MuniLand Part 3 of 4 – Falling Crude Oil Prices and Muni Credit: The Loser and Neutral Credit Impacts

$60bbl of oil will likely reduce shale oil production, negatively impact AK and be neutral for CO and ND

West Texas Intermediate oil contracts closed at ~$55bbl on 12/15/2014. Soon after the oil swoon, Moody’s placed Alaska on negative credit outlook without revising the state’s AAA credit rating. We agree with Moody’s assessment of Alaska’s outlook and credit quality. Alaska’s budget and balance sheet are highly exposed to the price of crude oil. Nearly 20% of Alaska’s general fund revenue and 25% of the State’s economic output comes from oil and gas extraction activity. Accordingly, forecasting oil production and price is extremely important to the State’s fiscal condition, and boy did they get it wrong.

At the beginning of the 2015 budget process, Alaska forecasted oil at $105bbl. The forecasting error will result in a material 2015 budget imbalance, and, as we showed in last week’s note, the state faces long-term secular trends of lower oil production. But it’s not all bad news. Alaska’s Permanent Fund has $48.9B in AUM that buffers against any near term issues and supports balance sheet liquidity.

Now let’s take a look at North Dakota. From the U.S. BEA table below we see economic activity from oil and gas extraction and supporting activities has accelerated since 2007. This economic boost has resulted in the lowest unemployment rate in the in the Union at 2.8% (Oct’14). The State is definitely at risk from $60bbl of oil, but we see the impact as neutral—and here’s why. North Dakota runs a biennium budget process that builds in conservative oil and gas revenue estimates. The current average used in revenue estimates is $75 per barrel FY'14 and $80 per barrel in FY'15.

The impact of lower crude oil prices on the state’s general fund is limited due to a ceiling on oil and gas revenue of $300M annually. The remainder of the oil and gas tax revenues is used on a Pay-Go basis or saved for future uses in the Legacy Fund. In 2010, North Dakota established its Legacy Fund, which receives 30% of all revenue collected from oil and gas production and extraction taxes. The Legacy Fund cannot be tapped until 2017, so the reserves are protected. North Dakota’s finances are in excellent shape. As a point of comparison, in FY’13, North Dakota’s undesignated fund balance was $2.1B versus California’s negative $14.3B undesignated fund balance.

For our Colorado based clients, we see the fall in oil prices as credit neutral. Colorado has benefited from the rise in shale oil extraction techniques. The Green River Formation in the Piceance River Basin is now seen as a major source of shale oil reserves. This has made Colorado a wildcatter hotspot. Fortunately Colorado has a balanced economy. State real GDP comes from a combination of sources, including a large Federal Government presence at 12%, 8% from the information technology sector, 19% financial services industry and 14% from professional services.

Oil and gas and related activities are only 3.6% of real GDP. Furthermore, the State of Colorado is well managed and there is a diverse offering of highly liquid and fundamentally sound credits from which to select. Watch for next week’s note about the big winners from lower oil prices – California and, surprisingly, Texas.

Sources: SNWAM Research, U.S. BEA, U.S. EIA