- The double blow of a collapse in oil prices and the COVID-19-induced recession will likely have an outsized economic effect in oil-producing states compared to the rest of the country.
- U.S. oil-producing states are entering a new period of credit deterioration not unlike what occurred in mid-2015 after the last price rout.
- Over the past five years, various budgetary management techniques prevented more significant credit deterioration among oil-producing states.
- Any sharp pull-back in oil exploration and production will likely inflict considerable strain on oil-producing state economies and revenues.
S&P Global Ratings expects that the double blow of a collapse in oil prices and the COVID-19-induced recession will have a greater effect on U.S. oil-producing states than on the rest of the sector. In our opinion, these states are entering a new period of potential credit deterioration, not unlike what occurred in mid-2015 after the last price rout.
Following the last price decline (mid-2015), all oil-producing states--except Texas and Montana--saw downgrades of one-to-two notches. Negative rating actions occurred during a period of national economic expansion due to the countercyclical nature of energy markets. A fiscal shock from the current recession to these states, so soon after their economic recovery from the last one, will magnify economic and budgetary challenges.
From the end of July 2014 to mid-February 2016, the price of West Texas Intermediate (WTI) fell 76% to $26.21/barrel (bbl) from $107.62/bbl before showing some stabilization over the past year (see chart 1). But as COVID-19 started to spread, oil prices began to fall in mid-January. During April, the drop was dramatic, as the settlement price of WTI declined to negative $37.63/bbl on April 20. With no ability to store oil, large paper positions had to be liquidated, pushing the WTI contract settlement price into negative territory. From the beginning of January to April 21, 2020, the price of WTI fell 84% before starting to rebound, signaling a new period of stress for oil-producing states. So far this year, we lowered our rating on the state of Alaska one notch to 'AA-', assigning a negative outlook, and have revised our outlook to negative from stable on New Mexico and Oklahoma.
S&P Global Ratings has long held that the outsized budget reserves of oil-producing states have provided an effective fiscal cushion during a transition to lower oil prices. However, not all states have been able to bolster reserves and some may find it difficult to enact further budget cuts.
Global Supply-Demand Mismatch Is A Major Disruption To Energy Markets
Initial worldwide spread of the coronavirus resulted in the sudden stop to the global economy and travel restrictions between and within major oil-consuming countries, triggering a significant drop in global demand. The resulting oversupply led oil markets into a severe supply-demand imbalance entering the second quarter of 2020.
Prior to COVID-19 travel restrictions, S&P Global Ratings' oil price assumption was $55/bbl for WTI in 2020, 2021, 2022, and beyond. To date, we have revised our price assumptions twice (see table 1) due to the supply-demand mismatch. The current price assumption of $25/bbl for WTI in 2020 is subject to further revision throughout the year.
|S&P Global Ratings' Oil And Natural Gas Price Assumptions|
|--New prices--||--Old prices--|
|Brent||WTI||Henry Hub||AECO Hub||Brent||WTI||Henry Hub||AECO Hub|
|2022 and beyond||55||50||2.5||1.5||55||50||2.5||1.5|
|WTI--West Texas Intermediate. AECO--Prices are rounded to the nearest $5/bbl and $0.25/mmBtu. bbl--Barrel. mmBtu--Million British thermal units. Source: S&P Global Ratings.|
Over the long term, OPEC production cuts and declining U.S. production should help address current excess oil supply. The easing of social distancing restrictions should support a recovery in global economies, spurring industrial and vehicular use of crude oil-based products, which in turn, should lead to stronger crude oil demand and prices.
For more information see, "S&P Global Ratings Cuts WTI And Brent Crude Oil Price Assumptions Amid Continued Near-Term Pressure" (published March 19, 2020 on RatingsDirect) and "Potential Fallen Angels: U.S. Oil And Gas Companies Walk A Thin Line Between Investment Grade And Speculative Grade" (published May 12, 2020).
Oil-Producing States' Recession May Be Deeper And Longer Than In Other States
Social distancing will have negative consequences for state economies and budgets this year (see "COVID-19-Induced Recession Throws Curveball To U.S. State Budgets," published May 21, 2020). However, the double blow of a collapse in oil prices and the COVID-19-induced recession will likely have outsized effects on the eight main oil-producing states (see table 2). S&P Global Economics now forecasts the U.S. economy will contract 5.2% this year--including a historic (annualized) decline of almost 35% in the second quarter (see "An Already Historic U.S. Downturn Now Looks Even Worse," published April 16, 2020).
|Real Gross State Product Data For Major Oil-Producing States|
|Year-Over-Year Real Gross State Product|
|Growth rate (%)||Rank||Growth rate||Rank||Growth rate||Rank||Growth rate||Rank|
|e--estimate. p--projected. Real gross state product (2012 US$, SAAR). Ranks are shown from 1 (fastest growth) to 50 (slowest growth). Sources: Bureau of Economic Analysis; IHS Markit; S&P Global Ratings.|
We expect the recovery will be gradual as fears linger and social distancing endures, but we expect the economy will at least partly reopen in the third quarter. Plummeting oil prices, which may average $30-$35/bbl for the remainder of the year, could result in further economic contraction in these states, even if the rest of the U.S. begins to recover.
While employment in mining and natural resources is not significantly concentrated within these eight states, mining's effect on economic output is, and both measures significantly exceed that of the nation (see chart 2). Similar to the effects observed five years ago, any sharp pullback in exploration and production will likely inflict considerable strain on these state economies and revenues.
Oil-Producing States' Weak Demographic Trends Will Slow Pace Of Recovery
The current economic environment will likely further erode demographic trends, leading to increased negative net migration among most oil states. During the Great Recession, those states performed better than the rest of the U.S. in terms of nonfarm employment growth, but as energy markets declined in 2014, these same states performed worse than the rest of the country. This is also observed among the negative net migration collectively experienced among oil states (excluding Texas). Due to the size of Texas and its economic diversification, the state has been able to better weather the energy led downturn.
One Austerity Period Has Just Ended, But Another Is Likely Beginning
One tool used by states after the last price rout was budget cuts. In the case of Oklahoma, revenue shortfalls were acute in the wake of the oil price downturn in 2014, contributing to deep cuts in common education appropriations in subsequent fiscal years. The reduction in Oklahoma's education spending in five of the previous ten fiscal years culminated in a statewide teachers' strike in 2018. (see "Oklahoma Teacher Strike Highlights State Sectorwide Budget Pressures," published April 13, 2018). However, as economic pressure eased and revenues improved, budget cuts were reversed only in the past few years (see table 3).
It was not until recently that S&P Global Ratings observed all oil-producing states having positive economic growth (see "With Oil Price Volatility, Recent Economic Gains In U.S. Oil-Producing States Are At Risk," published March 12, 2019). Through various budgetary management techniques, including expenditure reductions and reserve use, oil-producing states avoided significant credit deterioration. During this new period of stress, similar tools will likely be used, but some states may find it more difficult to cut budgets further. Other states leaned more heavily on reserve balances in the past, but never fully replenished those funds.
|Oil-Producing States: General Fund Expenditure Changes|
|(Fiscal 2014 to 2019)|
|*Texas has a biennium budget, the change in expenditures in odd-numbered years represents less of change in expenditures, but a transfer to reserves at the end of the period. Sources: National Association of State Budget Officers, FY 2019 State Expenditure Data.|
Isolating Oil's Effect On State Budgets
Below, we have provided a summary of key price and budgetary assumptions among the eight main oil-producing states' levels of direct fiscal dependence on oil-related revenue. However, a relatively low direct reliance on oil-related revenue does not inoculate a state's budget from the fiscal fallout related to an overall slowing economy. Most oil-producing states have revised revenue assumptions based on changing economic conditions over the past three months. Those with a heavy direct reliance on oil-related revenue have to contend with some of the most immediate budgetary challenges:
- What oil price did the state assume in its budget?
- How much does the state's operating budget rely on oil-related tax revenue?
- Did the state accumulate reserves while oil prices were high?
Beyond oil, other mining activities can play a significant role in state budgets, such as coal and natural gas extraction. For each of the states below, we provide additional detail on how oil production may affect budgets.
On April 17, 2020, we lowered our rating on the state's general obligation (GO) debt to 'AA-' and assigned a negative outlook. The rating action was based on our view of a structural gap now identified for fiscal 2020 of almost 25% and an adopted structural gap of about 21% for fiscal 2021 resulting from a collapse in oil prices. In the past, Alaska's outsized budget reserves provided an effective fiscal cushion against more rapid credit deterioration. However, the enacted budget virtually depletes the state's traditional reserve balance, its constitutional budget reserve fund, by the end of fiscal 2021. In our opinion, the state has narrowing fiscal options beyond fiscal 2021 to return to structural balance. If actual results end up at worse-than-enacted levels, the state will be left with limited options to return to structural balance other than significant reform of its fiscal profile or further drawing on its earnings reserve account for operations.
The spring revenue forecasts project significant year-over-year declines in oil-related revenue to $1.1 billion in fiscal 2020 from $2.0 billion in fiscal 2019 (a 46% drop), and a further decrease to $716.6 million for fiscal 2021 (a 35% drop). The revenue forecast is based on Alaska North Slope (ANS) oil prices remaining below $30.00/bbl for the remainder of fiscal 2020, resulting in an annual average price of $51.65/bbl, and an ANS price forecast of $37.00/bbl for fiscal 2021. For 2021, only 20% of unrestricted general fund revenue is oil-related, compared to approximately 100% almost a decade earlier.
The governor's initial 2021 budget proposal, released prior to the acceleration of the COVID-19 pandemic, reflected a modest increase in general fund outlays, which we anticipated would have to be revised downward. As lawmakers work through the next budget (now to be completed in a special session), a standing challenge is the relatively limited room they have to cut, given that roughly 70% of the general fund is non-discretionary.
However, the state's major revenue mix is far removed from what is was decades ago, when mineral-derived revenue accounted for a substantial share; it now relies on sales and personal income taxes, which together account for three-fourths of general fund revenues (net of dedications). While mineral revenues (severance and royalty) account for about 7% of general fund collections, we anticipate the hit to the current and next fiscal year budgets will be the ancillary services and payrolls that support the state's energy sector.
For more information see our report, "Louisiana's Resilience To Be Tested As Economic Pressures Weigh On Budget Outlook" (published May 4, 2020).
Montana's enacted budget for the biennium includes $2.6 billion in fiscal 2021, and is focused on building reserves while investing in education, health care, and infrastructure. The enacted budget was based on revenue estimates by the Legislative Fiscal Division prior to the pandemic and recent volatility in oil prices. The enacted budget has estimated total reserves at about $294 million, or 11% of expenditures, in fiscal 2021. Although revenue collections through March were above estimates, recently reported revenues for April are beginning to show significant softening, with a 5.6% decline in total year-to-date revenues compared to 2019. The state is exposed to potential economic softness that could cause it to fail to meet projected growth in the next year. It plans to update its biennial revenue estimates in June.
Oil production taxes specifically are estimated to contribute slightly above 2% to the state's general fund revenues for fiscal 2021. Although Montana's general fund has not relied heavily on direct oil and gas receipts, the state's gross state product (GSP) and personal income tax have experienced slower growth due to declines in mining, oil, and agriculture production in recent years. Nevertheless, year-to-date oil production tax revenue collections are down $4.7 million, or 16.7%, due to the decline in oil prices and this decrease is expected to worsen as the fiscal year closes.
New Mexico (AA/Negative)
On May 19, 2020, we revised our outlook on the state 'AA' GO rating to negative from stable due to a weakened energy market. About 34% of New Mexico's general fund revenue derives from oil and gas production, around half from direct severance taxes and mineral rents and royalties deposited in the general fund, and about half indirectly from gross receipts taxes on oil and gas activity.
When the state adopted its fiscal 2021 budget based on a December revenue forecast, it had expected to end fiscal 2020 (June 30), with general fund reserves equal to $1.89 billion, or 26.7% of recurring appropriations, and projected its fiscal 2021 budget would end with a sizable $1.90 billion, or 25.0% of recurring appropriations. However, the recent drop in prices and production has been swift and is expected to cause a dramatic fall in revenue.
The state expects to issue a finalized revenue forecast in mid-June, shortly before an expected legislative special session called to make budget adjustments. The state believes that the outcome of the special session will enable it to avoid fully depleting reserves. However, in our view, the oil and gas market will remain weak for several years, and ongoing budget pressures may persist for some time.
North Dakota (AA+/Stable)
The state's current budget projects $4.9 billion in direct oil-related revenues (9% of biennial general fund expenditures), of which about $400 million is deposited in the general fund. The forecast, however, assumes WTI crude oil prices of $48.50/bbl as of January 2020 that gradually transition to $48/bbl by June 30, 2021, which is significantly above current WTI prices and S&P Global Ratings' assumptions.
North Dakota began the biennium with strong revenue growth projected through 2021, with a fiscal 2019 ending balance of about $1.3 billion, or about 30% of general fund biennial expenditures across its general, budget stabilization, and strategic investment funds. During the last oil price rout, the most significant general fund revenue source--sales and use taxes--missed initial estimates by 46%. At the time, the state received significant support from its available resources, drawing over $1 billion from various sources. North Dakota still has significant balances in various reserve funds, but, in our view, large and repeated drawdowns in the current and next biennium could create serious fiscal pressures not commensurate with the rating level.
For more information see our report, "North Dakota's Deep Reserves, Structural Budget Allow Near-Term Credit Stability While Longer-Term Pressures Persist" (published May 14, 2020).
On May 11, 2020, we revised our outlook on the state 'AA-' GO rating to negative from stable due to considerable budget uncertainty following a steep decline in revenue collections. Although Oklahoma's budget relies less on gross production tax collections (roughly 5%-6% of general fund revenue), a contraction in energy sector activities has rippled through other economic sectors and affected consumer spending. As a result, budget pressure is likely to be more deeply felt from a steep drop-off in income and sales tax collections. The state's Board of Equalization declared a revenue failure of 6% (or $416.7 million) for the remainder of fiscal 2020 and available revenue is projected to decline 16.6%, or $1.366 billion, under the state's worst-case scenario in fiscal 2021. While Oklahoma entered fiscal 2020 with its highest reserve levels in state history, projected budget conditions for fiscal 2021, if unmitigated, would expend much of the state's $1.035 billion in rainy day balances (approximately 12.4% of general fund expenditures) at the end the next fiscal year. Although we recognize that reserves exist to provide flexibility in times of unexpected revenue shortfalls, such as Oklahoma is experiencing now, we believe continuing reliance on reserves to balance budgets in lieu of making structural adjustments could be a negative credit factor.
On April 20, 2020, we affirmed our 'AAA' GO rating on Texas with a stable outlook. While the energy sector continues to play an important role in Texas' economic health, broad-based economic growth--most pronounced in the state's metropolitan statistical areas--has helped diversify its employment base. In terms of total employment figures, as reported by the Texas Workforce Commission, industry employment for the mining sector has contracted considerably since 2014, while other sectors have more than offset the decline. For the five-year period from July 2014 through July 2019, the sector shrank 18.2% (56,900) to approximately 256,000, while total non-agricultural employment grew 10.7% over the same period.
The magnitude of the effects of current economic challenges will depend on their depth and duration, but at present, the state's strong financial position combined with its strong financial management and oversight, will, in our view, afford it a degree of flexibility to manage challenges as they arise. This includes its sizable reserves that are forecast to remain near 8% of biennial appropriations (as of Jan. 31, 2020, the economic stabilization fund maintained a balance $11.48 billion including $3.7 billion in unspent appropriation authority) and strong available liquidity. While we anticipate the current situation will remain fluid, active management will remain a key credit consideration to address developments on the ground and the subsequent second-order effects as they materialize.
Wyoming does not have a state income tax and has a significant dependence on coal and gas mining-related and oil-production revenue, with about 19% of general fund revenue in fiscal 2019 consisting of mineral severance tax. The state released an updated consensus revenue forecast at the end of May, which lowered its forecast general fund/budget reserve revenue for the combined remaining fiscal 2020 period and the 2021-2022 biennium by $1.1 billion against its January forecast, used to enacted its 2021-2022 biennium budget. The state now projects combined budget and legislative stabilization reserve account balances will fall from $1.7 billion at biennium end 2019-2020, or 66% of combined general fund and school foundation program expenditures on an annualized basis, to $978 million, or 40% of combined general fund and school foundation program expenditures on an annualized basis at the end of the 2021-2022 biennium. The state's new projection lowered its calendar 2021 oil price forecast from $50/bbl to $35/bbl, rising to $45/bbl in 2022; it lowered its assumed natural gas prices in calendar 2021 from $2.75/thousand cubic feet (mcf) to $2.60/mcf, which would stay stable at $2.60/mcf in 2022; and lowered its 2021 coal price forecast from $12.10/ton to $12.00/ton, falling further to $11.90/ton in 2022. The state is expected to hold a special legislative session to make budget adjustments following the revised revenue projections.
- COVID-19 Induced Recession Throws Curveball To U.S. State Budgets, May 21, 2020
- Potential Fallen Angels: U.S. Oil And Gas Companies Walk A Thin Line Between Investment Grade And Speculative Grade, May 12, 2020
- The COVID-19 Outbreak Weakens U.S. State And Local Government Credit Conditions, April 2, 2020
- All U.S. Public Finance Sector Outlooks Are Now Negative, April 1, 2020
- S&P Global Ratings Cuts WTI And Brent Crude Oil Price Assumptions Amid Continued Near-Term Pressure, March 19, 2020
- U.S. Oil-Producing States' Fiscal Preparedness Varies As Prices Collapse, March 11, 2020
- ESG Industry Report Card: Oil And Gas, Feb. 11, 2020
- An Already Historic U.S. Downturn Now Looks Even Worse, April 16, 2020
- Long-Term Credit Challenges Facing U.S. State And Local Governments In Coal-Producing Regions, Sept. 25, 2019
- With Oil Price Volatility, Recent Economic Gains In U.S. Oil-Producing States Are At Risk, March 12, 2019
This report does not constitute a rating action.
|Primary Credit Analyst:||Timothy W Little, New York + 1 (212) 438 7999;|
|Secondary Contacts:||Oscar Padilla, Farmers Branch (1) 214-871-1405;|
|David G Hitchcock, New York (1) 212-438-2022;|
|Ladunni M Okolo, New York (1) 212-438-1208;|
|Thomas J Zemetis, New York + 1 (212) 438 1172;|
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