‘Double Whammy’: Oil Crash Adds to Virus Budget Woes in Some States

As the drastic economic downturn driven by the coronavirus stresses state budgets, those with sizable gas and oil industries are dealing with the added pressure of the recent oil price crash.

When the oil and gas sector falters in states where it makes up a large chunk of the economy, tax collections tied directly to the amount of crude and gas pumped from the ground tend to deteriorate. But so do other sources of revenue, like sales and income taxes, as energy companies spend less on equipment and supplies and lay off workers.

These cycles have played out before. But the current one is happening as widespread business closures and stay-at-home orders meant to help stop the spread of the highly contagious virus are also blowing holes in state tax collections. Meanwhile, states are contending with the costs of the public health response and  soaring unemployment.

"The bottom line is that the oil and gas producing states are right now being hit with a double whammy,” said Dale Craymer, president of the Texas Taxpayers and Research Association. “Not only the losses from the coronavirus shutdowns, but also from the drop in oil and gas.”

An advantage for many oil-producing states is that they know swings in energy markets can mangle their budgets and they tend to stash away savings to help get through rough times. 

“Oil states are some of the best prepared to be able to deal with downturns because their revenues, in the past at least, have been so volatile in economic downturns,” said Nick Samuels, an analyst at Moody’s Investors Service. “It's the energy producing states that have built up reserves that are some of the strongest.”

But the fiscal challenges oil states are now confronting and the flexibility they have to manage them varies. And reserve funds alone are unlikely to solve all of their problems. Officials in some of these states are bracing for the possibility of budget cuts, tax hikes, and economic recoveries that could lag behind other parts of the country.

Oil prices cratered around March amid a supply glut. The virus slowdown has shattered demand for fuel as people travel less by plane and car. Tensions between Saudi Arabia and Russia over crude production that led them to engage in an oil “price war” also contributed to the crash.

This week, oil prices rebounded some, but remained well below where they’ve stood in past years and still short of the estimated levels that states used to plan their budgets. 

In early January, spot prices for West Texas Intermediate crude oil were around $60 per barrel, according to the U.S. Energy Information Administration. This week they’d climbed above $20. That’s up from around $12 last week and well above a slide into negative price territory last month for some futures contracts. But long gone are the high-flying prices up over $100 seen back in 2014.

Against this backdrop, Alaska is in an especially vulnerable spot. For years after the Trans Alaska Pipeline System came online in 1977 to move North Slope crude south to a seaport in Valdez, the state was able to cover expenses—including annual payments to residents known as “dividends”—using the abundant revenues that flooded in from the oil sector.

But even before the coronavirus, oil production in Alaska, and tax revenue from it, were waning. North Slope production was around 2 million barrels per day in the late 1980s, but shrank in subsequent decades to around 400,000 to 500,000 barrels per day in the past five years or so.

Taxes on oil production supported as much as 90% of the state’s unrestricted general fund spending as recently as 2014, according to Mouhcine Guettabi, an economics professor at the University of Alaska Anchorage. But he noted that a previous fall in oil prices around 2014 dragged down the state’s economy into recession territory between 2015 and 2018.

“The oil industry has carried the load for years,” he said. “Obviously the whole thing changed as a result of the drop in oil prices from over $100 to $40.”

State Rep. Ivy Spohnholz, a Democrat, who is vice chair of the House Energy Committee, described the circumstances the state is now in as “devastating.” State budget projections for this upcoming fiscal year were based originally on a $59-per-barrel price for oil.

“Alaska has been struggling financially for the last five or six years because of low oil prices and declining production,” she said. “We've already cut our budget about 40% in the last five years. This is going to mean no capital budget, this is going to mean additional layoffs and cuts.”

In addition to prior budget cuts, the state has burned through savings in recent years to balance its budget. Spohnholz noted that Alaska had stacked up about $14 billion in savings accounts when oil prices were high. “This next year,” she said, “we will spend the last of that savings.”

Sen. Bert Stedman, a Republican who co-chairs the Senate Finance Committee, is also ill at ease with where things stand with Alaska’s budget. “Structural deficits will take you into bankruptcy if you don't fix them,” he said. “And we have a structural deficit that needs to be corrected and we're working through that process.”

On top of the oil crash, Alaska is also now facing the likelihood that the upcoming season of summer tourism and cruise ship visits—major economic engines for some communities—could be undermined as people cancel travel plans due to the virus.

Stedman and Spohnholz both acknowledged that there could be thorny debates on the horizon about whether the state should adopt a statewide sales or income tax—it currently has neither. Asked what his preference would be for a new tax, Stedman replied: “None.” But then he added: "That will be the bitter pill of providence that's going to get shoved down the legislature's throat."

Louisiana lawmakers are contemplating a slide in the oil sector as well—one that will come on top of declines in other crucial tax revenues, like those tied to sales and casinos. 

"It's just kind of the perfect storm with the coronavirus and the collapse of oil and gas,” Sen. Mack "Bodi" White, Jr., who chairs the Senate Finance Committee, said late last week.

“If it were just the oil, it would be significant to deal with,” he added. 

White referenced estimates indicating that as much as 60% to 70% of the state’s oil and gas workforce could be laid off—another gut punch to the economy. “We could lose as many as 23,000 jobs in drilling and oil exploration,” he said. “These are high paying jobs, many of them.”

The main group that lobbies on behalf of the industry in Louisiana has been pushing to suspend state “severance taxes” imposed on oil production. Democratic Gov. John Bel Edwards announced last month the state would delay the collection of the taxes.

“We're going to have to have tax relief for the industry,” White said. “If we don't relieve them with some of their taxes, some of the drilling companies, they won't come back.”

Greg Albrecht, chief economist in Louisiana’s Legislative Fiscal Office, noted during a committee hearing this week that a state revenue forecast from last year, for fiscal 2021, assumed oil would be in the $60 per barrel range—more than double the price June contracts for West Texas Intermediate crude oil were trading at on Thursday afternoon.

“Until you have sustained prices in the $50 a barrel range,” Albrecht said, “we’re not going to see much mineral revenue recovery.”

He also pointed out that overall Louisiana’s economy wasn’t booming even before it was hit by the pandemic and oil price crash. “We never had a whole lot of momentum to begin with,” he said. "And I don't know that we're going to come back with a lot of strong momentum.”

The drop in oil prices is also a concern in Texas.

“We Texans like to think that we have a modern diversified economy, but the reality is we're still five to six times more dependent on oil than the rest of the nation, so it's a huge factor here,” said Craymer with the taxpayers and research association. “It's a big part of our economy, but it's a bigger part of our state treasury.”

Texas has a large rainy day fund, known as the “economic stabilization fund,” where it deposits a share of tax revenues from oil and gas production. At the close of fiscal 2019, this fund had a cash balance of $6.8 billion and $3.3 billion in investments, for a total of about $10 billion, according to a February report from the state comptroller.

About five years ago, the state took action to siphon off some of the money that was going into the rainy day fund so it could be put towards highways. Craymer suspects this road construction funding could fall during this downturn.

The same goes for funding for public colleges and universities. “Typically higher education budgets come under tremendous pressure during periods when we're losing a lot of oil and gas money, and I expect that will happen again,” he said.

He also noted that there hasn’t been a major bill to raise new taxes in Texas in decades and doubts that will change now. Tapping the rainy day fund and using “smoke and mirrors and accounting gimmicks” are all more politically palatable than raising taxes, Craymer said.

"We've been through this before, we'll get through it again,” he added. "But the one wild card is we've never had to deal with this at the same time we've been dealing with a major pandemic."

In Oklahoma, another gas- and oil-dependent state, lawmakers on Monday put forward a budget plan for the upcoming 2021 fiscal year that was in some ways rosier than expected.

The $7.7 billion proposal would use about $406 million in reserves, along with federal aid, cuts in one-time spending and other maneuvers, to help bridge a $1.4 billion budget shortfall that Republican Gov. Kevin Stitt projected last month.

It would limit cuts to most agencies to 4% or less and—with the injection of federal aid—may actually raise the level of spending on education. The plan would also leave an estimated $600 million of leeway to close gaps in fiscal 2022, according to the lawmakers backing it.

“This is a far better budget than many expected,” said Senate President Pro Tempore Greg Treat, a Republican. “We successfully avoided the catastrophic cuts some had feared.”

Stitt’s office didn’t respond on Wednesday to a request for comment on whether the governor had taken a position on the Legislature’s plan. A state Senate spokesperson said on Wednesday that to the best of their knowledge Stitt was still reviewing the plan.

The oil downturn is expected to add headwinds to Oklahoma’s economic recovery, as the nation tries to claw its way back from the downturn the virus has caused. 

An April 14 forecast from RegionTrack, an economic research firm, said the weak outlook for oil prices into next year “provides little reason to expect anything other than layoffs, production declines, and financial distress” for Oklahoma’s energy sector during 2020 and into 2021. The report predicts 8,000 to 10,000 oil and gas jobs will likely be lost over the next four quarters.

Back up in Alaska, Stedman, the Republican senator, said reducing Medicaid costs down to the federally allowable minimums may be one place the state can find additional savings. He raised doubts, however, that cuts alone will be enough to fix Alaska’s budget shortfalls.

Last year and in April, Republican Gov. Mike Dunleavy used his veto power to reject hundreds of millions of dollars of spending lawmakers included in budget legislation.

But Stedman pointed out that lawmakers effectively erased savings Dunleavy achieved with his veto pen last year, when earlier this year they had to approve a supplemental funding measure to cover uncontrollable costs like $142 million for Medicaid and $110 million for fighting wildfires.

“You don't have the ability of cutting the fat hog,” Stedman said. “That doesn't exist.”

"We're not going to be able to reduce the budget to make it balance without total elimination of departments,” he added. “You can't shut the state down, release the prisoners out of prisons, shut the courts down and shut your fish and game down and your department of highways.”

One unique aspect of the state’s finances is the Permanent Fund, a massive endowment established in the 1970s where the state deposited oil tax revenues over the years. It currently holds about $60 billion and generates sizable investment earnings.

“We're in a pickle but we've still got a pile of cash,” said Stedman.

But the Permanent Fund isn’t like any old state reserve account. Tapping into it is a sensitive matter because it funds the annual dividends that Alaska residents receive.

Legislation enacted in 2018 allows for a limited amount of the fund’s market value to be withdrawn each year from an “earnings reserve” and used to help cover state expenses. By 2020, the fund became Alaska’s top source of unrestricted general fund budget revenues.

Stedman said that while pulling more money from the Permanent Fund to deal with the current financial crunch may seem like the easiest path forward, it could shortchange future generations. He said he’d want to see a plan that would force the state to pay this cash back.

Withdrawals from the fund under the state’s existing policy totaled about $2.9 billion in fiscal year 2020 and $3.1 billion in fiscal 2021, which begins in July.

For fiscal 2021, $680 million of the budgeted withdrawals were earmarked for dividend payments and the remaining $2.4 billion for general government costs. In fiscal 2020, $896 million went to dividends, and about $2 billion to cover other costs. An additional $172 million from a different savings account also went to dividends in fiscal 2020.

The 2021 budget legislation Dunleavy signed last month provides for a $1,000 dividend. Even before the virus, the governor has pressed for higher dividend payments, including about $3,000 for each Alaskan in a budget plan he proposed in December.

Spohnholz noted that dividend payments have been lower in recent years than they once were and below levels prescribed by a formula written into state law. The state representative said a combination of politics and budget pressure has been guiding distributions.

“We really need to rewrite the dividend so that we can kind of resolve this issue,” she said. “It's a political hot potato every single year and Alaskans need some clarity.”

Guettabi, at the University of Alaska Anchorage, said he and other economists have called for potentially raising the dividend in the near term as a way to provide a financial boost to people who are out of work due to the coronavirus shutdown. 

Looking ahead, though, lawmakers have limited options with the state’s budget. 

“We have no choice but to either borrow money from the debt market, take money out of the Permanent Fund, or change programs and raise taxes. Those are about the only levers you’ve got,” Stedman said. "You’ve got to have cash to make your payroll,” he added. “It's got to come from somewhere.”