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Cheap oil is killing Oklahoma’s economy

WSJ Market Data Group
Where investment banks currently see the price per barrel of U.S. crude-oil futures in the next few quarters.
Fertile Ground Compost Service

OKLAHOMA CITY – As oil prices continue to slide with no recovery in sight, the Oklahoma economy has begun to contract. Oil prices have fallen to 12 year lows, and the industry is undergoing its largest downturn since the 1990’s. Meanwhile, investment bank forecasts continue to become more bearish.

According to the latest data released by the Bureau of Economic Analysis, gross domestic product in Oklahoma declined 2.4 percent in the second quarter, ranking last among U.S. states.

Prompted by depressed oil prices, these numbers were a stark reversal of the 6.5 percentage growth that occurred during the first quarter. In addition, gross receipts to the treasury were down 3 percent for fiscal year 2015, caused in large part by the significant decline in revenue collected from the oil and gas gross production tax. Collection of these taxes fell $409.56 million or 46.3 percent from the previous year.

Oil forecasts continue to decline, with investment banks slashing their previous prognostications.

The median price per barrel estimate is just over $50 for the fourth quarter of 2016. This spells disaster throughout Wall Street and poses a significant problem for the Oklahoma economy.

Even if prices rise to $50 a barrel, many shale producers are not able to break-even at such price points.

While to many, lower gas prices seem to be beneficial to the middle and lower classes, seemingly only negatively affecting the top brass of oil companies, the impact of low oil prices has a widespread effect on the Oklahoma economy that reaches across socioeconomic lines.

Declining oil prices harm more than just those employed directly in the oil sector. Oklahoma’s two largest cities, Oklahoma City and Tulsa, are both ranked in the top five nationwide in jobs tied to oil related industries.

Although elevated prices at the pump may take its toll on some, higher oil prices are beneficial for the overall health of Oklahoma’s economy. When the price of oil is high, Oklahoma experiences large gains in jobs, wages, and economic vitality. It ranges from the larger markets of Oklahoma City and Tulsa, to small towns which benefit in the restaurant, retail, and hospitality sectors.

When oil declines in value, it is inevitable that jobs will be lost within that specific sector. However, there is much collateral damage that ensues from the loss of a booming oil industry. The most recent data approximates that 25 percent of jobs within Oklahoma are linked to the oil industry.

Effects on Jobs

Earnings continue to fall for oil companies, which in recent years have seen record profits. As a result they have had to decommission approximately 60 percent of their rigs as well as drastically reduce investments in exploration and production. Due to this, 250,000 workers within the oil sector have lost employment globally, and manufacturers of drilling equipment have significantly reduced their output.

While many oil companies were able to combat the steep decline in oil prices in 2015 with hedges put in place prior to that calendar year, companies like Devon Energy, which were significantly hedged at a high price point, were not afforded that luxury this time around. Oil and gas hedging protections for exploration and production (E&P) companies have fallen to 11 percent of total production volumes, leaving several E&P companies highly susceptible to financial stress.

States with the largest amounts of rigs, North Dakota, Texas, and Oklahoma, are predicted to undergo the greatest reduction of employment within the oil sector.

In a report issued in the fall, Jason Brown, a senior economist with the Federal Reserve Bank of Kansas City, warned that job losses within the industry in Oklahoma could amount to upwards of 16,000. In addition, these concerns extended beyond the oil industry. Brown stated that, “Expenditures on constructing and operating oil and gas wells may also indirectly affect demand for other goods and services such as gravel, water, concrete, vehicles, fuel, hardware, consumables, food services and housing.”

The report from the State Treasurer has already shown this to be true. During 2015, the mining and logging sector, which includes oil and gas, suffered a reduction of 12,900 jobs in the state. In addition, manufacturing reported a loss of 7,900 jobs. In December, the Business Conditions Index persisted below “growth neutral” for the eighth consecutive month sliding from 37.5 in November down to 35.5. An index rating below 50 signals an expected economic decline in the next three to six months.

Many may point to the unemployment rate as an indication that the economy is stable. However, although the jobless rate fell minimally from August through November, this statistic is not indicative of an improving economy. Instead, according to Lynn Gray, OESC Director of Economic Research and Analysis, the decline is, “due to a declining number of continuing unemployment insurance claims as job seekers are beginning to exhaust their unemployment benefits.”

Effects on the state budget

Outside of job losses within the oil industry, the most glaring negative effects of cheap oil can be seen in the reduction of state revenues. The 3 percent decrease in revenue has caused the state to slash budgets amongst a $900 million budget shortfall.

In the most recent report, State Treasurer Ken Miller asserted that, “Gross collections show all four major revenue streams were impacted by the downturn in the energy industry.” December was a particularly abysmal month, with revenue dropping by nearly 9 percent compared to receipts collected in the same month of 2014, contributing to the worst December bottom line since 2010.

Budget cuts are hitting school districts hard with one superintendent describing the cuts as the “worst financial crisis to Oklahoma school in decades.” In total, $47 million is being cut from the state education budget, leaving superintendents across the state scrambling for solutions. The cuts will affect almost every aspect of education including professional development, buses, extracurricular activities, as well as school lunches.

The state also recently received bad news from the credit rating firm Moody’s, which revised Oklahoma’s outlook to negative in late December. The firm issued the following as part of its report: “Revenues this year have significantly underperformed what was budgeted for fiscal 2016 and are expected to remain weak in fiscal 2017. Contraction in the energy sector has led to labor market weakness in that sector as well as in the manufacturing sector.”

Real Estate Concerns

Filings for foreclosure continued to fall nationally in 2015 according to RealtyTrac's yearly report. Foreclosures were down 3 percent from 2014 and a staggering 62 percent from its height in 2010. In stark variation, Oklahoma has moved counter to this trend with foreclosures up 92 percent during the past year.

Chad Wilkerson, Branch Executive of the Kansas City Fed's Oklahoma City Branch, said in December that, “an increasingly sluggish outlook for the state’s important oil and gas industry and a recent upsurge in state unemployment claims suggest a potential for some future difficulties.”

However, for now, the Oklahoma real estate market has remained stable. Statewide home prices continued to grow in the third quarter of 2015 with prices increasing at approximately a 5 percent year-over-year rate. In addition, commercial real estate vacancies remained low through the midpoint of the past year.

Houston, a key energy city has not been so fortunate. Both commercial and residential real estate have suffered greatly, and many economists warn that continued depression of oil prices could lead Oklahoma real estate to follow suit.

Lawrence Yun, chief economist for the National Association of Realtors, said he will continue to watch home prices in both Oklahoma and Louisiana, states where real estate markets were hit hard during the 1980’s oil glut. "Fewer jobs means less home buying demand and that will naturally soften the housing markets in those job-impacted areas," said Yun.

Sentiment is mixed as to how much a continuance of cheap oil will affect the Oklahoma housing market. However, other energy dependent areas have already shown negative effects, and history has shown that depressed oil prices have caused contraction in the state’s real estate market in the past.

Oil Prices Expected to Remain Low

In late November, with oil prices hovering around $40 a barrel, the London-based firm Energy Aspects issued the following statement: "Oil market sentiment has turned back to 'max-bearish' of $20 oil is back." At that juncture, $20 oil was considered a worst case scenario.

With U.S. crude dropping below $27 on Wednesday, before a considerable rally to shift prices above $32 a barrel to close the week, that price point does not seem too far off. Firms have now shifted their worst case scenario price to $10 a barrel. Over the past year and a half, investment banks have continuously forecasted oil to be much higher than it has reached, and have had to scramble to recalibrate their predictions to match the oversupplied market.

It was only a year and a half ago that both Brent Crude and West Texas Intermediate were trading above $100 a barrel. There is no telling how long before oil will begin to approach anywhere near those prices. In addition, many financial institutions are now projecting that it will likely take until 2017 for significant price increases to occur. Before any substantial recovery ensues, production will have to be cut significantly in order to restore market balance.

The main catalyst for oversupply in the market and the significant reduction in prices has come at the hands of Saudi Arabia and other Gulf states. The Saudis control nearly 20 percent of oil reserves globally, which allows them the rare ability to substantially dictate market supply.

During the current downturn, the Kingdom has been consistently resistant to decrease supply. Their strategy is aimed towards driving out North American frackers and other high-cost producers across the globe.

They have continued to pump at high levels despite registering a record deficit of $98 billion in 2015. At the latest OPEC meeting in December, they once again rebuffed pleas to cut supply, believing they have the financial reserves to outlast other suppliers and regain dominant market share.

Other significant reasons for lower prices are the decreased demand in Chinese and other emerging markets, as well as the re-entry to the exporting market by Iran. The Chinese are the world’s second largest oil consumer and decline in their demand has heavily contributed to weakened demand globally. In addition, as growth has decreased in the emerging market economies, their demand for oil as well as other raw materials has steadily decreased.

Then there are the Iranians, who recently had sanctions lifted and are now able to produce oil for sale on the global market once again, which will only add to the current oversupply.

The economic indicators of the past as well as the forecasts of the future suggest that if cheap oil persists, the state of the Oklahoma economy will only worsen. Revenues will continue to decline, unemployment will increase, wages will fall, and the housing market will likely suffer as well.

Oil prices are unlikely to recover significantly anytime soon, and although investment banks predict a slow but steady rise throughout the year, these same firms have routinely been wrong about price recovery over the past 18 months.

Even if they are correct about their forecasts, they have stated that oil prices are unlikely to reach levels which are profitable for U.S. producers until 2017. Oklahoma has already fallen into a "mini recession." Time will tell whether the economy deteriorates further causing it to fall further into a mild or even major recession.

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Brian Woodward

Brian Woodward is a native of Oklahoma and currently resides in Norman, Oklahoma. However, he... read more

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