Written by: Samira Fatehyar
Synopsis
You can listen to the podcast here.
Crisis after crisis after crisis. That’s the best way to put what’s been going on over the past several weeks in the US. We are experiencing a vaccine shortage in the midst of a pandemic with different variants now surfacing. Questions like will Covid be something that will never going away? It’s too early to tell is what many epidemiologists have stated. All that aside, it’s been interesting for me to see two different worlds, one in where investors believe wholeheartedly that this market high will continue, and another world where everyday working Americans are tired and losing hope. The war on Wall Street that we talked about last time, is something we need to draw our attentions to more. Compared to other countries, Americans are ranked among the most overworked compared to other developed nations. At some point this does take a toll on our society.
So now, put this together will an energy crisis that is affecting the Southern United States. Many states experiencing rolling blackouts because of a disastrous winter storm. Parts of Texas reaching temperatures colder than Alaska. This is an issue that we need to examine, because it has lasting economic effects. But before we dive into that, let’s look at a commercial real estate update. Later, we’ll take a look at what’s going on in Europe.
Economic Update
REIT Returns
For those of you familiar with this blog, you are aware that whenever I want to do a real estate update on the commercial real estate sectors, I use REIT data for a number of reasons. REIT returns is the most easily available data to analyze the current state of the commercial real estate market.
A quick refresher:
Commercial real estate is essentially made up of retail, office, industrial, multifamily, as well as mixed use. REITs, or real estate investment trusts, are companies that own, manage, and/or finance income producing properties. These companies have shares that are publicly traded so investors can buy these and receive a dividend without having to actually buy physical property. There are certain requirements to become a REIT, two important criteria include investing at least 75% of total assets into real estate, US treasuries, or cash as well as paying a minimum of 90% of taxable income through shareholder dividends every year. There are also three types of REITs: equity, mortgage, and a hybrid of both.
Nareit is the National Association of Real Estate Investment Trusts. The importance of Nareit is that it publicly provides REIT performance data.
So, now that we’ve gotten the basics down, let’s take a look at the latest Nareit Returns report.
Table 1
Nareit Domestic Returns, Feb. 12, 2021
https://www.reit.com/sites/default/files/returns/DomesticReturns.pdf
Looking at Table 1, above, might be a little confusing so let’s just focus our attention on the compound 1 year annual total returns column.
Table 2
Best to Worst Equity REIT Rankings, Feb. 12th, 2021
Created myself, using data from: https://www.reit.com/sites/default/files/returns/DomesticReturns.pdf
From Table 2, above, that I created, we can easily see that based on the 1-Year Compound Annual Total Returns, Timber REITs seem to be doing the best with a 1-year annual return of 21.79%. You may be wondering, timber? What is a Timber REIT? According to the US Forest Service:
A timber REIT is a REIT in which more than 50% of its asset value is real property in the trade or business of producing timber.
With everything we have experienced during the pandemic, the rising housing demand and shortened supply of homes, it makes sense that lumber prices has skyrocketed. But, it’s not only new construction in housing that has caused prices to increase, but also many people’s desire to remodel their homes in the meantime. All of this has taken a toll on raw materials, which in the end drives up home prices as well.
Graph 1
Lumber Prices over the past 5 years
https://tradingeconomics.com/commodity/lumber
Looking at Graph 1, above, we can see that lumber prices have increased to unprecedented levels. $994.90/1000 board feet. It’s crazy to think about but these prices are not sustainable and when the demand for housing decreases and the remodels get done, we will have lumber and timber prices go back to a more normal level.
Going back to Table 2, the rest of the positive 1-Year Returns are normal as it was predicted and seen that there was a rise in demand for these sectors: Data Centers, Industrial, Self Storage, and Single-Family Homes. I foresee sustained positive returns for data centers, industrial, and self storage. I do believe that timber and single family homes will still remain positive for some time but at a decreasing rate.
But let’s not lose sight that out of the 18 sectors, only 5 of them are in positive territory. This is big. Granted, we knew office, retail, lodging/resort, and apartments were going to get hit. I was not expecting to see that big of a decrease in Health Care, though I guess it makes some sense when you see much of healthcare industry moving to virtual visits when possible, which translates to less actual square footage needed in health care.
Texas Energy Crisis
Texas’ Energy history
If you haven’t heard any news about Texas, well basically their power grid was on the verge of collapse due to a polar vortex that has it them several times in the past week. Before we dive into what happened, I think it’s best to first understand Texas’ energy infrastructure. In case you didn’t know, there are 3 different power grids in the contiguous United States. There is the western interconnection, the eastern interconnection, and then the Texas interconnection. I’ll note that the Texas interconnection doesn’t encompass all of Texas but it does for the majority of Texas. The City of El Paso is on a different grid, along with the Upper Panhandle and a part of East Texas. I’ll also note that Texas produces more energy than any other state in the US.
Map 1
The Power Grid System of the Contiguous US
https://datacache.duke-energy.com/Content/electricity101/build/about-power-supply-5a.html
So, you may be wondering why does Texas have their own power grid? I wondered the same thing. It essentially comes down to the Federal Power Act in 1935. This law gave authority to the Federal government to regulate power companies that were involved in interstate commerce. At the time and ever since then, Texas power companies have agreed to not sell power outside of the state. So in order to get away from Federal regulations, Texas decided to have its own power grid essentially. There have been times in history when Texas has given some of its power to other states, but was able to bypass federal regulations by even doing that, but even then it’s been mostly in emergency situations. The Electric Reliability Council of Texas (ERCOT) oversees and manages the power within the Texas interconnection.
So, Texas won’t sell power to other states but can states sell power to Texas? The short answer is no. See, because Texas’ power grid is made up of many transmission lines within the state, it lacks major transmission lines to connect another power grid. That’s why there is a Western and Eastern interconnection to help states in situations like this to be able to access power from another state. Now, don’t get me wrong, I admire that Texas can provide energy for itself, but it’s almost like they never thought something like this could happen. That their energy supply wouldn’t be able to keep up with high energy demand in subfreezing temperatures for a sustained period of time. Of course, no one thought this could happen in Texas, but it has. Climate change is real with new types of weather patterns occurring in different places.
I also encourage everyone to set aside their politics when we assess this issue. We’ve divided the US into blue states vs red states, but seem to be forgetting that we are the United States. Our fellow Americans are quite literally suffering in Texas because the people in charge didn’t think something of this magnitude could happen.
What Happened?
So now that we understand the history of Texas’ power system, I think we can now go question what happened that led them to this point. A polar vortex from the Arctic, that jet streams usually encapsulate to just the Arctic region, escaped and basically traveled to Southern states. This polar vortex brought massive amounts of snow and subfreezing temperatures to many areas in Texas. Well first of all, Texas does not normally experience these kinds of temperatures. At one point, parts of Texas were colder than Alaska. In any case, just know that it got VERY cold in Texas.
Because it got very cold, Texans put a higher demand on electricity since they needed to stay warm. Unfortunately, due to lack of insulation the natural gas lines became depressurized, basically it couldn’t move inside the pipe. So, their number one electricity source took a major hit because of the below freezing temperatures. What about all their other energy sources?
I’ve been seeing numerous media outlets reporting that this lack of energy supply was caused because of the use of green (renewable) energy. I can tell you that is false. According to ERCOT, they noted the following table below.
Table 2
Texas Electricity Generation by Fuel, 2019
https://comptroller.texas.gov/economy/fiscal-notes/2020/august/ercot.php
Looking at Table 2, above, we see that natural gas makes up 47.4% of the total electricity generation, then coal with 20.3%, then wind energy by 20%, then nuclear by 10.8% and solar by 1.1%. Okay, so we understand why natural gas supply plummeted, but let’s take a look at the other fuel types. Coal plants require water to stay online but because a lot of the water froze, they have not been able to produce coal. Wind turbines were down because none of the turbine blades were equipped with antifreeze or other kinds of heating elements. Nuclear power plants were also down because the cooling ponds they need, froze and the pipes that move the water did not have any kind of insulation. Solar only produces 1.1% of the total electricity, so even if it was able to produce some energy, it was cold and cloudy most of those days, so they weren’t able to produce much energy. So this created a total and complete crisis. On top of all of this, there is very limited energy storage capacity for renewable energy sources. Those blaming renewable energy for this crisis need to look at the stats above and put their politics aside. Again, the majority of Texas’ energy is from fossil fuel sources. The failure isn’t from the sources, but instead from something else.
The biggest mistake that is clear to me in all of this is just how dependent Texas was on water not freezing and not doing anything to winterize or at least insulate pipes. Not enough money was put aside to prepare for a scenario like this. And granted, a scenario like this wasn’t in many models, but it has happened and will now have lasting implications. See, if Texas wants to be completely energy independent, they’re going to have to be a lot more strategic in their planning. With independence comes a lot of responsibility. If only the pipes were more insulated, I wonder how much of a difference that would have made to avert this level of crisis.
Prices
Basic economic principles tells us that when there is excess demand and a shortage in the supply, prices of the good will tend to skyrocket. What we witnessed early last week in Texas was absolutely unprecedented but could have easily come out of a textbook. ERCOT had put in place a price cap on wholesale energy of $9,000/megawatt hour. Texas hit this price cap during the latest deep freeze.
Graph 4
ERCOT Houston real-time power price, 2013-present
https://www.bloomberg.com/news/articles/2021-02-16/skyrocketing-texas-power-prices-may-enrich-some-bankrupt-others?sref=jbVt2saA
The price of wholesale electricity rose by 10,000%, from an average of $25-$50/megawatt hour to $9,000/megawatt hour! This is insane. As I’m writing this (Wednesday the Feb. 17th, 2021), they are still experiencing prices of $8,500+.
Map 2
Real Time Prices of wholesale energy, February 17th, 2021
http://www.ercot.com
Now, many think that the power companies are going to be making a ton. But the reality is that, yes for those power generators that can actually sell their energy, that’s great, they’re able to make a lot of money. But for those who can’t, they are unfortunately losing a lot. Retail electricity providers that are unable to meet their commitment are being forced to buy at the very high spot price ($8,000-$9,000) and will only be able to sell power for a tenth of the cost. But those that are truly suffering are not limited to companies. Like in every American story, the average everyday American suffers. But before we get into the implications of this crisis, I want to look at how this energy crisis has impacted the agriculture sector.
Agriculture Impact
China recently ordered one of its largest amounts of corn and soybean from the US. Unfortunately because of the Arctic freeze its become nearly impossible to get shipment to our Pacific Northwest Ports. Additionally, many soybean processing plants have had to slow down production because of the extremely high energy costs. But this crisis didn’t only affect our crops, it’s also affecting meat processing plants as well. Tyson Foods was among meat producers that were forced to shut their plant in Texas.
According to Bloomberg,
Prices for hard red winter wheat delivered in May rallied as much as 3.7% to $6.4525 a bushel on Tuesday. Corn for May delivery climbed as much as 2.5% while soybeans for May delivery rose as much as 1.6%. Ethanol and cattle prices also jumped.
This is having effects much wider and greater than any of us would have imagined a winter storm in Texas would have caused. And this unfortunately didn’t just affect the farmers and meat producers in Texas, it stretched to many other states as well.
Sanderson Farms, the U.S.’ third-largest chicken producer, said the winter storm is affecting operations in Texas, Louisiana and Mississippi. As many as 200 broiler houses in Texas lacked power Tuesday morning and four were destroyed in Mississippi as snow collapsed roofs.
Though, I will mention that I do only foresee agriculture commodity prices rising in the short term due to this shock. But I do foresee inflation eventually catching up on food prices.
Implications
What does this all mean? Why did I decide to write about this topic? Because this stretches far beyond just Texas. Unfortunately, the US’s infrastructure is deteriorating. The US once prided itself on continuously using the most sophisticated technologies, but when you don’t maintain and keep things in running order, they will eventually fail. And yes, this was a rare winter storm, but that’s still not enough of an excuse, at least for me, to why ERCOT couldn’t have implemented some kind of regulation into just insulating pipes from freezing. The worst part? Water pipes across Texas bursted. Many homes have been flooded because of this. What I see here is just a lack of vision and eyes solely focused on generating money.
The best example for this is in real estate. Now, I’ve seen many mom and pop type landlords that weren’t educated in real estate and what it truly entailed. They would simply take a tenant’s check every month and cash it. Nothing more. I mean, yes if the tenant had this problem or that problem they would fix it. But then something big happens, the roof that’s been on the building for 30+ is causing a lot of roof leaks. Well, these landlords didn’t put any money aside from their tenant’s checks to put back into the building and now they can’t replace the roof, they can only keep patching it. Okay, now come times to sell. These landlords are upset that the price of their building is worth so low. Well, when you don’t put the money back into the asset to keep up with maintenance it’s going to lose a lot of its value.
The same is true for our infrastructure, but our infrastructure problem can’t simply be fixed now. We haven’t put much if anything aside for big infrastructural changes within the US. Look at our roads! Look at how you could be paying for extremely fast internet, but the connecting wire that goes into your house is still copper, which ends up slowing it down anyway. Look at our modes of transportation! We’re crippling with debt in the US, paying out massive amounts of money to foreign countries and to domestic corporations, but when it comes to taking care of our people and infrastructure it seems like we don’t have the time nor money for it. The situation will unfortunately continue to deteriorate unless we do something about it. I’m not calling on regulation but a shift in ideology. A shift from trying to make an extra buck to instead investing part of the profit back into our country. This will help spur economic growth and will even act as an insurance to help with our next crisis.
The sad reality is we are still in the middle of a pandemic with high unemployment rates but now our very own in the south are suffering from bitter cold temperatures and the loss of power to warm themselves. I’ve heard first hand stories of people trying to keep their newborns warm when outside was -2 degrees Fahrenheit. They had no electricity and had to close themselves off to one room and hope that everyone would stay warm enough. This is something I thought I’d never see in my own backyard. People’s homes are flooded. My biggest question is will their home insurance policies cover the loss? It’s not flooding caused by a hurricane of what they are used to, but flooding caused by pipes bursting because no one thought of insulating pipes. There are people without running water. It’s just so hard for me to grapple with the reality in front of us. Texas officials are at a loss of what to do at the moment. There’s reports of hospitals with no running water and no heat.
Granted, Puerto Rico went through something similar due to a massive hurricane, but they didn’t have to deal with crazy low temperatures. Though I will say that it took 1 full year to recover the power grid. It’s just insanity to me. Many grocery stores across Texas have limited the amount of items people can purchase in order to keep from hoarding. Many other grocery stores have outright closed, including 500 Walmart stores across the region. Additionally, millions of Texans are under a boil notice since many water treatment plants lost power and led to the creation of environments where bacteria could breed. I suspect this boil notice will continue for some time. As of Friday, February 19th, 14.4 million Texans were affected by water outages.
economic costs
Now, let’s turn our attention to the economic costs. What are some of the lasting effects this will have on our oil supply and thus oil prices? Sure, many are now with power again and a lot of the ice will be melting soon. But where does that leave everything else? Many are comparing this crisis to the California power crisis in 2000-2001. But the main difference there was that California had the ability to import energy from neighboring states, but because of Texas’ closed system, that can’t be a possibility this time.
As of Friday, February 19th, roughly 40% of the nation’s crude production is offline. It’s strange to see Brent crude trading in the $60 range when not even a year ago we saw it trading at negative prices. It’s mind boggling how tumultuous 2020 and 2021 are turning out to be. But these problems are not only affecting us domestically.
Crude markets in Europe are rallying as traders replace lost U.S. exports. OPEC and its allies must decide how much longer they keep millions of barrels of their supply off the market.
OPEC’s decision will have a major affect on oil and gas prices in the coming months. The biggest problem is we still don’t know how badly the oil refineries might have been affected.
Citigroup Inc. said it expects a production loss of 16 million barrels through early March, but some trader estimates are now almost double that.
Many oil refineries are unsure of how much damage they might be facing with needing energy to restart the pumps but also pipes bursting due to frozen water. To make matters worse, many companies laid off large portions of their workforce due to demand falling last year because of Covid. Executive VP of Operations at Basic Energy Services, Jim Newman, was pretty pessimistic on when full restoration would come. He said the following:
I would say it will take weeks; a lot will unfold as we assess the damage as we thaw out.
To top all of this off, Accuweather has estimated the cost of damage and economic loss to be roughly $50 billion. I think we will see the cost of this substantially rise. If only we had put money back into the infrastructure system, we, the taxpayers, wouldn’t have to be spending all of this money.
European View
So with all the chaos happening here in the states, you might be wondering, are we the only ones experiencing this? The short answer, is no. Europe is also facing quite a lot of chaos due to the pandemic and many of the economic effects of it. I have an update on Italy and what has transpired there since my last episode and we also look to see how England is doing.
Italy Update
In our last episode, we talked about both the political and economic crisis Italy is currently enduring. Since our last episode, Mario Draghi has accepted the position of Prime Minister. Though there were many Italian politicians against this move as they wanted the people to decide on their next Prime Minister, I think it was absolutely imperative that they have someone responsible enough to distribute the 200 billion euro funds that are coming in. I hope for the best for Italy and I truly hope that Draghi will do what’s best for Italy and its economy.
England
England has suffered quite a bit for reasons beyond the pandemic, including Brexit. If we take a look at recent GDP numbers out of England we see just how bad things have gotten economically. Graph 4, below, shows just how badly England was hit in 2020.
Graph 2
UK GDP Annual Growth Rate (January 2018-present)
https://tradingeconomics.com/united-kingdom/gdp-growth-annual
According to the Office for National Statistics:
Britain's gross domestic product shrank by 7.8 percent year-on-year in the fourth quarter of 2020, following a revised 8.7 percent contraction in the previous three-month period and compared with market expectations of an 8.1 percent fall, a preliminary estimate showed. Household consumption dropped 8.4 percent (vs -8.6 percent in Q3) and fixed investment fell 3.5 percent (vs -7.0 percent in Q3). At the same time, net external demand contributed negatively to the GDP as exports slumped 23.5 percent and imports declined at a softer 8.9 percent. Public investment, however, grew 0.5 percent, following three consecutive periods of contraction. Over the year 2020 as a whole, GDP contracted by 9.9 percent, the largest annual fall on record.
This is a big blow for England. The timing of everything really made things worse. Brexit was already forecasted to bring some economic downfalls, but the pandemic only exacerbated things. Another key piece of bad news for England is that Amsterdam has now overtaken London as the largest share trading hub. Chart 3, below, illustrates this.
Chart 3
Average Daily share trading in Euros
https://www.bloomberg.com/news/articles/2021-02-12/city-of-london-s-brexit-tab-rises-with-stock-and-swaps-moves?sref=jbVt2saA
To add to this many Londoners that work in finance are leaving the city to relocate to other hubs such as Amsterdam.
Chart 4
Number of Finance Job Openings in London, 2015-2020
https://www.bloomberg.com/news/articles/2021-02-12/city-of-london-s-brexit-tab-rises-with-stock-and-swaps-moves?sref=jbVt2saA
Looking at Chart 4, above, it’s obvious that there aren’t many finance jobs left in London because it’s not the hub it once was. Many financial executives in London are extremely pessimistic on what’s to come because they are not only competing with European markets but now, investors may find the liquidity of the US and Asian markets more desirable than European financial markets. This could truly be a devastating blow to England if they don’t come up with something to boost their economy soon.
Concluding Remarks
I dedicate my time to writing about problems because I want us to find solutions. I don’t see the point in politicizing events, especially economic disasters. Sure, poor governance and corruption can be the culprits, but it doesn’t need to be separated into blue vs red. This phenomenon of corruption and poor governance is not something that exists in only red states or only blue states, it exists in every state and in many levels of our system. That’s a pretty undeniable fact. No state is perfect. No government is perfect. But that’s why we need to hold those in power accountable for actions they have taken. America, we can do better than this. This isn’t what our Southern neighbors deserve. Puerto Rico didn’t deserve what it had to endure as well. But because it’s now within the contiguous US, I think it’s giving us a bigger picture of the failures.
We can do better. Let’s not normalize what we are witnessing. We need to make that commitment to ourselves, that we will do better for future generations. People lining up at grocery stores and only being allowed 15 items at checkout, homes caving in because of pipes bursting, people dying because they can’t keep warm, or groceries stores running out of water and hoping for a new shipment to come in over the weekend should never be something Americans should experience. Yet here we are. Let’s do better. Till next time!