Changing World Oil Markets and the Texas Economy: FAQ

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Texas 2036 engaged Center for Houston’s Future to assess the potential implications for the Texas economy and its fiscal health if oil prices were to remain weak for the next 15 years through 2036. The goal was to focus attention on the state’s need to evaluate long-term revenues sources, especially for education funding, in order to prepare for the possibility of a future with declining oil prices.

1. How did CHF approach this research?

  • Develop oil price scenarios. By convening an expert industry and academic panel and reviewing substantial information about global oil demand, supply and economics, we agreed on four scenarios of future oil prices through 2036.
  • Forecast Texas oil/gas production. Leveraging the proprietary resource modeling on Texas geologic formations developed by the Bureau of Economic Geology (BEG) at the University of Texas, we projected statewide oil/gas production volumes under each scenario.
  • Estimate impacts on Texas economy and budget. Using future prices and volumes for oil and gas as inputs, we developed and used a spreadsheet model to calculate revenue collections from Texas exploration and production (E&P) activity under each scenario.
  • Calculate impacts on Texas public K-12 funding. Given the size and importance of K-12 funding as a public policy concern, we analyzed revenue collections from E&P activity to estimate contributions via various mechanisms to Texas public school expenditures under each scenario.

2. What four oil price scenarios did CHF create over the next 15 years?

  • Constant $60/bbl: Among our oil price scenarios, this is the highest, in which OPEC consistently maintains discipline among global oil producers to keep prices at the high end of the range.
  • Declining $40/bbl to $30/bbl: This is our most conservatively low-priced scenario, in which OPEC barely keep prices above or at the low end of the range and productivity improvements from technology advancements drive market-clearing prices down.
  • One Boom/Bust Cycle: In this scenario, oil prices run from the bottom of the price band in 2020 ($40/bbl) up to the top of the price band by 2028, and then back down to the bottom of the declining price band in 2036 ($30/bbl).
  • Two Boom/Bust Cycles: This is similar to the One Boom/Bust Cycle scenario, except involves two cycles between the bottom and the top of the price band over the next 15 years, reflecting a higher degree of volatility in world oil markets.

3. How does the approach and resulting oil price scenarios differ from other oil and gas industry forecasts?

CHF limited this research to oil price scenarios that some observers may consider too pessimistic. We made this deliberate choice so that Texas policymakers can begin to grapple with the potential consequences of low oil prices and reduced levels of Texas oil production.

4. How much does Texas state and local governments rely on oil and gas exploration and production activity?

Including all state and local taxes and royalties, in total, Texas E&P activities in 2019 contributed $13.5 billion to public finances. Roughly $9 billion of these taxes paid to the state or approximately 7% of the $128 billion fiscal year 2019 Texas budget is attributable to E&P activities. Severance taxes accounted for $5.6 billion, sales taxes $2.9 billion, property taxes $2.1 billion and royalties $2.1 billion.

5. What is the Texas severance or production tax and how much revenue does it produce?

The Texas severance or production tax has been in existence since 1905. With some exceptions, oil production in Texas is taxed at 4.6% of its value. Natural gas production in Texas is taxed at a rate of 7.5%. At the oil peak in 1981, severance taxes on oil and gas production accounted for a combined 28% of all taxes collected by the state, only to suffer a precipitous drop in collections during the mid-1980s. Reflecting the declining role of oil and gas E&P in the Texas economy since then, the proportional importance of the severance tax to overall state tax collections has fallen to about 5%.

6. Beyond the severance tax, what other taxes is oil and gas exploration and production activity subject to in Texas and which one may experience the most decline given the four oil price scenarios?

In Texas, oil and gas exploration and production activity is subject to several taxes, such as the well servicing tax, franchise taxes, motor vehicle sales taxes (for trucks used in exploration and production), motor fuels taxes (for operating rigs and vehicles) and the hotel occupancy tax (for exploration and production labor working away from home).

Of all other taxes that apply to Texas E&P activity, the most significant is the sales tax, which overall is the single largest source of revenue to the State of Texas. In 2019, sales taxes on Texas oil and gas exploration and production activity were estimated to represent over 7% of all Texas sales tax collections, because drilling and fracking inevitably involve substantial purchases of equipment, consumables and other goods that bear the 6.25% state sales tax (and in certain cases, local sales taxes of up to 2%). These sales tax collections are assumed to be proportional to rig count, which is not anticipated to return to 2019 levels under any of our scenarios.

7. How much property taxes do oil and gas exploration and production generate for local entities?

Property taxes on oil and gas reserves in the ground are collected by hundreds of local taxing jurisdictions: municipalities, counties and independent school districts. Property tax rates on oil and gas assets (underground resources and installed infrastructure) are around 2.3% of assessed market value. Current market value of oil and gas assets can be challenging to assess, given uncertainties about the timing of future production volumes in the face of ever-fluctuation prices for oil and gas.

Statewide, local property tax collections by independent school districts account for about 60% of the total Texas public school funding in recent years. Of the estimated $2.1 billion in property taxes collected from oil and gas interests across the state in 2019, roughly $1.5 billion was collected by independent school districts and $0.4 billion was collected by counties.

8. How does the Economic Stabilization Fund rely on oil and gas production?

The Economic Stabilization Fund – also known as the Rainy-Day Fund – was instituted as a safety net for the state in 1989, largely to avoid a recurrence of the severe economic downturn and associated fiscal challenges in Texas caused by the mid-1980’s oil price collapse. The fund relies solely on severance taxes, as the following formula shows:

After 0.5% of total annual severance tax collections are set aside for administrative costs and another $1.131 billion ($532 million per year from oil severance taxes and $599 million per year from gas severance taxes) are contributed to general revenues coffers, 37.5% of the remainder is directed to the Economic Stabilization Fund. In a typical year, in which roughly $5 billion is collected in severance taxes, the deposit into the Economic Stabilization approaches $1.5 billion.

With cumulative severance tax contributions and compounding returns since its inception over 30 years ago – net of appropriations the Texas Legislature has made in the past – the Economic Stabilization Fund has grown to a balance of $11.6 billion. Currently, the ESF is subject to a minimum requirement known as a “sufficient balance,” which was established at $7.5 billion for 2020-21, and subject to further increases as the size of the state’s budget grows.

9. In total, how much does Texas public K-12 education funding rely on oil and gas exploration and production?

In 2019, about $6 billion of Texas public K-12 school funding (20% of $32 billion annual expenditure) can be attributed to oil and gas exploration and production activity. One fourth of this amount is collected by the independent school districts through property taxes on oil and gas producing properties, with the remaining 75% collected by the state as royalties and taxes (primarily, severance taxes and sales taxes).

10. Does your report anticipate world oil demand will peak between now and 2036?

After more than 100 years of nearly uninterrupted market growth, the global outlook for oil no longer assumes ever-increasing demand. Even before COVID-19, it was becoming increasingly clear to most industry observers that oil demand likely will peak sometime in the next few decades and then gradually decline during the remainder of the 21st century. OPEC has indicated that it believes global oil demand will peak sometime after 2040. The pandemic has done nothing but accelerate the timing of this shift. For instance, Rystad Energy recently forecasted that COVID-19 advanced the point of peak oil demand to the late 2020s.