When we started this series of bullets, we agreed with the Federal Reserve that the U.S. economy as a whole will benefit from lower crude oil prices. Specific to municipal credits, the winners from lower oil prices may be sales taxes, big states like California and Texas, and potentially highway user trust fund revenues. First and foremost, more cash in the consumers’ pockets will likely benefit local economies by spurring consumption. States with sales tax revenues, like California and Texas, will benefit from more consumption activity. Another potential beneficiary of lower crude oil prices are highway user trust funds, which generally apply a unit charge to each gallon of gasoline consumed.
Citigroup’s Municipal Research Team argues that highway user trust funds will benefit from lower oil prices because more people will hit the road and thus increase vehicle miles driven. At the margin this may hold true, but more energy efficient cars, baby boomers retiring and commuting less for work, adoption of alternative motor vehicle fuels such as electricity and biofuels and a preference by younger people to live in urban centers near mass transit options are contributory factors reducing the vehicle miles driven. Therefore, we see lower oil prices only as a marginal benefit to highway and road funding.
So why will California, the third largest crude oil producer, and Texas, the largest oil producer, benefit from lower oil prices? The answer may surprise some of you. Though California produces a lot of oil, other parts of its economy are more important. The majority (54% as of 2013) of California’s real GDP comes from finance activities, professional services, manufacturing and information industries. As you can see from the table below, oil and gas extraction represents less than one percent of real state GDP. Furthermore, California’s general fund is mainly supported by income, sales and corporate taxes. Oil and gas are not a material component of the California economy or government finances. Can this be true of Texas too?
The Texas state economy is very well balanced. No industry is more than 15% of the State’s real GDP (see bar chart). Yes, oil and gas account for 11% (2013) of the GDP, but this is down from 12% in 1997 and is nowhere near as important to the state’s economy as for Alaska or North Dakota. Recall from the first installment of “Falling Crude Oil and Muni Credit” that the breakeven price on Texas crude is between $50 and $60bbl. Now that crude oil has broken through this level, what are some of the secondary impacts? Well, this past week U.S. Steel announced layoffs – starting in March – for its Ohio and Texas plants. Some manufacturing jobs will likely be cut as a result of less extraction activity, but drilling down into the U.S. BEA data we see that manufacturing activity in Texas is roughly evenly split between the nondurable goods (7.8%) and the durable goods segment (7.0%). In fact, Texas manufactures more computers than metal pipes. From a state finance perspective, oil and gas royalties are only 2.5% of Texas general fund revenues. In addition, most of SNWAM’s credit exposure is wrapped by the Texas Permanent School Fund (PSF). The PSF is a permanent and perpetual fund used to insure the debt of public schools. The credit strength of the fund is significant. In cases where we do not own PSF wrapped debt, our credits are concentrated in the metropolitan areas of Texas, which are even less leveraged to oil and gas activity than the rest of the state. So even if the turmoil in the crude oil markets spills over to the Texas economy, our credit selections are insured and strong.