The Fuse

Oil Downturn Rocks State Budgets

by Nick Cunningham | August 25, 2020

The oil industry has been ravaged by the downturn in crude prices, with debt piling up and bankruptcies on the rise. But U.S. state governments dependent on oil and gas revenues to fund their budgets are also facing a fiscal crunch.

The plunge in fossil fuel revenues compounds the economic wreckage in other sectors from the coronavirus. Unlike past cycles, however, there are now questions about the structural nature of the industry’s decline.

States are hit on lower prices and on lower volumes.

State budgets rocked by downturn
The oil market downturn has inflicted a double-whammy on state budgets: not only have prices fallen sharply, but they collapsed to such a degree that production declined as well. States are hit on lower prices and on lower volumes.

Texas leads the nation in oil and gas bankruptcies, which shouldn’t be surprising given its outsized role in the nation’s oil supply. The Permian has lost nearly 300 rigs since March, and production is down by roughly 15 percent to 4.1 million barrels per day (Mb/d). The U.S. saw fossil fuel job losses in excess of 118,000 between March and July; Texas accounted for nearly 40,000 of those eliminated jobs. Revenue from oil operations was down by 77 percent in June, compared to a year earlier, and gas receipts were down by 84 percent.

But while the media spotlight is often on Texas in good times and in bad, the Lone Star State is vastly more economically diversified than the other major oil-producing states of North Dakota, Alaska and Wyoming.

More than 80 percent of Alaska’s revenues come from taxes on the oil industry. Alaska’s oil production has been eroding for decades, but the sharp downturn in prices led to more acute fiscal pain. In March, Alaska estimated that the decline in oil prices could add $300 million the state’s deficit in fiscal year 2020 and $600 million in fiscal year 2021, according to the Tax Foundation, a figure that now looks overly optimistic. Alaska is withdrawing billions of dollars from its reserves.

North Dakota, which funds 53 percent of its budget from oil and gas, is not faring much better. The state bore the brunt of the substantial supply shut-ins when the market crashed in March and April, when WTI fell into negative territory. Landlocked and far from tidewater and global markets, North Dakota’s oil was hit hard when physical markets seized up. Bakken production plunged from 1.44 Mb/d in March to 0.88 Mb/d in May. Output has rebounded to 1.1 Mb/d, but the state is still suffering from lower-than-expected production and lower prices. Oil tax revenues in North Dakota in July were 83 percent lower than they were projected to be as part of the state’s budget.

Oklahoma’s budget hole topped $1.3 billion, and decided to use up its rainy day fund to plug the gap, according to E&E News. New Mexico slashed spending by over $400 million in June. Wyoming, which sources 60 percent of its budget from oil, gas and coal, was forced to cut its biennial budget by 10 percent, a cut of $250 million.

Oklahoma’s budget hole topped $1.3 billion.

The sharp decline in oil revenues comes as state budgets have been pounded by broader lockdowns and business closures related to the pandemic. All told, U.S. state budgets are set to see a combined $555 billion hit over a three-year period, according to the Center on Budget and Policy Priorities.

Cyclical or structural?
Oil and gas producing states are somewhat familiar with booms and busts. In the past, states and their fossil fuel workers could take comfort in the fact that a boom would eventually follow a bust. The downturn in 2020, while historic in size and scope, may turn out to be the latest cyclical downturn. The savage cuts to upstream spending could sow the seeds of the next upcycle as very few new projects come online.

Supply growth was exceeding demand growth even before the pandemic.

However, that view is far from consensus. Supply growth was exceeding demand growth even before the pandemic. Now, some analysts estimate that the world has already hit peak demand. That assertion remains up for debate, but even if the peak remains at some point off into the future, most analysts see weak demand growth at best going forward. With plenty of supply – not to mention millions of barrels of oil in spare capacity in OPEC countries – the odds of supply-scarcity boom in prices seems increasingly remote.

Ultimately, from a state-budgeting perspective, that means that the glory days of oil-driven economic growth stories are likely a thing of the past. Even a rebound in market conditions does not guarantee the good days come back – with each successive downturn, the industry employs fewer and fewer people, increasingly relying on automation.

For U.S. states that derive the bulk of their revenues from extractive industries, drilling and mining will remain key sectors of the economy for the short and medium-term. But the imperative of economic diversification and transition are becoming topics increasingly difficult to ignore.

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