Wednesday,
March 18, 2020 / 01:43 PM / By Fitch Ratings /
Header Image Credit: ET Energy World
The sharp decline in oil and natural gas prices will
reduce economic output and revenues in US states, cities, counties, and
single-purpose districts with significant energy sector exposure, says Fitch
Ratings. Governments' vulnerabilities to these fiscal pressures will be
compounded by the broader economic pressures caused by the coronavirus outbreak
and related containment efforts, although the situation remains uncertain and
is evolving rapidly.
The current price decline may represent a longer-term
shift in the demand and supply landscape, causing these states and local
governments to adjust to a longer period of negative or reduced growth in the
building blocks of their revenue bases. This could lead to a change in Fitch's
assessment of the underlying economic fundamentals of these credits and in some
cases, a reassessment of these ratings.
States that have increased their financial resilience
since the 2014-2016 natural resources downturn are expected to weather the
current tumult with a limited rating impact, although those outcomes are
predicated on the continuation of sound fiscal policies, which include
provisions for an extended period of market weakness. Energy states whose
revenue systems are less reliant on natural resources development, feature more
diverse economies, or have accumulated significant reserves, such as Colorado
and Texas, are also expected to maintain greater financial stability.
A sustained drop in oil prices could negatively affect
the ratings of a handful of local government issuers with a high degree of
economic and taxpayer concentration in the energy sector. However, most local
governments in oil producing regions appear well prepared for a transitory
period of stress and have withstood temporary prior price declines of up to one
to two years with minimal ratings migration.
The effects to the energy sector will be a function of
the duration of depressed oil prices and a government's level of economic
diversity, structure of its revenue framework, spending flexibility and current
level of reserves. The nature of a local government's participation in the
industry and location in their state will also determine how vulnerable it may
be to declining prices. Communities with 'downstream' energy facilities such as
petrochemical manufacturing may benefit from lower energy prices.
Generally, Fitch believes US energy states and most
local governments have sufficient fiscal tools to address near-term economic
and financial stress linked to energy price drops. However, strained energy
markets coupled with the coronavirus pandemic creates significant uncertainty
as to the extent to which policy actions can address a longer-term shift in the
demand/supply equation, requiring state and local officials to make greater and
more fundamental budgetary adjustments than they have in past energy industry
downturns.
Following the 2014-2016 natural resources downturn,
when the price of West Texas Intermediate dropped to a low of $36.82 per barrel
(bbl) from more than $100.00/bbl, sharp declines in financial resilience or
weak budgetary responses resulted in rating downgrades for the states of
Alaska, Louisiana, Oklahoma and West Virginia. These states have rebuilt their
financial resilience since the downturn and are now rated 'AA-', 'AA-', 'AA' and 'AA', respectively, all with Stable Rating Outlooks, although Alaska's
multiple downgrades from 'AAA' reflected its inability to advance financial
policies that ensure stable financial performance.
Texas' rating of 'AAA' remained intact through this
period of stress due to its greater economic and revenue diversity and sizable
reserves. Montana also sustained its 'AA+' rating due to increased economic
diversification and conservative fiscal policies. As oil and natural gas
development has expanded in the US over the past several years, current oil and
natural gas price turmoil may cause economic harm to a broadened group of US
states.
As it did during the 2014-2016 period, Fitch is
monitoring 15-20 local governments with energy concentration in Texas,
California and Alaska that are at elevated risk for negative rating action.
Issuers consist primarily of smaller communities in production areas but also
include industry headquarter cities. Fitch ultimately took no negative rating
actions on at-risk issuers during the last energy downturn as prices recovered,
alleviating much of the economic concern. In the current environment, we expect
the combination of reduced exploration activity and coronavirus economic
pressures will be felt most acutely in the smaller, more concentrated oil-based
economies, while larger cities may experience less severe effects, given the
size and diversity of their regional economies.
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