The rapid decline in oil prices since midsummer has been driven by a confluence of excess supply and geopolitical factors. While much of the investment world’s attention has been on the disruptions sinking oil prices have had on energy sector stocks, currencies, and global politics, investors in municipal bonds should also take note, as many U.S. state and local budgets depend on oil exploration and production revenues. More important, oil’s influence on inflation and economic growth—both globally and domestically—will also influence monetary policy and the level of Treasury yields, which serve as an important reference point for municipal yields.
Some oil-reliant states have prepared better than others
Investors naturally look toward the large energy-producing areas of the U.S., namely Texas, Alaska, Louisiana, and North Dakota. Oil’s current price below $60/barrel, particularly if it is prolonged, will likely have an impact on the budgets for these states and selected issuers within the states. However, a closer look is required to avoid rash decisions, as each of these states has varying underlying risks.
Alaska’s risk may seem the greatest, as 90% of the state budget is tied to oil- and gas-derived revenues. Additionally, the state originally budgeted oil prices at $105/barrel in fiscal year 2015 (period ending 6-30-15). Recently, the state has updated its forecasts to $76/barrel. While the state’s forecast is above current trading levels of crude oil, Alaska is somewhat insulated by its extremely large financial reserves, currently at levels larger than the entire state’s budgeted expenditures, as officials recognize its economic concentration in a single sector.
Texas also remembers the havoc that oil declines wreaked on its budget in the mid-1980s. In part due to its previous overreliance on oil revenues, Texas has diversified its economy over the past 25 years. The state also maintains a large rainy-day fund totaling nearly 9% of expenditures (among the highest percentage nationwide) and has used a more conservative price of $80/barrel for fiscal 2015 budgeting, reducing the prospect of a large midyear budget deficit.
Louisiana’s situation is more tenuous. Its forecast assumed $97/barrel oil for fiscal 2015, and the state maintains leaner cash reserves compared with Alaska and Texas and has a larger statewide energy sector concentration than Texas.
Lastly, my home state of North Dakota has seen a recent boom. Near term, the state used a conservative $80/barrel price for forecasting, and debt from the state remains so rare that it offers very little by way of ripple effect to the market. Even among these four energy-centric states, the fundamental story is quite different.
Beyond states, we continue to monitor how oil may carry into other sectors.