary to explore and produce the minerals. This right comes without asking permission to enter to use the surface or the surface substances. The mineral lessee does not have to pay for using the surface, surface substances, or to clean up. But to gain goodwill, some oil companies offer to pay surface damages and restore the surface.

This begs the question: What substances belong to the mineral owner, and what substances belong to the surface owner?

In Texas, the answer depends on the wording of the mineral reservation. When the terms minerals or oil, gas and other minerals are used, oil, gas, salt, sulfur and possibly uranium belong to the mineral owner. Coal, lignite and iron ore are also included when they lie within 200 feet of the surface and can be produced without destroying (depleting) the surface.

The substances owned by the surface owner in this situation include sand, gravel, caliche, surface shale, building stone, limestone and groundwater. As mentioned earlier, the coal, lignite and iron ore also belong to the surface owner if they lie on or within 200 feet of the surface and the production destroys the surface.

The two surface substances used most often by oil companies for exploration and production include groundwater for drilling and fracking, and caliche for constructing roads and drilling pads. Statewide, it takes between ten and 40 acre-feet of groundwater to frack a horizontal well. In many

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cases, this represents a significant amount of free groundwater for the oil companies.

in the determination of whether a surface use by the lessee is reasonably necessary.

But under the circumstances indicated here Exceptions to the Rule (i.e., where there is an existing use by the surface owner, which would otherwise be precluded Texas case law holds three exceptions. Oil companies must, or impaired, and where under the established by law, pay surface damages when they (1) use more surface, practice in the industry there are alternatives groundwater and/or caliche than is reasonably necessary, (2) available to the lessee whereby the minerals can negligently injure the surface or (3) fail to accommodate the be recovered) the rules of reasonable usage of the estates. The Center’s Minerals, Surface Rights and Royalty surface may require the adoptions of an alternaPayments (recenter.tamu.edu/pdf/840.pdf) discusses these rules tive by the lessee. in more detail. ater, the high court stated that this alternative must be The accommodation of the estates doctrine or rule is the pursued even if it requires additional funds as long as it most recent recognized exception and the least understood. is an established industry practice.

Many surface owners mistakenly think this means the oil The rule was further refined in Sun Oil Co. v. Whitaker. companies must accommodate all their needs as a surface In this case, the surface owner protested the use of masowner when they enter to explore and produce the minerals. sive amounts of groundwater in a waterflood project being The rule is much more restrictive. conducted on the property. The owners maintained that the Also known as the “alternative means doctrine,” the rule project significantly affected water flowing to the surface, serves to balance the rights of the surface owner and the minwhich in turn reduced the amount of groundwater available for eral lessee’s use of the surface when unnecessary injury to the irrigation and shortened surface occurs. the life of the irrigated The Texas Supreme farmland. The surface Court established the owner claimed the doctrine in Getty Oil v. accommodation of the Jones (1970). Jones was a estates doctrine required farmer in Gaines County the lessee to take water who operated several from sources located pivot irrigation systems. off the leased premises.

The lateral arms cleared This was a reasonable objects less than seven alternative, according to feet high. During the Whitaker. winter of 1967, Getty The high court disentered and drilled two agreed, limiting the oil wells within these doctrine to reasonable systems and erected two alternatives that exist on pump jacks. One rose the premises, not off.

17 feet on the upstroke Merriman v. XTO and another 34 feet.

Energy Inc., decided by These heights prevented the Texas Supreme Court the operations of two of THE ACCOMMODATION OF THE ESTATES DOCTRINE was established in 2013, offers another Jones’ pivot irrigation through a court case, Getty Oil v. Jones (1970), in which a landowner refinement. Merriman systems. Jones asked successfully sued Getty because the height of its pump jacks made it purchased the surface of Getty to install shorter impossible for irrigation systems to operate. a 40-acre tract in 1996. pumps or to construct He received no minerals. Merriman, a full-time pharmacist in below-surface cellars to allow the operation of the irrigation Limestone County, conducted a cattle-raising operation on this systems. and other acreage he owned in the area on weekends. etty refused, relying on its implied right. Jones sued Once a year, he drove his cattle to the 40 acres, sorted them Getty for an injunction to install shorter pumps and/ using temporary stock panels and electric fences in conjuncor below-ground cellars and for surface damages.

When the issue reached the Texas Supreme Court, it ruled in tion with permanent fencing and structures. When the sorting ended, he removed the temporary working pens and returned Jones’ favor. Though Getty had the right to use as much of the the area to grazing. surface as reasonably needed, the right is not exclusive. Said Merriman challenged XTO’s right to place a drill site on the the court: 40 acres citing the accommodation of the estates doctrine. The . . . the implied right in favor of the mineral estate trial court held the doctrine did not apply. Merriman appealed. is to be exercised with due regard for the rights of The appellate court affirmed the trial court, and the issue went the owner of the servient estate. The due regard to the Texas Supreme Court. concept defines more fully what is to be considered

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The high court added a wrinkle to the doctrine as pronounced in Getty Oil v.

Jones. It ruled that the surface owner must prove that he or she had no reasonable alternative means of maintaining the cattle operations on the property. The surface owner must show that any alternative means he or she pursues would be impracticable and unreasonable under the circumstances. Merriman failed to meet this burden of proof. hat is interesting about this case is that the surface owners now face two burdens of proof. They must prove no reasonable alternatives exist to their current uses, while, at the same time, proving the lessee has reasonable alternatives to develop the minerals.

In 2014, the Amarillo Court of Appeals rendered an interesting decision in City of Lubbock v. Coyote Lake Ranch LLC. It did not involve a dispute between the surface owner and the mineral lessee but between the groundwater owner and the surface owner.

The City of Lubbock purchased groundwater rights in Bailey County for municipal purposes. The deed gave the city the exclusive use of the surface for ingress and egress to explore and produce the groundwater, similar to rights given to an oil company to explore and produce the minerals in a lease.

In 2012 and 2013, the city proposed a plan to implement the exploration and development of the groundwater. The surface owner, Coyote Lake Ranch (CLR), sued to stop the project because a reasonable means existed to ameliorate the surface damages. The trial court agreed and issued an injunction. The city appealed.

The appellate court reversed the trial court and dissolved the injunction. The trial court applied the accommodation of the estates doctrine requiring due regard of the two interests.

However, the doctrine applies only when one of the estates is dominant over the other, such as when the mineral and surface estates have been severed. A severance of the ownership of the surface from the groundwater does not create a dominant estate. “Our research has yielded no case in which a Texas court has applied the doctrine to the groundwater context, and CLR has cited none that have.� The appellate court rejected the application of the doctrine to this situation.

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The case of Valence Operating Co. v. Texas Genco LP decided by the Waco Court of Appeals in 2008 involved a rather complex situation.

Valence (the mineral lessee) wanted to drill within a disposal area being operated

by Genco, a coal-burning electricity generating plant.

The coal-burning process produces fly ash and bottom ash that require a Class II Industrial Landfill Permit from the Texas Commission on Environmental Quality for disposal.

In 1985, Genco acquired a permit for a 450-acre disposal site. In 1994, the site was modified to include the 91 acres where Valence intended to drill a test well. The disposal sites were recorded in the deed records. Genco sought an injunction to prevent the drilling based on the doctrine.

In the past, Genco accommodated Valence’s needs for drilling by allowing them to drill on the outer fringes of the landfill. However, the landfill had literally been surrounded by drill sites. The present proposed drill site would be located within the interior of the disposal site.

The trial court granted an injunction. Valence appealed. The appellate court upheld the imposition of the injunction by quoting from Getty Oil v. Jones.

Where there is an existing use by the surface owner, which would otherwise be precluded or impaired, and where under the established practices in the industry there are alternatives available to the mineral lessee whereby the minerals can be recovered, the rules of reasonable usage of the surface may require the adoption of an alternative by the mineral lessee. asically, the reasonable alternative for Valence was to drill a directional well located 1,000 to 1,150 feet from the bottom-hole location. This is an industryestablished, technically and economically feasible alternative.

Valence argued that this would require an off-premise use in violation of the rule set forth in Whitaker discussed earlier. The court pointed out that the admission of evidence was not challenged by Valence at trial, and consequently it could not be raised on appeal. Second, the directional drilling would occur on the lease but outside the disposal area.

B

TIERRA GRANDE

Consequently, it would occur at an off-site location but not off the premises.

Missed Opportunity

I

n 2014, the Texas Supreme Court rendered an opinion, Key Operating & Equipment Inc. v. Hegar, that raised concern among surface owners regarding the lessee’s right to use the surface of a non-drill site tract to access a well drilled on a pool. The lessee (Key) created a 40-acre pooled unit by taking ten acres from a 191-acre tract and combining it with 30 acres from a 60-acre tract. Key built an access road across the 191 acres to reach the well drilled on the pool.

The Hegars later purchased 85 surface acres within the 191acre tract. The 85 acres included the access road. The Hegars built a house and were content with Key’s use of the road until Key drilled a second well on the 60-acre tract. Key used the road to access both wells. The truck traffic became unbearable, and the Hegars sued Key for trespass.

The Hegars proved, through expert testimony, that all the production from the pooled well came from the 30 acres taken from the 60-acre tract. As a general rule, absent the surface owner’s consent, the surface of one tract cannot be used to support or benefit minerals produced from another. Key did not have the Hegars’ permission.

The trial court agreed and enjoined Key from using the road across the Hegar’s property. The Hegars did not rely, introduce or argue the application of the accommodation of the estates doctrine at trial. Their case was based on trespass. Key appealed.

The appellate court affirmed the trial court’s injunction but relied heavily on the application of the doctrine to do so. Key appealed to the Texas Supreme Court. The high court reversed both the trial court and the appellate court and dissolved the injunction against Key’s use of the road.

The court ruled that the owner of the dominant mineral estate has the right to go upon the surface of the land to produce and remove the minerals. When pooling occurs, the implied right extends to the surface of all tracts having a portion placed in the pool regardless of where the production originates. Consequently, Key had the implied right to cross any part of the 191 acres, which included the Hegars’ 85 acres, to reach the well.

The high court indicated that the application of the doctrine may have altered the outcome of this case. However, because the doctrine was not introduced and argued by the Hegars during the trial, the appellate court could not apply it on appeal.

Fambrough (judon@tamu.edu) is a member of the State Bar of Texas and a lawyer with the Real Estate Center at Texas A&M University.

THE TAKEAWAY Surface owners without minerals face many perplexing and even confusing situations when an oil company enters to explore and produce the minerals. Surface owners gain some relief and protection under the recently recognized accommodation of the estates doctrine.

APRIL 2015

These cases summarize the procedural and substantive rules regarding the present application of the doctrine.

• The doctrine applies only where one estate is dominant over another, such as where the surface and mineral estates have been severed.

• To prove the doctrine’s application, the surface owner always bears the burden of proof.

• If the surface owner does not raise (introduce and argue) the application of the doctrine at trial, the appellate courts are precluded from applying it.

• The surface owner must have some permanent, pre-existing use of the surface that will be precluded by the mineral lessee’s operations.

• The surface owner always must prove that under established industry practices a reasonable alternative exists on the premises whereby the surface owners’ pre-existing use can be preserved and the lessee can recover the minerals even though it may increase costs.

• In addition, the surface owner must prove that he or she has no reasonable alternative means to continue the pre-existing, permanent use on the premises if the lessee conducts its operations.

• If the surface owner prevails, both surface damages and an injunction are possible remedies.

23

Texas Economy

By Ali Anari

Texas GDP Expands Post Great Recession

By Ali Anari

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TIERRA GRANDE

A

An ongoing research program at the Real Estate Center monitors changes in the relative macroeconomic importance of the Texas economy within the U.S. economy. This is measured by monitoring Texas’ shares of U.S. gross domestic product (GDP), U.S. total incomes and U.S. employment. The current research program focuses on the economic performance of the Texas economy in the aftermath of the Great Recession (GR) of 2008–09.

During this period the Texas economy expanded its share of U.S. aggregate output and emerged in a much stronger position compared with the nation. The state’s share of the nation’s GDP surpassed New York in 2007, and currently Texas ranks second after California.

Texas’ growing share is mainly attributable to the higher contributions of the state’s construction, manufacturing, trade, and professional and business services industries.

APRIL 2015

Measuring Relative Macroeconomic Importance

T

his research program measures Texas’ relative macroeconomic performance by comparing Texas’ share of U.S. GDP with Texas’ share of the U.S. population. The size of a regional economy is typically described in terms of its GDP and the structure of the economy in terms of industry gross value added (GVA). GDP is the total monetary or market value of all goods and services produced in a region during a specific period (year or quarter) measured in terms of value added by each industry or economic activity. Gross value added is the net output of an industry after adding up the monetary values of all outputs of the industry and subtracting monetary values of all inputs purchased from other industries. Adjusting GDP and GVA for depreciation gives net domestic product (NDP) or net value added (NVA).

The data used consists of time series of total annual GDPs and industry GDPs for the United States and Texas from 1997 to 2013 and annual population data for the same period. The GDP data are adjusted for inflation so they measure quantities of goods and services produced in the United States and Texas.

25

Figure 1 Texas Share of U.S. Gross Domestic Product 9.0 Texas share of U.S. GDP

Percent

8.5 Texas share of U.S. population

8.0 7.5 7.0 1997

2005 2009 2013 Figure 2 Texas, California and New York Shares of U.S. GDP

16

2001

14 California

Percent

12 10

Texas

8

New York

6 1997

60

2005 2009 Figure 3 Texas Share of U.S. Mining and Logging Industry GDP

40 30 20

Texas share of U.S. population

10 0 1997

12

2001

2005 2009 2013 Figure 4 Texas Share of U.S. Construction Industry GDP

Percent

11

Texas share of U.S. construction GDP

10 9 8 7 1997

11

Texas share of U.S. population

2001

2005 2009 2013 Figure 5 Texas Share of U.S. Manufacturing Industry GDP Texas share of U.S. manufacturing GDP

Percent

10 9 8

Texas share of U.S. population

7 6 1997

26

2013

Texas share of U.S. mining and logging GDP

50 Percent

2001

2001

2005

2009

Sources: U.S. Bureau of Economic Analysis and Real Estate Center at Texas A&M University

2013

The Big Picture Texas’ share of U.S. GDP hovered around 7.5 percent from 1997 to 2005 but since 2006 has trended upward, reaching 8.9 percent in 2013 compared with 8.4 percent for the state’s share of U.S. population that year (Figure 1). The state’s share of U.S. GDP has been through three distinct periods since 1997: from 1997 to 2002, Texas’ share of GDP was higher than its share of population; from 2003 to 2008, the state’s share of U.S. population was greater than its GDP share; and a period of more than population share in the aftermath of the GR (Figure 1). The gap between the state’s share of U.S. GDP and the state’s share of U.S. population has been positively widening in the aftermath of the GR due to the Texas economy’s higher than national average growth rates (Figure 1).

Texas’ share of U.S. GDP surpassed that of New York in 2007 (Figure 2). While California’s share of U.S. GDP has changed little since 1997, Texas has been narrowing the gap between its share of U.S. GDP and California’s share (Figure 2).

Texas’ Growing U.S. GDP Share

C

hanges in Texas’ share of total U.S. GDP over time are attributable to changes in the GDPs of U.S. industries located in Texas. Texas industries fall into two groups: those whose shares of U.S. industry GDPs exceed Texas’ share of U.S. population and those whose shares are less than Texas’ population share. Texas’ shares of the U.S. GDPs of mining, construction, manufacturing, transportation and utilities and trade industries have been larger than the state’s share of U.S. population. Those with less than the state’s share of U.S. population are the financial activities industry, education and TIERRA GRANDE

Figure 6 Texas Share of U.S. Trade Industry GDP 10.0

Percent

9.5

Texas share of U.S. trade GDP

9.0 8.5 8.0

Texas share of U.S. population

7.5 7.0 1997

12

2001

2005 2009 2013 Figure 7 Texas Share of U.S. Transportation and Utilities Industry GDP

Percent

11 10

Texas share of U.S. transportation and utilities GDP

9 8 7 1997

8.5

Texas share of U.S. population

2001

2005 2009 2013 Figure 8 Texas Share of U.S. Professional and Business Services Industry GDP Texas share of U.S. population

APRIL 2015

7.5 7.0 Texas share of U.S. professional and business services GDP

6.5 6.0 1997

8.5

2001

2005 2009 2013 Figure 9 Texas Share of U.S. Education and Health Services Industry GDP

Percent

8.0

Texas share of U.S. population

7.5 7.0 6.5

Texas share of U.S. education and health services GDP

6.0 5.5 1997

8.5

2001

2005 2009 Figure 10 Texas Share of U.S. Leisure and Hospitality Industry GDP

2013

Texas share of U.S. population

8.0 Percent

health services, leisure and hospitality, information industry, agriculture and the government sector.

Texas has the largest mining and logging industry among all states, accounting for 44.1 percent of the GDP of the U.S. mining industry in 2013 (Figure 3). Despite the ups and downs of oil prices, the state’s share of the nation’s mining GDP has accounted for about 40.5 percent of U.S. mining GDP from 1997 to 2013 and since 2011 has trended upward (Figure 3).

Texas’ share of the GDP of the U.S. construction industry has been greater than the state’s share of U.S. population since 1997 (Figure 4). A steep upward trend in the state’s share of the GDP of the U.S. construction industry since 2006 increased the share to 11.9 percent in 2013 compared with 8.4 percent for Texas’ share of U.S. population in the same year (Figure 4).

Texas’ share of the GDP of the U.S. manufacturing industry has been larger than the state’s share of U.S. population since 2003 (Figure 5). In the state’s post-GR recovery, its share of the nation’s manufacturing GDP increased to 10.6 percent in 2013 compared with 8.4 percent for its share of the U.S. population in the same year (Figure 5).

Texas’ share of the GDP of the U.S. trade industry has been above the state’s share of the U.S. population since 1997 but has remained less than 8.5 percent until 2006 (Figure 6). The state’s share of the U.S. trade industry GDP expanded in the post-GR recovery and reached 9.7 percent in 2013 (Figure 6).

Texas’ share of the U.S. transportation and utilities industry GDP has been greater than the state’s share of U.S. population since 1997 but did not exceed 11 percent until 2011 (Figure 7).

The state’s share of the U.S. transportation and utilities industry GDP increased from 9.9 percent in 2010 to 11.5 percent in

Percent

8.0

7.5 7.0 6.5 1997

Texas share of U.S. leisure and hospitality GDP

2001

2005

2009

Sources: U.S. Bureau of Economic Analysis and Real Estate Center at Texas A&M University

2013

27

9

Figure 11 Texas Share of U.S. Financial Activities Industry GDP Texas share of U.S. population

Percent

8 7

Texas share of U.S. financial activities GDP

6 5 1997

8.4

2001

2005 2009 2013 Figure 12 Texas Share of U.S. Other Services Industry GDP Texas share of U.S. population

Percent

8.0 7.6

Texas share of U.S. other services GDP

7.2 6.8 1997

8.4

2001

2005 2009 2013 Figure 13 Texas Share of U.S. Government Sector GDP Texas share of U.S. population

8.0 Percent

7.6 7.2

Texas share of U.S. government sector GDP

6.8 6.4 1997

9

2001

2005 2009 2013 Figure 14 Texas Share of U.S. Information Industry GDP Texas share of U.S. population

Percent

8 7

Texas share of U.S. information industry GDP

6 5 1997 9

2001

2005 2009 2013 Figure 15 Texas Share of U.S. Agriculture GDP Texas share of U.S. population

Percent

8 7

Texas share of U.S. agriculture GDP

6 5 4 1997

2001

2005

2009

Sources: U.S. Bureau of Economic Analysis and Real Estate Center at Texas A&M University

28

2013

2013, well above the 8.4 percent Texas share of the U.S. population in 2013 (Figure 7).

Texas industries whose shares of GDPs of industries are less than the state’s share of U.S. population but are trending upward in the post-GR recovery are professional and business services, education and health services, leisure and hospitality, financial activities and the other services industry (Figures 8 to 12).

Texas’ share of the U.S. government sector GDP has remained less than the state’s share of U.S. population since 1997 and has remained around 7.2 percent since 2010 (Figure 13).

Two Texas industries, information and agriculture, have been losing their market shares over the past decades. Texas’ information industry (internet service providers, web search portals, publishing industries, broadcasting and telecommunications) suffered more than the nation’s information industry in the aftermath of the U.S. dot-com bubble bursting. Texas’ share of the U.S. information industry’s GDP has fallen from 7.2 percent in 2000 to 5.8 percent in 2013 (Figure 14).

Texas’ share of the U.S. agriculture industry’s GDP has decreased from 7 percent in 2004 to 5 percent in 2011 and has remained the same since then (Figure 15).

Texas Real Estate Industry Implications

T

exas’ growing shares of U.S. GDP and population mean more demand for housing units. The state’s construction industry’s growing share of U.S. GDP is expected to increase demand for Texas lands. Texas’ growing share of U.S. trade GDP is expected to increase demand for commercial real estate properties. Upward trends in Texas’ shares of professional and business services, education and health services, leisure and hospitality, and financial activities GDPs mean upward trends in demands for office and commercial real estate properties. Growing mining and manufacturing GDPs for Texas are expected to increase demand for industrial real estate properties.

Dr. Anari (m-anari@tamu.edu) is a research economist with the Real Estate Center at Texas A&M University.

THE TAKEAWAY A Center study determines how important Texas’ economy is to the overall national economy by monitoring and comparing Texas and United States GDPs, total incomes and employment. Since the Great Recession, Texas has expanded its share of U.S. aggregate output.

TIERRA GRANDE

APRIL 2015

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