October 19, 2005 Federal Reserve Districts Eleventh District--Dallas

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Eleventh District economic activity continued to expand in September and early October. Two major hurricanes caused loss of life and significant economic disruptions in some areas, destroying property and dislocating families and businesses. Many areas of the District received an influx of evacuees that accelerated activity and made assessment of the underlying business cycle more difficult. Some firms anticipate increases in demand, at least temporarily, to supply goods and services to evacuees and to support rebuilding efforts. Still, in the near term, many contacts say the higher cost of fuel, energy and other inputs has dampened the economic outlook. Demand for energy and manufactured products remained strong, but hurricane damage slowed the rate of growth of activity. Retail sales and service sector activity increased and, for some firms, was boosted by the storms. Construction and real estate activity continued to strengthen, and some markets were strongly stimulated by demand from hurricane evacuees. There was little change in activity in the financial services sector, where contacts say the supply of credit continues to outstrip demand. Agricultural producers reported that dry conditions are hurting some production, but hot weather is encouraging a large cotton crop. Prices There were numerous reports of price increases--some sizeable--since the last Beige Book, most notably for energy, petrochemicals, plastics, transportation and some construction-related products, such as sheet rock and cement. Lumber prices increased considerably after Katrina, partly because of increased demand but also because of uncertainty about shortages and about the extent of the damage. Lumber contacts say prices are not expected to rise further but may remain high for some time. Fuel surcharges and rising energy costs have become a serious concern for most manufacturers. Some manufacturers have been able to pass a portion of the cost increase to selling prices, but others say stiff competition is forcing them to absorb rising costs by looking for additional productivity increases. Retailers report upward price pressure from vendors, but stiff competition is limiting the ability to pass cost increases forward to selling prices. Some manufacturers and retailers say they are making plans for price increases in the first quarter of 2006. Heavy demand and hurricane disruptions pushed crude oil prices to near $70 per barrel, but prices fell to $62 per barrel in early October, the lowest price of the last two months. Crude inventories remain near 5-year high levels. Distillate inventories (diesel and heating oil) are near a 5-year high, but contacts say inventories should be building more rapidly. A series of mechanical problems, fires in the refinery system and a strategy of building distillate inventories had reduced gasoline inventories prior to the storms. Gasoline inventories have bounced back strongly as increased imports bolstered supply and consumers reduced gasoline consumption in response to high retail prices. Natural gas prices increased from $9 per million Btu to $14. With the approaching heating season, contacts are concerned about the loss of natural gas production in the Gulf of Mexico. Natural gas inventories were heavy last spring but were reduced close to normal levels by a very hot summer. Injections into inventory have been near normal in recent weeks despite the loss of Gulf production, partly because so many large gas-using petrochemical plants are down. The strength and uncertain path of Hurricane Rita led to an unprecedented shutdown of 90 percent of petrochemical capacity on the Gulf Coast. Coming on the heels of Katrina, the result has been widespread shortages of many chemicals and plastics. A number of large producers declared force majeure, allowing them to break contracts. Basic chemicals and plastics are now on allocation, with sizable price increases for ethylene, propylene, polyethylene, PET bottle plastic, polystyrene, polyvinyl chloride and polypropylene. Chemical prices have not risen in the rest of the world, but contacts say it takes roughly six weeks for imports to reach U.S. markets. Labor Market The labor market appears to be tightening. There are more reports of rising wages, such as for workers to support the energy industry, professionals with financial experience, accountants, auditors, auto mechanics, truck drivers, engineers and software programmers. Anecdotal reports suggest accountants are receiving sizable raises and bonuses. The high cost of gasoline is discouraging some workers from taking low-paying jobs with long commutes. Temporary service firms expect wages to gradually increase to keep pace with higher energy costs. Contacts expressed optimism that evacuees would bring much needed skills to the labor pool, and some businesses report hiring skilled workers who intend to stay in the District. Hiring has picked up to provide goods and services to evacuees. Manufacturing Manufacturing activity expanded but hurricane disruptions slowed the rate of growth, particularly for energy-related products. Demand for construction-related materials remained strong and in some instances increased. Food manufacturers also reported higher demand. Demand for metals was mixed. Some producers experienced a strong surge in orders to supply product to the Gulf Coast, but others reported a dip in orders, largely because of a loss of the New Orleans market. Prices are up for some metals, such as for copper and scrap steel. Demand for lumber was stronger than usual because competitors in the Gulf Coast and New Orleans were unable to fill their orders. Demand for paper products was unchanged over the past month. Respondents in high-tech manufacturing said sales and orders continued to grow at a solid pace. The semiconductor industry reported no noticeable impact from the hurricanes, although some electronics producers had increases in orders for emergency related items, such as two-way radios. Demand from Asia continued to pickup. Refinery utilization rates have fallen sharply, with about 15 percent of U.S. capacity still out of service. The decline in utilization has been similar to the drop that occurs with the usual fall maintenance schedule, but maintenance has not been done. Contacts expect more mechanical problems because some plants are being run hard. Respondents say refinery margins have increased from an "excellent" $10 per barrel to $22 in September. Refined product imports have soared. A lack of basic inputs is keeping a number of chemical plants on partial or complete shutdown. Contacts say the actual damage to these plants is not serious. The system is unbalanced for a number of products, pushing up costs and prices. For example, chlorine and caustic soda are joint products. Much of the demand for chlorine was put out of service by Katrina, but the demand for caustic soda remains strong. Chlorine is hard and expensive to store, so caustic soda users (particularly pulp manufacturers in the southeast) are facing allocations and large price increases. Services Demand for temporary staffing services picked up in most parts of the District, with some of the increase resulting from the disruptions caused by Hurricane Katrina. Orders to supply workers to lumber and mobile home manufacturers climbed sharply, while demand for skilled workers in high-tech manufacturing in Dallas and Austin remained strong. Legal firms reported good demand for their services. Accounting firms report very strong demand, especially for audit services, mergers and acquisitions and Sarbanes-Oxley related services. Demand is up for railroad, trucking and cargo firms. The rail and trucking industries say they are operating at or near full capacity. Trucking firms say Katrina and Rita have recently stimulated demand for shipping, but their ability to increase fees is not keeping pace with rising fuel prices and, in some instances, customers are choosing to forgo shipments because prices are too high. The rail industry has been unable to meet demand because of a lack of capacity. Grain volumes have almost tripled because grain that used to be shipped down the Mississippi by barge to the New Orleans port and is now being shipped by rail to other international ports. Shipments decreased significantly for chemicals, petroleum products, coke, pulp, paper, lumber, wood and raw logs. Contacts were surprised by a significant and unexpected slowing in rail shipments of metals, metallic ores (used in cars, appliances and construction), cars and other construction-related materials. This was unrelated to the hurricanes, they say, and suggest that this may indicate an upcoming slowdown in consumption of intermediate goods and home building. A sharp increase in jet fuel costs has added to the airline industry's difficulties. Contacts say demand remains strong despite fare increases. But higher ticket prices have not been sufficient to cover fuel costs for most airlines, leading some carriers to reduce flights. This, along with the bankruptcy of two more major carriers, has reduced capacity in the domestic market--but not enough for most carriers to be profitable. The labor market for airline employees has become even looser as some workers attempt to flee newly bankrupt carriers. High fuel costs along with proposed pension reform are expected to force further structural change in the industry. Retail Sales Retail sales continued to increase, with strong sales of bottled water, generators and gasoline. The District became home--at least temporarily--to upwards of a quarter of a million evacuees. Contacts say these additional shoppers will make it difficult to interpret sales figures. Retailers serving higher income customers reported better sales growth than those serving lower income customers, who are spending a larger share of their income on gasoline. A large retailer noted that customers had increased use of credit cards instead of debit cards and questioned if they are conserving cash or are cash constrained. Contacts were less optimistic about the outlook for sales for the rest of the year, and at least one national retailer had canceled orders in anticipation of slower national sales. Auto sales were mixed. Demand for fuel efficient vehicles increased slightly, but sales of trucks and SUVs fell 20 percent. Construction and Real Estate The large influx of evacuees generated a surge in real estate activity. The long-term impact of the hurricanes is a wild card for real estate markets because it is unclear where displaced businesses and residents will choose to put down roots. Apartment demand was strengthening prior to Katrina and exploded as evacuees fled New Orleans. Sharply increased demand affected apartment markets in most metropolitan areas, but the effect was most dramatic in Houston, where the market tightened up virtually overnight after being one of the most overbuilt markets in the country. Big blocks of class A apartments were snapped up by employers to use as corporate housing. Demand from evacuees in the Dallas area was mostly for older properties, helping reduce the chronic overhang of class C and D properties, at least temporarily. Contacts expect occupancies to tighten over the next year because there is little construction planned for 2006. Demand for new and existing homes remained strong. While demand was slightly boosted by sales to hurricane evacuees, the larger influence continued to be from relocations and investment purchases. In Austin, sales strengthened for higher-priced homes. Builders in Dallas say competition is stiff, holding down price increases despite strong demand. Rising construction costs have led builders to be more uncertain about the outlook. Office markets continued to improve at a steady pace. Leasing continued to increase in Dallas, and landlords are reducing incentives while rents are holding firm. Houston's office sector also continued to improve, with rising occupancies and rents, but contacts say Katrina's impact has not been huge. Some temporary space has been absorbed by legal and energy firms with operations in both Houston and New Orleans, and some of the energy firms may choose to remain in Houston, which reflects an on-going trend. Financial Services Deposit and loan growth remained solid, according to contacts, who report that the supply of credit continued to outstrip demand. Respondents report continued pressure on net interest margins and a lot of competition on the pricing of loans, but credit quality is still good. Hurricane-related disruptions to financial services appear to have been only short-term. Energy Although the hurricanes weakened activity in this sector, contacts report strong underlying demand and emphasized their inability to fill orders or provide services without long lead times. International activity also remained strong. Service firms continued to push through price increases and build margins. The hurricanes caused some significant loss of rigs in the Gulf of Mexico, and repairs have been hampered by a lack of infrastructure. Katrina's damage to Louisiana's staging areas for the Gulf forced the industry to move its logistical base to Cameron, Texas, which was wiped out by Rita. Loss of docks, boats, warehouses and equipment has hampered repairs in the Gulf. The repair effort will create jobs for diving companies, supply boats and helicopter transportation for months or years to come. Agriculture Hot and dry weather conditions prevailed across most of the district, stressing crops and pastures, reducing hay production and compelling ranchers in the driest areas to liquidate cow herds. The cotton crop has benefited from the hot weather conditions, and producers are expecting yields to be just under last year's record harvest. Cattle prices are high. Contacts are uncertain about the full economic impact of the hurricanes. There were pockets of considerable disruptions, particularly to poultry producers in East Texas and to the rice crop that was ready to be harvested. Producers are extremely concerned about the recent surge in fuel prices which has pushed up fertilizer, chemical, irrigation and other production costs. Return to top Kansas City San Francisco