Changing World Oil Markets and the Texas Economy

While the Texas economy has become more diversified over the last several decades, our state’s oil and gas sector continues to play an important role in the state’s economy in terms of GDP and employment. It also remains a significant contributor to the state’s budget, and more specifically, K-12 public education funding.  Over the last several years, it has become increasingly apparent that changing oil prices translate into significant impacts on our state’s economy and the state’s budget. This is because Texas’ oil production, now driven mostly by shale production, is highly sensitive to changing world oil prices, as we have seen during the pandemic.

In particular, the state’s K-12 educational funding system, which remains heavily dependent on revenues generated from the state’s exploration and production activity, is linked to global energy market trends and world oil prices. As a result, there is a growing concern that the underlying revenue sources for public education could be at risk as world energy markets transition. This study arose from a concern that trends in oil market conditions could lead to significant economic impacts on the state and, in particular, to a risk that the underfunding of the K-12 education system might endanger the public education of the future youth of Texas.

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    We reached several conclusions regarding the future of world oil markets, and the implications of potential oil market weakness to the health of the state’s economy and public finances.

    Oil Market Conditions

    • Hydraulic fracturing in shale rock formations spawned a revolution in oil production.  Texas has been the biggest beneficiary of this revolution, given the massive size of the Permian Basin’s shale resources.
    • OPEC still plays a dominant role in setting world oil prices, despite the shale revolution.  It is in OPEC’s interests to choreograph supply decisions among leading oil suppliers to keep prices in a band between $40-60/bbl.
    • Oil prices in this range can economically support continued meaningful production volumes from the Permian Basin, albeit at lower growth rates than during the last decade.  Permian shale production is likely to serve as the marginal supplier of oil in world markets for years to come.
    • Under more adverse oil market conditions – such as unanticipated large declines in global oil demand if the global economy shifts away from fossil fuels at an accelerated pace – production volumes from the Permian could decline significantly.

    The Texas economy

    • During most of the 20th century, the Texas economy was tightly coupled with the oil industry, rising and falling with state production. The Texas economy has significantly diversified since the oil market collapse of the mid-1980s, and oil booms and busts do not have as much economic impact.
    • E&P activity, however, is still a major force in the Texas economy, accounting for roughly 250,000 direct jobs and about 10% of gross state product.
    • Moreover, some degree of economic volatility due to oil market swings remains: The effects of the COVID-19 pandemic – combined with the collapse in oil prices earlier in 2020 – caused E&P employment in Texas to fall by roughly 20%.
    • Under the “low-but-plausible” oil price scenarios we analyzed, we found that the state’s macroeconomic activity stemming from the E&P sector would likely not grow significantly from 2019 levels and could decline by 25-50% by 2036.

    Texas Budget

    • 2019 E&P activity in Texas contributed an estimated $13.5 billion in revenue to public coffers.  Severance taxes accounted for $5.6 billion, sales taxes $2.9 billion, property taxes $2.1 billion and royalties $2.1 billion.
    • The Economic Stabilization Fund, known as the Rainy-Day Fund, is funded solely by severance taxes on oil and natural gas production, and was valued at about $10 billion before the COVID-19 pandemic.  Its value may decline under more pessimistic oil market scenarios, assuming continuation of current trends of appropriations from the ESF.
    • About $6 billion of Texas public K-12 school funding in 2019 (20% of roughly $30 billion total annual expenditure) can be attributed to the E&P sector.  25% of this amount is collected by ISDs via property taxes on oil and gas producing properties, with the remaining 75% collected by the state as royalties and taxes (primarily, severance taxes and state taxes).  Weak oil market conditions in the future would put significant downward pressure on these amounts.
    • The Permanent School Fund, currently valued at about $46.5 billion, is also funded solely by E&P activity, via royalties on oil and gas produced from state-owned lands. Under current disbursement trends and assuming historical investment performance continues, the PSF, because of its large size, will continue to grow even if oil and gas royalty collections were to fall to zero.
    • To better insulate Texas K-12 education from downside risks of weak oil markets, Texas policymakers may consider a variety of changes to public finance mechanisms.