Oil price collapse a gut punch for producing states

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With oil prices plummeting, energy-producing states of the Southwest face another economic rollercoaster less than six years after the last collapse.

Futures prices on West Texas Intermediate Crude fell more than 25% Sunday night to below $33 per barrel after Russia refused to support a production cut by the Organization of Petroleum Exporting Countries, or OPEC. Now, Monday, oil prices are noted to be down 31% over the weekend. While COVID-19 was not the primary cause, the massive global weakening is feeding into the oil price weakening.

Analysts at Goldman Sachs warned that prices could fall into the $20 per barrel range, a level not seen since the 2014 collapse.

“We believe the OPEC and Russia oil-price war unequivocally started this weekend when Saudi Arabia aggressively cut the relative price at which it sells its crude by the most in at least 20 years,” Goldman Sachs analysts said in a research note. “This completely changes the outlook for the oil and gas markets, in our view, and brings back the playbook of the ‘New Oil Order,’ with low-cost producers increasing supply from their spare capacity to force higher cost producers to reduce output.”

Oil prices fell more than 60% from $100 per barrel in 2014 when Saudi Arabia flooded the market in an attempt to put U.S. producers out of business. The process of hydraulic fracturing in deep shale formations has made the U.S. the world’s leading producer, lifting the economies of southwestern states Texas, Oklahoma and New Mexico. However, the so-called “fracking” industry is in deep trouble as investors who have never profited from the business retreat amid a wave of bankruptcies.

Nigel Green, chief executive and founder of deVere Group in London, said the oil prices and government bond yields make recession all but certain this year.

“Oil’s sharpest one-day drop since the 1991 Gulf war has further fueled the sell-off in global stock markets that started a couple of weeks ago on fears that coronavirus is going to severely damage economic growth,” he said. “With the combination of the implications of the oil stand-off and the outbreak, I now believe that it’s almost inevitable that there will be a global recession this year.”

Revenues from oil and gas production make up the rainy day fund reserves of Texas and Oklahoma and back severance tax bonds in New Mexico. Oil and gas production is also a key economic factor in Colorado, Utah, and to a lesser degree, Kansas. Texas’ Permanent University Fund and Permanent School Fund that back guarantee bonds for schools and universities are derived from oil and gas producing state lands.

Texans approved a constitutional amendment creating the Economic Stabilization Fund in 1988, after an oil price plunge and economic recession that forced lawmakers to raise taxes to fund state government. The Legislature structured the fund to automatically set aside some tax revenues in boom years to help the state during downturns. Subsequent legislation and another constitutional amendment made further changes to its funding mechanisms.

The crude oil and natural gas production taxes are by far the most important funding sources for the fund, contributing more than 85% of its revenue.

The industry was showing weakness in 2019 before the virus known as COVID-19 brought massive shutdowns in China and upheaval throughout the world.

“Virus uncertainty has hit the energy sector at a time when it was reestablishing its footing, with many firms reporting better-than-expected fourth-quarter 2019 earnings,” analysts at Kroll Bond Rating Agency said in a recent report on the impact of the COVID-19 virus across various sectors. “Still, the most recent selloff in the price of oil is threatening to be the fourth 20% correction in the past 18 months.”

“This is the classic oil shock, the thing that comes from nowhere,” said Bill Gilmer, director of the Institute for Regional Forecasting at the University of Houston’s Bauer College of Business.

When the 2014 collapse came, the energy capital of Houston lost 75,000 jobs in the industry but gained jobs overall because of the strength of the national economy at the time, Gilmer said.

The question in the current scenario is how deeply the national economy will be affected by the COVID-19 virus outbreak and reaction. The current downturn also follows a credit squeeze that had already lowered rig counts in the major producing regions.

A fracking operation in Texas. The sudden collapse of oil prices is expected to pummel the U.S. oil production industry.

“There are still a lot of good companies in the fracking business that will be able to survive this,” Gilmer told The Bond Buyer. “I’m not sure the whole fracking industry is at risk.”

In Oklahoma, Treasurer Randy McDaniel reported that gross receipts returned to negative territory in February, pushed down by shrinking sales, gross production, and motor vehicle tax collections.

February total monthly collections were $956.8 million, down by $14.7 million, or 1.5%, from February 2019. Collections from individual and corporate income, and use taxes were greater than those of the prior year, but not enough to offset the downturn in the other sources, McDaniel said.

Sales tax collections for the month were down by 3.4%, while gross production taxes on oil and natural gas are off by almost 20%. February marks the sixth consecutive month of contraction in both revenue sources, McDaniel said.

“Through the end of last month, we have seen a downward trend spurred by low oil and gas prices,” McDaniel said. “In the coming months, we will be closely monitoring national and international developments relating to the coronavirus and the resulting economic impact.”

In the wake of the 2014 collapse that brought a series of revenue crises to the Sooner State, lawmakers followed Texas’ example and began siphoning revenues from oil and gas taxes to the state’s rainy day fund.

New Mexico, which shares the Permian Basin producing region with Texas has not yet registered the downturn after a bountiful 2019.

Land Commissioner Stephanie Garcia Richard announced record revenues Friday.

Before the latest collapse, the State Land Office expected to raise another $1 billion this year for public schools, hospitals and other beneficiaries.

The State Land Office’s Royalty Management Division reports royalty revenue three months after production, so the revenue reported for the month of February actually reflects production from November.

“For the first time in history, our monthly royalty revenue will be near or over $100 million for four months in a row,” Garcia Richard said.

Revenue from royalty payments is directed to the State Investment Council for investment in the Land Grant Permanent Fund.

With its more diverse economy, Texas was able to withstand the 2014 collapse with minimal damage, but the advent of COVID-19 has been described as a “black swan” event whose unexpected ramifications are difficult to quantify.

“The pace and magnitude to which the coronavirus has undermined global confidence is nothing short of historic,” Kroll analysts said. “At this point, given the fluidity and uncertainty of the outbreak, it is hard to rule out any outcome.”

At The Bond Buyer’s Texas Public Finance Conference in Austin last month, state Comptroller Glenn Hegar acknowledged that growth in the state is expected to soften in 2020, but he did not cite any specific impacts.

Texas has not seen a decline in state sales tax revenue since August 2017. Annual sales tax collections did not drop until 2016, nearly two years after the oil prices collapsed.

Texas oil and gas producers have pinned their hopes to the export market, particularly China. But the COVID-19 outbreak has refocused attention on Europe, where Texas exporters compete with Russian gas pipelines.

In February, the U.S. Department of Energy issued four long-term orders authorizing exports of domestically produced LNG from four proposed projects in Texas.

In separate orders, DOE authorized three export project proposals in the Brownsville area and Corpus Christi.

The export capacity of the four projects is enough LNG to supply more than half of Europe's import demand, according to U.S. Secretary of Energy Dan Brouillette.

"In Europe, as much as anywhere in the world, energy security is, in fact, national security, and energy security depends upon energy diversity," Brouillette said last month at the Atlantic Council in Washington, D.C. "The fact is, and it remains, that many European countries are dependent on Russian gas to meet more than 75% of their annual gas imports, and given Russia's use of energy to bend other nations to its will, those nations must diversify.”

However, some analysts see Russia primed to crush the U.S. fracking industry. Russia joined an alliance with OPEC known as OPEC-Plus in 2017, going along with production targets. But last week, Russia refused to cooperate with production cuts, setting off competition among OPEC nations for market share.

The International Energy Agency on Monday cut its forecast for global demand, anticipating a 90,000 barrel a day decline this year, from a previous forecast of an 825,000 barrels a day increase.

“The coronavirus crisis is affecting a wide range of energy markets — including coal, gas and renewables — but its impact on oil markets is particularly severe because it is stopping people and goods from moving around, dealing a heavy blow to demand for transport fuels,” said Fatih Birol, the IEA’s executive director, in a statement.

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