- A prolonged period of low oil prices could pressure employment, assessed valuation, and the general economic outlook of local governments throughout oil-producing states.
- We believe that sales tax revenues are at greatest risk for significant declines in oil-producing states, based in part on historical performance during the previous period of low oil prices.
- Risks vary across states given industry exposure, particularly when considering the different facets of upstream, midstream, and downstream operations.
Many school districts and communities in Alaska, Colorado, Louisiana, New Mexico, North Dakota, Oklahoma, and Texas have concentrated economies heavily dependent on the oil and gas industry. As a result, S&P Global Ratings believes a prolonged period of low oil prices could rapidly create negative credit pressure for some obligors in these states, similar to the winter of 2015/2016 when oil prices declined below $35 a barrel (West Texas Intermediate; WTI), causing assessed values (AVs), sales tax collections, and other credit metrics to drop significantly.
As the trend and impact of low oil prices becomes clearer, we expect many affected municipalities to draw on reserves. Additional state support could also bolster finances during times of distress. However, it may still be necessary to make budgetary adjustments, and issuers/obligors with limited revenue diversity--such as those dependent on special tax revenues--may experience more pressure. In our view, bond issues secured by sales tax and other special tax collections are exposed more directly to coverage volatility during periods of low oil prices because oilfield services companies may slow down day-to-day operations, reducing their business transactions. In addition, we could see employment contraction if these companies exit. Therefore, if oil prices remain low, coverage levels for revenue bonds are likely to decline, leading to direct credit pressure.
Prolonged Low Oil Price Could Exacerbate Pressures
Oil production breakeven prices vary across states and regions across the south, but if oil prices remain at approximately $35 dollars a barrel, producers will have to make difficult decisions on how to proceed, affecting economies in oil-producing states. Recent surveys of oil producers reveal breakeven prices at about $50 dollars a barrel for most shale operations in West Texas and across the U.S. Other producers in Alaska and offshore have varying breakeven prices, but due to efficiency gains and technology advances made by some oil producers, breakeven prices have decreased since the 2015/2016 decline in breakeven oil prices. However, if low oil prices persist, and if local governments and school districts do not make quick adjustments to account for reduced revenues, it is likely their credit quality could deteriorate.
The oil and gas industry comprises a broad set of activities, which can be categorized into the following:
- Upstream operations: The first step in oil and gas supply chain, upstream consists of exploration and production operations focused on extraction. Oilfield services companies typically have short-term contracts that do not provide for stability of revenues and are more susceptible to cyclical swings in the market.
- Midstream operations: This includes the transportation, storage, wholesale marketing, and trading of oil, natural gas, and refined products. In this sector, companies generally undertake sizable capacity projects only if they have secured long-term contracts, which tend to mitigate revenue volatility.
- Downstream operations: The last step in oil and gas production before products are delivered to consumers, this stage includes oil refineries, petrochemical facilities, and distributors. These companies typically have greater flexibility in sourcing different types of crude oil, which minimizes feedstock costs and enables the refinery to more readily bring its finished products to market.
What We Are Watching For In Oil-Producing States
In Texas, we will monitor sales tax collections closely given the state's extensive oil and gas activities. We have also observed AV declines in school districts and local governments following oil price volatility; however, these values typically lag oil price declines by a year or more. Generally, many of the obligors susceptible to these swings have high reserves and can withstand a short period of austerity.
Many of our ratings in the western and southern part of the state have concentrated economies focused on upstream activities like exploration and production, as well as significant midstream operations such as pipelines. Companies that operate in the Permian and Eagle Ford basin will likely see immediate effects, although some may be able to maintain operations depending on management decisions and how efficient their processes are. In the southeastern part of the state, large petrochemical facilities will likely not see an immediate effect, as feedstock prices will likely decrease.
One mitigating factor is a one-year lag before lower mineral valuations affect AVs in Texas, giving local governments and school districts time to prepare. On the other hand, sales tax receipts will likely take a more immediate hit if low oil prices persist, within cities and counties that have a high concentration of upstream oil and gas activities, given the nature of oilfield services and constant turnover and maintenance of equipment. In addition, employment contraction could result in reduced discretionary consumer spending.
In Louisiana, we will look mainly to coastal parishes to see if recent efficiencies in offshore drilling will enable operations to continue if low oil prices persist. Certain parts of Louisiana focused on petrochemical operations will likely not see immediate effects, while others that focus on offshore drilling may see economic deterioration if oil prices remain low for an extended period of time. In the short term, downstream petrochemical facilities will benefit from lower prices as an input into their production process.
Historically, we have observed relative AV stability for obligors in southwest Louisiana whose economies focus heavily on petrochemicals. However, coastal parishes dependent on offshore drilling and marine services are more likely to see declines due to their reliance on upstream operations. Parishes located around the Haynesville basin in the northern part of the state, which rely more on natural gas, also saw declines during the previous period of low oil prices. We have also observed widespread variations in sales tax collections. Coastal areas focused on offshore activities have historically seen large declines in collections during periods of low prices as service company operations and employment contract. In areas with a heavy petrochemical presence, we have observed stability in collections during previous price troughs, as these facilities generally expand to take advantage of lower feedstock costs.
We will monitor the state budget and oil operations in the northern part of the state, which is dependent on upstream oil and gas production, while watching for indirect effects to other obligors in the state. The state budget is dependent on oil revenues and any sustained period of low prices could hurt revenues, and result in state budget cuts that force municipalities to adjust their budgets. Despite this, we believe that rated municipalities have some insulation from budget woes, particularly Anchorage, which derives nearly all of its tax revenue from local economic sources rather than statewide oil-related activities.
In Oklahoma, school districts across the state are typically very reliant on state funding, which could lead to budgetary pressure. A prolonged suppression of oil and gas prices is likely to disrupt business activity and consumer spending, weakening income and sales taxes. We will closely monitor the state's financial position and how state funding will affect school districts. During the 2015/2016 oil price decline, state revenues were adversely affected by low commodity prices, which forced midyear budget cuts for school districts, adversely affecting their finances. However, since those revenue declines, the state has made large deposits into its rainy day fund, which provides additional cushion. Given the reserve caps for school districts required by the state, a prolonged oil price decline will place pressure on local finances.
Upstream activity in the state has declined in recent years based on the lower rig counts, but the state continues to have a large pipeline presence. Of the local governments and school districts we rate, most do not have economies that are heavily concentrated in oil or gas activity, but many have indirect exposure, with a high number of state residents employed in the sector. As sales taxes generally constitute a large portion of operating budgets for municipalities, decreased consumer sentiment or energy employment contraction could lead to revenue pressures throughout the state.
We will monitor state aid to school districts since state aid makes up a large percentage of school district revenue, while also closely watching gross receipt tax revenues that are collected locally and that make up a usually sizable portion of local government budgets. The majority of oil and gas activity in New Mexico is focused on upstream activities, and is located in the southeast (Permian Basin) and northwest (San Juan Basin) regions of the state. If low oil prices persist, counties and municipalities in those regions could see budgetary pressures from declines in both gross receipts tax revenue, as well as, ad valorem tax revenue based on production value and equipment used in oil and gas extraction. School districts across the state could also face budgetary pressure, regardless of the oil and gas activity in the district, as state aid often accounts for over 90% of general fund revenue. Therefore, any budgetary pressures put on the state by persistently low oil prices would likely be passed on to school districts. Gross receipts tax revenue bonds in New Mexico usually maintain coverage well in excess of 2x maximum annual debt service (MADS), and would likely maintain strong MADS coverage in the event of a prolonged decline.
While we anticipate that near-term stress is unlikely for Colorado obligors, we will be particularly focused on local governments with energy-concentrated economies and special districts. We do not expect an immediate impact to school districts, even those with high levels of oil and gas production, because state aid to school districts provides the difference between the total funding and local share of revenue, which somewhat mitigates any local losses due to energy volatility.
Although oil and gas production is a determinant for county assessor calculations of property valuations, we do not expect an immediate impact to local governments. If a city or county receives a sizable percentage of revenue from a combination of severance taxes or oil and gas ad valorem taxes, or both, the impact of a sustained price decline would likely be felt in the next fiscal year (2021), and we believe localities would have sufficient time to prepare when budget development occurs in fall 2020. If low prices persist, there could be longer-term implications for valuations, particularly in oil-concentrated economies. For special districts (including metropolitan districts) that are highly concentrated in oil and gas, more notably, entities with limited tax structures, a prolonged period of low oil production would likely be detrimental to the budget in the long term, as these districts would have a narrow ability to generate additional revenue beyond their respective tax caps.
In North Dakota we will watch sales tax revenue bonds closely, viewing general obligation (GO) ratings more favorably in general given the strong cash positions many obligors maintain. We expect that the most immediate effects of any production slowdown will be seen in weaker sales tax performance and possibly fewer oil and gas production subsidies for local governments. The Bakken Shale region saw a dramatic uptick in oil and gas drilling in the early 2010s that gave way to a similarly dramatic decline during the last slump in global oil prices in 2015 and 2016. Amid this period of economic volatility, we lowered our ratings on several sales tax revenue bonds issued during the oil and gas boom. GO ratings were pressured as well, but held up much better given the strong cash positions that many issuers had built up in the previous years, in part from subsidies from the state in the form of oil and gas production taxes provided to certain designated oil hub cities.
Although the state has had somewhat of an economic rebound since 2016 amid a period of relative oil price stability, it is still heavily concentrated in oil and gas production. Many North Dakota local governments have also issued substantial debt to fund the infrastructure needs that have come with the sudden growth of the past decade and could see high debt service costs crowding out other budgetary priorities in a prolonged lower-revenue environment.
- U.S. Oil-Producing States' Fiscal Preparedness Varies As Prices Collapse, March 11, 2020
- Unrestrained Supply Swamps Oil Outlook: S&P Global Ratings Revises Oil & Gas Assumptions, March 9, 2020
This report does not constitute a rating action.
|Primary Credit Analysts:||Alex Louie, Centennial 303-721-4559;|
|Joshua Travis, Farmers Branch 972-367-3340;|
|Kate Boatright, Farmers Branch (1) 214-871-1420;|
|Secondary Contacts:||Jane H Ridley, Centennial (1) 303-721-4487;|
|Alexander Vargas, CFA, Chicago (1) 312-233-7093;|
|Michael Parker, Centennial + 1 (303) 721 4701;|
|Scott Nees, Chicago (1) 312-233-7064;|
|Joseph Vodziak, Chicago + 1 312 233 7094;|
|Calix Sholander, Centennial + 1 (303) 721 4255;|
|Stephen Doyle, Farmers Branch (1) 214-765-5886;|
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