Oil & the Aberdeen Hotel Market; Stick, Twist or Burn

By Joe Stather

Investor appetite for the Aberdeen hotel market has grown substantially over recent years in tandem with exceptionally strong trading growth and a remarkable pace of profit recovery post-recession. The market has accelerated past other provincial UK cities, including Edinburgh, in terms of total revenue per available room (TrevPAR) and average hotel profits experienced double digit growth for 2014 based on the previous year. However, corporate and conference hotel demand has accounted for almost 50% of the market’s volume mix over the last 12 months and given that Aberdeen’s business activity is largely centred around the petroleum industry, there is little surprise that the city’s hotel owners and operators are concerned about a recent fall and potentially long-term reduction in the price of Brent crude. 

Traditionally, the relationship between room revenue per available room (RevPAR) and the value of Brent crude has been used to give an indication of the hotel market’s reliance on North Sea oil extraction. On this basis, owners and operators would have subjective reason for alarm as the relationship shows a fairly strong correlation of 0.8; the same correlation also applies between the price of Brent crude and hotel total revenue. On the other hand, and perhaps of greater significance to the investment community, fluctuations in hotel gross operating profit show a moderate correlation of 0.6 when equated to changes in the price of oil which suggests that a fall in oil price has a lower impact on the Aberdonian hotel bottom line and investor returns. One particular reason for this is the direct impact of oil value on wider commodity prices, whereby a drop in oil prices will reduce energy costs and, furthermore, lessen the general price of foodstuffs, which are often two of the most significant operating expenses for a full-service hotel.    

Some sources claim that the actual challenge facing Aberdeen’s economy and thus continued demand for hotels, is not the price of oil but the role that the coastal city will play when fossil fuel is no longer extracted from the North Sea; this comes with news that some of the world’s largest oil producers are to begin decommissioning their installations in the Brent field. North Sea oil production has in fact been falling for over 14 years and at a compound annual decrease of -8% since 2007; however, hotel performance in terms of total revenue and gross operating profit bears no correlation whatsoever (-0.7 and -0.8 respectively).    

Whilst the extraction of North Sea oil has been in considerable decline, there has been a growing realisation that Aberdeen has become the financial, administrative and intellectual heart of the global energy industry and this in turn has increased non-drilling activity and supported if not heightened hotel demand.

The strongest correlation between any of the metrics considered was Aberdeen hotel room supply and the price of oil over the 14 years to YE 2014. Although there was roughly a 24-month lag between a fluctuation in oil price and the changing degree of room supply growth, the correlation coefficient was a staggering 0.9. This presents a strong argument that few properties will be added to the construction pipeline whilst crude prices remain low largely due to impacted developer confidence. Consequently, hotel supply increases in the mid-term will be nominal thus reducing the dilution of future hotel revenues and allowing for less constrained performance growth in the market. 

A decade ago we may have seen a much higher impact from falling crude prices as the city was hinged on core activity relating to the extraction of oil, but the development of infrastructure in the interim has resulted in a platform that continues to attract global oil-services firms many of which are focussed on on-shore energy further afield, but looking to utilise Aberdeen’s pro-business credentials and avoid safety concerns in the other regions. There is also evidence of non-oil related firms migrating to the city which will increase diversity of demand for hotels and reduce the oil dependency of Aberdeen’s economic output. Whilst these trends are set to gather momentum, there is also an understanding that decommissioning of the Brent field will take 30 years in itself and be more technically intensive than the extraction of oil; this could create a new, pioneering sector of the oil-industry for which Aberdeen would be the centre of excellence. The UK government have cut tax on petroleum revenue from 50% to 35% in the most recent budget and it is hoped that this will ignite interest in exploration of other fields serviced by Aberdeen and thereby improve long-term prospects for the city. 

Aberdeen undoubtedly faces some challenges in the short-term, however, this concise ViewPoint has provided a fact-based insight suggesting that headwinds from the oil industry might not be so damning for the hotel market; indeed it highlights opportunity for owners to drive returns on their investment further down the line.