Fiscal Doomsday: How risky is Wyoming’s energy-based budget?By Gregory Nickerson — June 4, 2013
Here’s what budget doomsday could look like for Wyoming: It starts with the price of natural gas dropping to $1 per thousand cubic feet (mcf). Then, the listing of sage grouse as an endangered species brings a widespread ban on oil production on federal lands and minerals. After that, coal mining is cut in half due to regulations to reduce carbon dioxide emissions.
At the same time, Congress enters a budget crisis, reducing federal aid to state Medicare and highway programs, while also cutting Wyoming’s share of mineral royalties from 48 percent to 10 percent.
At that point, the bottom would drop out of Wyoming’s revenue stream.
But things could still get worse. A massive drought could dry up Wyoming’s reservoirs and irrigated fields, then spark a fire season that burns millions of acres of forests and grassland. Broke and burnt, the state could take decades to recover.
Yes, some of this scenario is far-fetched. But the potential combination of such economic and political risks is very real. Last year Wyoming saw one of its worst fire seasons ever, resulting in more than $43 million in unexpected fire bills.
And this spring, just weeks after slicing $60 million from the state budget due to low natural gas prices, Wyoming lost another $53 million due to sequestered Federal Mineral Royalties — and the sequester cuts may keep coming and shrinking the state’s revenue.
The cutting exercise has been a bucket of cold water for Wyoming officials who had enjoyed year-over-year budget growth for a decade. So it’s worth asking: What are the threats to Wyoming’s revenue? Does Wyoming have the financial and political wherewithal to survive another major bust? If an economic doomsday scenario comes to pass, are we ready?
Rock bottom, 1985
We don’t have to look very far back into Wyoming’s past to see a time when the budget did hit rock-bottom, moving state leaders to search for new sources of revenue, including an income tax.
Mitch Maycock worked at a local bank in Gillette back in the mid 1980s, when the state went through its worst bust in recent memory.
“The oil business had gone bust. The coal mines were producing, but the coal prices were low, too. It was not a good time,” Maycock said. “It was pretty rock-bottom in 1985. I think everybody was hurt. If you didn’t have a job, you were probably not going to find one, and if you had one you weren’t going to get a raise, so it was just tough times.”
As the depression sank in from 1985 to 1986, it took a toll on the local population: “People were just leaving Gillette by droves. It was a bust,” said Maycock.
And that made it tough for Stockman’s Bank, where Maycock worked.
“It was not a fun time to be a banker. From 1983 to ‘88 it didn’t seem like you could make a loan and ever get it paid back, no matter how safe it looked. Anyone who bought anything prior to 1987 lost money because prices were going down.”
Stockman’s Bank failed in 1987. First Interstate Bank moved in to buy the assets and hired Maycock, who worked his way up in the company. He retired about four years ago.
It took until the mid-1990s for the state economy to start turning around. Governor Mike Sullivan held office from 1987 to 1995.
“Mike Sullivan, he ran a state that was basically broke,” Maycock said.
According to former Gov. Sullivan, that’s not an exaggeration. In 1994, “we balanced the budget because a lady who died in Jackson left a $20 million estate tax, and that kind of saved us for that budget period. That was fortuitous,” Sullivan told WyoFile.
But for most of Sullivan’s eight-year administration, the budget pressure did not relent.
“We were faced with trying to do anything we could to reduce expenditures and my concern was to do it without compromising essential programs. We started with cuts, hiring freezes,” Sullivan said. “Then we started looking for any ways to boost revenues, and we did that by looking in every corner and every coffee can we had.”
In one session, Sullivan offered two budgets: one that included both cuts and “revenue enhancements” and another “doomsday” budget that included only cuts, with no new taxes. “The doomsday budget wasn’t pretty. It was really a meat axe,” he said.
In the end, Sullivan said, the state did raise its taxes on cigarettes and beer. He also proposed increases in the state sales tax that did not pass the legislature. “We got a couple increases that helped temper the difficulties. It didn’t solve the problems,” he said.
After Sullivan left office, things didn’t get much better. Every state account had been stretched to the limit, and there were no reserves left. That led to the Tax 2000 study, which looked at ways for the state to raise more revenue.
“They were talking about bringing on an income tax to bring in revenues. Fortunately, coal-bed methane busted loose and the state’s budget problems were solved,” Maycock said.
Solved, at least for the time being. Nearly thirty years after the 1985 bust, Wyoming still has an economy and a state budget based overwhelmingly on mineral production. When turmoil comes, as it periodically does, it jolts the state budget, leading agencies scrambling to adjust spending. Despite a $1.6 billion “rainy day fund,” if the hard times last for more than a few years, there’s not a lot for the state to fall back on.
Sheridan author Samuel Western is a long-time observer of Wyoming economics, and he’s a WyoFile contributor. He says nothing has changed Wyoming’s fundamental dynamics since the 1980s.
“The [budget] bust in the 80s and 90s occurred because we had no Plan B for tax diversification, and we still have no Plan B,” he said. “What we have not done is diversify our tax base. That’s the Achilles’ heel. When energy has these fluctuations, we are such a single-driver economy that we’re still vulnerable.”
Even with recent development in other sectors like tourism and technology, Western says Wyoming hasn’t moved away from its mineral tax base, despite earnest efforts by many in the state. “Every other industry is still dwarfed by mineral revenue,” he said.
The federal government substantially owns Wyoming’s mineral base, and it controls the purse strings when it comes to doling back to the state Coal Lease Bonuses and Federal Mineral Royalties – which totaled $1.9 billion out of the $8.9 billion that Wyoming spent in 2011-2012.
On top of that, the federal government puts another $1.4 billion toward state and local government programs, with about half of that going to the Department of Health. In total, about 40 percent of the state’s expenditures are reliant on federal payments.
As national spending climbs and the federal budget tightens, it’s anyone’s guess how much federal money will continue to flow to Wyoming.
“Every projection I’ve looked at shows that traditional funding sources from the federal government are going to decline,” said Western. If it does, “It’s going to give us less flexibility to endure times when energy prices are low.”
Compared to Wyoming’s position in the 1960s and in the 1984-85 bust, Western believes we are in much better shape today. “We have a lot more flexibility, and a great part of that is because we have revenue from the Permanent Wyoming Mineral Trust Fund.”
The permanent fund (PWMTF) yields between $200 million and $400 million in General Fund income each biennium. That significantly helps even out the peaks and valleys of revenue, and in recent years it’s been the second largest source of General Fund revenue, after sales and use taxes. Only severance taxes contribute as much to the General Fund. The 1960s bust preceded the creation of the PWMTF, and in the 1985 bust the fund held roughly $589 million, yielding $67 million in income to the General Fund that year.
The PWMTF has a current balance of $6.16 billion. When added with all the state’s other savings and holding accounts, Wyoming invests about $15 billion dollars in bonds, stocks, and private equity.
Since all investments carry a degree of uncertainty, does Wyoming risk losing all that money saved since 1975?
Wyoming State Treasurer Mark Gordon says the state is well positioned with a conservative investment strategy.
“[The portfolio] is diversified across classes, strategies, and opportunities, so the idea is that not all of those will perform badly across all climates,” Gordon said.
Gordon’s Chief Investment Officer, Michael Walden-Newman, says the stock market crash of 2008 proved the effectiveness of Wyoming’s strategy.
“The portfolio was tested and came out among its peers one of the best performing portfolios in the country,” Walden-Newman said. He emphasized that the state had $200 million in realized losses in 2008 – about 6 percent — while still finishing the year with a $567 million gain. The state was able to carry forward that $200 million loss and cancel it out with gains made in 2009 and 2010.
Part of the strategy is for Wyoming to invest in sectors not related to minerals so that the PWMTF is counter-cyclical: When minerals do poorly, the fund does well, hopefully.
“The primary goal of the investment portfolio is to protect the corpus of these funds, the second goal is to provide liquidity, and the third is to receive a return comparable to the risk we are willing to take,” Gordon said.
The strategy seems to have gained some recognition around the state.
“The investments of that trust fund have done really well. They got clobbered four years ago but they came back, plus,” said Mitch Maycock, the former banker from Gillette.
Walden-Newman echoed that statement, saying the state is poised to have a banner year in investment income this year. That income will help balance out revenue losses in other areas, while providing a little more security for the future.
At the same time, the state has $1.633 billion in its Legislative Stabilization Reserve Account (the “rainy day” fund). That money is invested along with the state’s “pooled accounts,” generating interest while still being liquid in case of emergencies.
That money could be used to cover unexpected events like last year’s fires and this year’s loss of royalty revenue. Thus far, however, lawmakers have been reluctant to spend from the rainy day fund, even on a one-time basis. And they are particularly averse to using such money for ongoing expenses, since that money likely cannot be replaced unless the state sees another economic boom.
On the revenue side, Wyoming faces two major risks, both related to mineral production. The first is a decline in the volume of coal, oil, and gas produced. The second is a decline in the prices for those resources.
A decline in volume could come for several reasons.
The state could face severe federal restrictions on industrial development if sage grouse are listed as an endangered species. Further, if the U.S. Environmental Protection Agency isn’t satisfied with Wyoming’s plan to address ozone in the Upper Green River Basin, it could block the development of thousands of proposed new natural gas wells in the western portion of the state. And efforts to curb CO2 emissions nationwide or worldwide could choke the state’s coal industry — which currently contributes about $1 billion annually to state and local governments through taxes and royalties on annual production of 400 million tons.
A significant liability for Wyoming lies in the fact that about 90 percent of the state’s coal mining, and more than 60 percent of its oil and gas production, occur on federal lands, according to Bill Mai, the economic analysis administrator for the state. That means federal rule changes over production and royalties can have major consequences in Wyoming.
Production can also decline because of dynamics in the national and international energy markets. For example, a shift to natural gas and renewables sources of energy for electrical generation sapped coal’s share of the power market from 50 percent in 2005 to 37 percent by 2012. Energy analysts once believed that such a large fuel shift in the power sector would take decades, because few had imagined the U.S. would discover such a vast new supply in shale gas.
Further, Wyoming doesn’t drive these markets, but instead must react to them. The same can be said of energy policies — these policies are mostly driven by influences outside Wyoming.
A drop in energy prices could also impact the state’s budget, as it has in the recent past. In 2008, the price for Wyoming’s natural gas averaged $7 per mcf. It then crashed to below $3 per mcf in 2009. That swift change happened in less than 12 months, and it was a major hit to the state’s balance sheet, leading then Governor Dave Freudenthal to call for 10 percent cuts to the budget.
Out of the three major minerals produced in Wyoming, natural gas contributes the most to the state’s severance tax collections — about $346 million in 2012. Gas is also the largest part of the state’s assessed valuation, standing at between 25 percent and 33 percent of the state’s $25 billion in property value for 2011 – and mineral companies pay property (ad valorem) tax on that. Natural gas also contributes significantly to the roughly $900 million in Federal Mineral Royalties the state receives each year.
Whether the decline in mineral revenue comes from a drop in production, a federal rule change, a drop in prices, or a combination of factors, the result is the same for the state budget: a major challenge in shrinking revenues.
Oil, gas, and coal contribute in large ways to the state budget through multiple streams of revenue. The most important stream is Federal Mineral Royalties, which go to the School Foundation Program and the Budget Reserve Account. A significant portion of federal mineral money comes from Coal Lease Bonuses, which have helped build dozens of new schools across Wyoming in the last decade.
Energy and minerals also provides all of the state severance tax, the bulk of property (ad valorem) taxes, and a significant amount of sales and use taxes.
If the price of oil, natural gas or coal goes down, it hits multiple areas of Wyoming’s revenue stream, and in turn hits the local economy, which then hits the sales tax. “ So it’s sort of a self-fulfilling prophecy,” said Sullivan.
Education is one of the major areas that could be hard hit by decreases in federal funding. Each biennium, the General Fund pays a scant $18.9 million of the $2.443 billion needed to fund the Department of Education, school construction, and the operation of K-12 Schools. Of that $2.443 billion total, about $231 million comes from direct federal funds, and nearly $800 million comes from Federal Mineral Royalties and Coal Lease Bonuses (aka federal energy money).
Percentage-wise, the state’s General Fund is paying about .77 percent of the cost for primary education, while direct or indirect federal payments cover about 42 percent.
While it might seem that Wyoming is well-off to have so much federal mineral money to pay for its schools, that situation actually creates a major risk: if the federal money goes away, the state must bridge the gap in funding — from the General Fund, savings, or other state sources.
The most likely way for Wyoming to see a shortfall in its newly enlarged education budget would be a decline in Federal Mineral Royalty revenue. That could happen because of declines in mineral production, but it could also come at the hands of Congress.
For decades, the royalties from production of federal minerals were split 50-50 between the federal treasury and the state where the minerals were produced. But in 2008 Congress took 2 percent off the top for administrative fees, reducing the state share to 48 percent. Prior to 1976, the states’ share was only 37.5 percent.
With increasing pressure on the federal budget, Congress could change the states’ share back to 37.5 percent, or less.
If Wyoming’s share of mineral royalties went down from its current 48 percent to 37.5 percent, the $611 million in federal mineral royalties that the School Foundation Program receives each biennium could shrink by more than $100 million.
While Wyoming depends heavily on tax revenue from minerals, many say the good news is that the state has plenty of resources to last for several more generations.
Economic analyst Bill Mai Right says that right now Wyoming has at least two major natural gas plays in the works: the 4,200-wells proposed at Moneta Divide West of Casper, and the 8,950-well Continental Divide-Creston project east of Rock Springs. In all, the industry proposes drilling up to 25,000 new natural gas wells in Wyoming over the next 10-20 years.
And then there’s oil. Mitch Maycock says he’s seeing the early signs of an oil boom in Campbell County. The city of Douglas is all but surrounded by new shale oil wells.
The coal resource in the Powder River Basin is so vast that it could provide production revenue to the state for decades or even hundreds of years.
Under today economics and technology, about 11.6 billion tons are economically recoverable, according to the Wyoming State Geological Survey. Currently the state produces about 400 million tons a year.
As technology develops, state leaders say Wyoming will likely gain access to resources that are currently out of reach. Gov. Matt Mead says that in-situ gasification of coal may open up coal reserves in the Powder River Basin that could not otherwise be mined.
“In terms of the near-term and long-term, [the] resources are there, and we just need to make sure we have the technology to keep up,” Mead told Wyofile. “[The] long term future of minerals looks very good.”
At the same time, Mead says he has faith in Wyoming’s ability to handle the ups and downs of the national economy. The state has energy resources, savings, investments, and a balanced-budget fiscal policy that gave the state the highest possible credit rating during the last recession, while other states and the nation saw their credit ratings downgraded. “[If] Wyoming were a stock, it’s a pretty good stock,” Mead said.
Nothing so far, however, has changed the state’s dependence in the energy industry. “We are blessed by our resources, but those resources are going to generate a majority of the revenue for a long time, and in many ways we are spoiled by that,” Sullivan said. “I think it would be healthier if it were better balanced.”
That opinion might be in the minority, but if individual residents paid more of the tax burden, it could potentially smooth out budget fluctuations of the kind Wyoming is seeing right now. Wyoming’s rapid revenue and budget growth plateaued in 2009, forcing Wyoming leaders to figure out how to respond.
Mead’s response last year was call for 6 percent budget cuts, which were implemented in the 2013 legislative session. Mead said he plans to use prudence in planning for the 2014 budget session, which will decide spending policy for 2015-2016.
“I’m going to try to be conservative on my budget [for the next session]. We recognize we have the risk of changing rules in Washington DC and changing mineral prices,” he said.
Mead will also keep pushing for a diversion of the statutory 1 percent from the Permanent Mineral Trust Fund to the Legislative Stabilization Reserve Account — the so-called “rainy day fund.”
By law, 1.5 percent of severance taxes must go to the permanent fund, but an additional 1 percent can be diverted to savings, the General Fund, or other accounts. If 1 percent of severance taxes were diverted to the “rainy day” fund, the state would have a little more cushion to prevent mid-biennium cuts like those put in place this year.
“What we don’t want to do is just have a completely catastrophic drop in revenue where we have to close down departments, because that makes it difficult for citizens who rely on those services,” he said.
In addition, Mead has pushed for building up a rainy day account balance equal to two years of General Fund spending, about $3.2 billion or double its current size. That way the state could budget for the cash it has on hand, rather than on projections which sometimes go awry, causing major disruptions. Legislators did not take up the proposal in the 2013 session.
As a tweak to the investment policy, Mead says he’d like to put more state money into local infrastructure. He says that could help towns and counties if federal funding for local governments declines.
“Any money we have in savings — that’s invested in other [companies and other] countries. But a mile of road and a water system for a small town has inherent value that helps diversify our investment overall,” Mead said. “I will continue to press for that in the next session.”
— Check out this related WyoFile feature: “Wyoming: Where independent people rely on federal funds”
Gregory Nickerson is the government and policy reporter for WyoFile. Originally from Big Horn, he holds an MA in history from the University of Wyoming and currently lives in Laramie. Contact him at firstname.lastname@example.org.
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