Oil prices took a tumble this week, dropping to just over $30 per barrel (bbl) — generating anxiety within Texas’ oil and gas industry. Oil prices had previously, and gradually, dropped to around $40 bbl as the coronavirus situation has unfolded.
The stark drop on March 9 accelerated concerns among the oil and gas magnates.
Comptroller Hegar, in reaction to the recent financial trends, stated, “The fundamentals of the Texas economy remain strong. The agency is monitoring weakness in financial markets, including commodities and energy markets. We have been tracking revenues carefully since markets began to soften.”
But another stakeholder stands to take a hit should oil prices remain depreciated: the state government.
Texas’ Economic Stabilization Fund (ESF) — colloquially called the “Rainy Day Fund” — is a type of emergency fund in case of a proverbial “rainy day.”
The ESF was established in 1989 as a result of the economic slowdown turned-small recession in 1990. The slowdown was partially caused by depreciating oil prices. Ideally, it serves as a cushion with which the state can somewhat mitigate economic externalities during a slowdown or disaster.
The ESF is funded by a few methods. The first and most significant is it receives 37.5 percent of the state’s oil and gas tax revenue (i.e. severance tax) that exceeds the revenue level in 1987 — $599.8 million for natural gas and $531.9 million for oil.
That means for every dollar brought in above those numbers, $0.375 goes into the ESF. Another $0.375 goes into the state’s highway fund.
Historically, it has also been used for other things such as increasing school funding.
In 2019, about $1.1 billion was transferred into the ESF from oil production revenues and $312 million from natural gas revenues. That amounts to over half of the net ESF transfer.
The Comptroller’s fiscal estimates projected the average price of oil for this fiscal year at $58 bbl, and through the first seven months of severance tax collection this fiscal year it has come just shy of that projection at $56 bbl. Their projection for next year is an average of $54 bbl.
The state government originally projected $3.9 billion in oil severance tax revenue for this fiscal year (reminder that 37.5 percent of that is destined for the ESF). And to date it has collected $2.15 billion — but with current prices 40 percent below projections, the chances of the state meeting its severance tax collection estimates are getting slimmer by the day.
It is difficult to project a dollar amount that the state would lose out on if the slowdown continues since collections are based both on production levels and prices — which are each particularly volatile at the moment.
But should the oil price hold at roughly $33 bbl, the state could lose about 40 percent of its projected oil revenue for every severance tax dollar collected above those 1987 levels — compared with its $58 bbl projections.
With current year-to-date FY 2020 collection levels, a 40 percent drop in oil revenues would roughly cost the state $263 million from its ESF projections across the remaining part of this fiscal year.
But that doesn’t even account for changing production levels into the equation.
Natural gas prices, meanwhile, have dropped 13 percent since mid-December.
The legislature has nearly sole control over the ESF and has the power to appropriate money from it for relevant causes — such as this past session when the legislature appropriated ESF money for Hurricane Harvey relief.
In emergencies, however, the state’s executive branch and/or the Legislative Budget Board members can temporarily shift money to a given need.
This is pulled from the General Revenue (GR) section of the budget. Other sources of funding for the ESF include half of the unencumbered surplus within the GR at the close of a given biennium; interest derived from the ESF; and any appropriations made by the legislature or transfers made by the Comptroller.
The ESF’s cap for the 2020-2021 biennium is set at $18.8 billion. Its “sufficient balance” — the amount the state is statutorily required to maintain in the ESF — is $7.5 billion. The comptroller’s office expects the ESF balance to remain below the cap.
A severe enough, and strung out enough, slowdown could eventually risk the state’s ESF dipping below that “sufficient balance” amount — especially if the state dips into it for economic downturn mitigation efforts.
However, the Comptroller’s office states a slowdown would have a minimal impact on the severance tax-portion of the General Revenue fund compared with the sales tax’s drop off during a slowdown.
This occurs because the severance tax sees a delay in impact by the market both because of its production-basis (which is itself a market reaction) and the fact that collections are based on the previous month’s production levels and prices. For example, the severance tax collection for March is based on February oil and gas production levels. And so, this month’s downturn won’t be seen in collections until April.
Additionally, many companies have “hedged” their prices which effectively lock in what they will be paid for months at a time. That may also cause a delay in the impact on tax collections.
Whereas, sales tax is one step less removed from the market fluctuations — relying on the consumer’s immediate willingness to spend their dollar.
Also, due to the 1987 constitutional amendment directing 75 percent of severance tax revenues to the ESF and highway fund, the state is less-reliant on those severance revenues for its general spending needs — which is heavily buttressed by the sales tax.
That said, both the Comptroller’s Office and the oil and gas industry recognize things will be tighter for some time while the downward forces (i.e. Saudi-Russian oil standoff and coronavirus/reaction to it) run their course.
Tom Currah, chief revenue estimator with the Comptroller’s office, stressed that we are seeing both a supply side (coronavirus, supply-chain disruptions) and demand side (Saudi-Russian oil production war) shock at the same time.
That’s what has driven the recent drastic change in economic outlook.
Currah stipulated, however, that Texas is in “pretty good shape” to cope with an economic slowdown — not least because it has over $10 billion saved up in the ESF. Coupled with that is the fact that revenues have been slightly ahead of projections of late.
Pointing to the oil price drop and coronavirus, Hegar added, “It is too early to tell with certainty how current fluctuations will impact long-term economic performance and state revenues” being only six months into the budget cycle.
“As I have said before during significant downturns in energy prices, the Texas economy is less reliant on severance taxes to fund the day-to-day functions of state government than it has been historically.”
Hegar maintains the state will continue to monitor the situation and has available numerous economic tools with which to help stem economic difficulties.
One thing to bear in mind that Hegar stresses often: there are going to be economic pains felt unevenly across the state. Some areas will become cash-strapped while others, such as the I-35 corridor, will potentially be less affected.
We are still early into this downturn and — as the old saying goes — nothing in life is guaranteed except death and taxes. But as the world, America, and Texas cope with the catalysts, the ripple effect they trigger will impact everyone’s pocketbooks in some way, shape, or form.
Which is precisely the kind of situation the ESF was designed to address.
Brad Johnson is an Ohio native who graduated from the University of Cincinnati in 2017. He is an avid sports fan who most enjoys watching his favorite teams continue their title drought throughout his cognizant lifetime. In his free time, you may find Brad watching and quoting Monty Python productions.