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NM facing potential $2B hit to state budget

Copyright © 2020 Albuquerque Journal

A drilling rig installs an oil and gas well south of Carlsbad in September. The world’s major oil producers have agreed to cut production. (Eddie Moore/Albuquerque Journal)

A mammoth deal by the world’s major oil producers to collectively cut global production by an unprecedented 14 million barrels a day failed to stir international markets Monday morning as the coronavirus rages on and crude prices remain frozen at near 20-year lows.

That’s bad news for New Mexico, which could be facing up to $2 billion in lost revenue in the new fiscal year that begins in July, said Sen. John Arthur Smith, D-Deming, chairman of the Legislative Finance Committee. That’s up from a previous estimate in mid-March of about $1 billion in losses.

“I think it’s in the $1.5 billion to $2 billion range now,” Smith told the Journal. “… That’s a reasonable guess, since it’s edging toward the $2 billion range.”

For every $1 drop in the price of oil, New Mexico loses on average about $22 million in revenue over a year. U.S. benchmark West Texas Intermediate started the year at about $60 a barrel, but since mid-March, it’s been stuck in the low 20s.

The longer prices remain depressed, the more state losses add up.

“Some experts in the oil and gas industry I’ve spoken with believe the hit to state revenue could reach $3 billion, depending on how long this situation lasts,” Smith said.

The problem is that the coronavirus lockdown has sliced global demand by between 25 million and 35 million barrels a day, representing a 25% to 35% plummet from the 100 million barrels a day the world consumes in normal times.

Cut ‘not nearly enough’

That drop in demand far outweighs the 14 million barrel-per-day production cuts that the Organization of Petroleum Exporting Countries, Russia and other major producing nations agreed to this weekend. And that, in turn, leaves markets awash in a tsunami of excess oil with no clear end in sight to the pandemic that has virtually ground land and air travel to a halt across the globe.

“Consumption is the big concern,” Smith told the Journal. “With demand down by 25% to 35%, the projected cuts to production are not nearly enough.”

Oil prices are unlikely to rise significantly until the pandemic subsides and oil consumption grows again. Even then, it could take many months, if not years, for the world to absorb the excess supply built up during the contagion, delaying any substantial rebound in prices for a long time, said Raoul LeBlanc, vice president for nonconventional oil and gas at international consulting firm IHS Markit.

The international agreements reached over four days of negotiations among OPEC, Russia and others countries led to a specific commitment by those nations to reduce their joint output by 9.7 million barrels a day, far more than any previous international accord to lower production. In addition, the U.S. and other nations grouped in the G-20 said low prices would force their domestic industries as well to collectively scale back output by about 4 million barrels a day.

That includes a projected 2 million-barrel drop in U.S. production by the end of the year, and possibly up to 3 million, according to IHS Markit.

Risk of industry collapse

Such joint international actions are unprecedented, reflecting collective recognition that unbridled production as the coronavirus ravages consumption would cause a massive surge in inventory that far exceeds market demand or even places to store the product, LeBlanc said. If left unchecked, that would prolong the oil crisis to well after the pandemic subsides, foreshadowing potential industry collapse.

“It’s a very impressive, historical cut, but they had to do it,” LeBlanc said. “In reality, they’ve agreed to not produce oil they couldn’t sell anyway.”

The real impact of production cutbacks could come after the pandemic is contained, if the producing nations continue to suppress output. The OPEC-plus countries agreed to reduce production by 9.7 million barrels a day for May and June. From July-December, the cutbacks would drop to 8 million a day, and in January, to 6 million.

An offshore oil platform and wells are silhouetted against the setting sun in the Gulf of Mexico off Louisiana in 2010. The major international oil deal struck over the weekend has had no apparent effect yet on oil prices. (Derick E. Hinkle/Bloomberg)

“The key is if they hold to the cuts as global inventory declines and demand rises again,” LeBlanc said. “They have to work over an extended period to manage the flow of oil into storage tanks to prevent massive overhang where they’re filling up every vessel, ship and storage tank available, which is what would have happened if they didn’t take action.”

Effect on Permian

Balancing supply and demand could take a long time, likely reflecting extended industry decline before recovery sets in. And it will be particularly painful in U.S. shale-oil basins such as the Permian in West Texas and southeastern New Mexico, LeBlanc said.

That’s because shale oil wells tend to have a huge spurt in output once drilled, followed by a rapid decline in productivity, which forces operators to keep drilling wells during boom times to grow or maintain production. With producers now cutting back most new drilling during the bust, shale oil output in Texas, New Mexico and elsewhere will plummet.

“There will be a massive downturn as U.S. shale producers fly off the back end of the production treadmill,” LeBlanc said. “The decline will be fast, but eventually it will mellow out as they stop drilling new wells. That could set them up for possible recovery in 2022-2024.”

If accurate, that would mean at least two years or more that New Mexico will face bust conditions that suppress critical state revenue.

Smith said state reserves to carry the budget through lean times will likely be depleted in the upcoming fiscal year.

“By the time we get well into the FY 2021 budget, I don’t think there will be any reserves left,” Smith said. “I hope I’m wrong, but the outlook isn’t very pleasant right now.”

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