January 2021 — Property Management Quarterly — Page 27 Leasing I t is no secret that the U.S. oil and gas sector has taken a hit during the pandemic. Crude prices temporarily turned neg- ative back in April due to the compounded headwinds of reduced demand and oversupply stemming from a price war between OPEC and Russia. Oil and gas companies rely heav- ily on a minimum crude price to ensure profitable extraction, mar- keting and distribution due to the capital-intensive nature of the industry. More than 40 oil and gas companies filed for bankruptcy in North America through October, according to U.S. law firm Haynes & Boone. This level of disruption is due in large part to the significant role debt plays in oil and gas bal- ance sheets, and this may be just the early signals of trouble for the sector. These various factors set the stage for a potential gradual shift in oil and gas real estate needs for the coming years. Oil and gas users including exploration and produc- tion, midstream, downstream and field service are stressed and have begun plugging wells and laying off thousands of employees across the oil patch. Since 2015, at least 12 E&P companies filed for bankruptcy in Colorado, according to Haynes & Boone, the second-highest number of bankruptcies west of the Missis- sippi River after Texas during this period. Concealed in this data is the fact that many bankruptcies outside of Colorado adversely impacted real estate needs in the state. The last time we saw this kind of stress in the oil and gas sector followed the oil price collapse in mid-2014. Bank- ruptcies did not immediately follow this crash. Rather, due to short-term financial engineer- ing and staggered debt service time- lines, bankruptcies accelerated about two years after the crash when distressed companies ran out of runway despite a modest recovery in prices. Commercial real estate companies should be prepar- ing for a similar outcome given the ongoing pressure in the sector. One year following the crash oil price crash in 2014, energy com- pany’s put about 1 million square feet of inventory on the market in downtown Denver. To date, sub- lease space in the energy sector is at about 13.5% of total energy sec- tor occupancy in Denver, while in 2015 it accounted for roughly 23% of energy sector occupancy. The year- over-year percentage contraction in oil prices in 2020 has so far been more severe than in 2014, and given the delayed impact on energy com- pany solvency, Denver could see a substantial increase in sublease activity, along with restructuring, of its energy sector occupants, poten- tially adding significant inventory to the market. n Oil and gas in Denver. Currently, there are 118 oil and gas companies that occupy 14.8% of downtown Denver’s commercial inventory, including 2.7 million sf along Colo- rado Boulevard in Midtown, 840,000 sf in Lower Downtown, 508,000 sf in Uptown, and 316,000 sf in the southeast suburban market, accord- ing to CBRE. While there have been no substantial Denver domiciled energy bankruptcies to date, chal- lenges already exist, with the mar- ket recording negative absorption of 547,000 sf in the third quarter of 2020. At the same time, sublease availability increased to 4.3 million sf. The reduction in demand for office space in the sector today portends more stress in the com- ing years, as oil and gas laid off approximately 107,000 employees between March and August, accord- ing to an analysis by consulting firm Deloitte. The sector is prone to cyclical employment trends, but up to 70% of these layoffs are expected to be permanent unless demand does turns around significantly before the end of 2021, according to the same Deloitte study. Many industry analysts also are predicting consolidation in the sec- tor nationally, especially for smaller and midsized E&P companies. This activity has yet to build momentum and may take several years to mate- rialize, but it could cut the number of oil and gas companies in Den- ver down the road. Today, most oil and gas companies simply lack the capital to merge with peers or com- mand sufficient premiums. n The end of the beginning. While the initial uncertainty around oil and gas prices stemming from the pandemic and the price war is eas- ing, the scars are likely to remain for some time. The pain will be real, but metro Denver has an opportuni- ty to cater to new users. The Denver commercial real estate market has several factors in its favor: a strong government employee base; a rapid transformation into a technology hub; and favorable demographics, with a median age in the Denver metro area of 37.7 years. If oil and gas companies continue returning real estate inventory to the market, there likely will be growing demand for that space from new users and owners should be positioning for that outcome. n Steps to soften the impact. In the intervening months and possibly years, owners should be cautious in how they work with oil and gas tenants in Colorado. Oil and gas vacancy rates are likely to remain elevated, and commercial real estate owners are primed to bear an outsized share of that burden. As such, if oil and gas companies come to owners seeking rent relief, own- ers should consider credit enhance- ments like accelerated termination rights, increased termination pay- ments and adjustments to assign- ment language in leases. These options improve ownerships’ flex- ibility and reduce capital require- ments needed to repurpose existing space for future tenants. s Oil & gas poised for eventual disruption in Denver Bradley Tisdahl Principal and CEO, Tenant Risk Assessment, btisdahl@tra-llc. com