DALLAS — Standard & Poor's anticipates overall stability for the majority of its rated local governments in Texas despite a dramatic oil price drop reminiscent of the 1980s, analysts said in a Jan. 22 report.
"The effect of low prices on the state's credit conditions will vary by region, and will be largely determined by the relative diversity of the employment base," S&P analysts Oscar Padilla and Christine Besset wrote.
In the five largest urban areas of Houston, Dallas-Fort Worth, San Antonio, Austin and El Paso, economic diversity is likely to mitigate the impact of the tumbling energy sector, the analysts predicted.
By contrast, heavily energy centered metropolitan statistical areas, notably Midland and Odessa will likely be the first to see an impact, the analysts said.
"These two cities participate in MSAs that we consider 'weak' largely due to their employment concentration in oil and gas," the report said.
Citing energy experts, S&P said the energy-dependent economies, especially those in the major shale plays, should anticipate a two-year recovery period. In 2008, oil fell from a peak of nearly $146 per barrel in July to less than $40 in six months. Oil did not hit $100 again until 2011.
"There appears to be no immediate mechanism to support higher oil prices in 2015," S&P said. "Most industry analysts believe that the process may take up to two years, and that crude prices will then stabilize at around $70."
Oil supplies are at their highest levels in 80 years after a weekly increase that was four times higher than anticipated by Wall Street analysts, according to the U.S. Energy Information Administration. Refineries operated at 85.5% of capacity last week, the lowest level since March 2013, the EIA said.
In 2008, the Organization of Petroleum Exporting Countries, whose members controlled about 40% of the world's oil, announced sharp cuts in production to stabilize prices. After the 2014 drop, OPEC said it would maintain current production, even if the price falls to $20 per barrel.
Based on Standard & Poor's price assumptions of $50 per barrel for West Texas Intermediate crude for 2015, "we believe exploration and production companies will cut capital spending by an average of 25% to 30% in Texas this year compared with 2014," its analysts wrote.
"In 2016, we believe E&P spending should stay mostly flat over 2015 as we expect WTI to only modestly rebound to $60 next year," the analysts said.
The price assumptions are critical for Texas and other states working on their budgets. The 2015 Texas Legislature is writing a two-year budget that runs through Aug. 30, 2017.
In his Jan. 12 revenue estimate, Texas Comptroller Glenn Hegar projected that lawmakers would have $113 billion to work with in the upcoming budget. That represents a 9.5% increase over the general fund revenues in the current biennium, Hegar said.
"We're all well aware that oil prices have dropped significantly in recent months," Hegar said. "Lower prices will likely lead to significant slowing in oil exploration/production, and has dampened our economic forecast."
For Texas, the greatest fear is a return to the deep slump that devastated the state's economy in the 1980s.
The S&P analysts said a "direct comparison is not wholly appropriate" between the current decade and the 1980s.
"In terms of economic output, while the oil and gas sectors' share of total output in the early 1980s was in the high teens, by 2013 it represented roughly 11% although total employment levels in the sector are similar," S&P said.
Texas governments have braced for a downturn this time, according to S&P, building up reserves from the higher property values and excise taxes on the surging production of the past two years.
The state's response to deteriorating economic conditions in the 1980s led to creation of the Economic Stabilization Fund, commonly known as Rainy Day Fund, made up of severance taxes from oil and gas production.
From 2006 to 2013, oil and gas severance taxes added a little over $9.5 billion to the ESF, according to S&P. After accounting for appropriations, the ESF is expected to reach $8.5 billion by the end of the current biennium and to reach $11.5 billion by the end of the 2016-2017 biennium, based on the state comptroller's revenue projection.
"So as state legislators begin their session, we believe that the state is in a far stronger fiscal position to manage the challenges brought by low oil prices," Padilla and Besset wrote.
Locally, Odessa in the Permian Basin has a three year reserve average of roughly 68% of expenditures, S&P said. Karnes County, in the Eagle Ford shale, had reserve levels of 211% in 2013.
"These reserves are exponentially higher than the national average reserve level of approximately 42% of expenditures," the analysts wrote. "We believe that the strength of their reserves will afford them the flexibility necessary to navigate the decline in revenue that is likely to occur in 2015. By contrast, we expect that issuers with lower reserve levels are likely to see increased pressure on their credit quality."
