There is an economic phenomenon that fascinates academics and sows dread among business leaders, politicians and financiers: the black swan event.
And one has just touched down in our lives.
Black swan events have three distinct characteristics. First, they are extremely rare. The term comes from the likelihood of seeing a black swan in the wild — it’s possible but highly improbable. Second, they are enormously disruptive and have widespread ramifications. A market correction is no black swan, a market’s destruction could be. Finally, the event is rationalized after the fact by reasoning that it could have been predicted. In other words, Monday morning quarterbacks apply the 20-20 vision of hindsight to prognosticate that the precipitating circumstances should have been detected, but weren’t — likely because observers were lulled into complacency by its rarity. The 2008 housing crash and the earlier dot com bubble are classic examples.
Make no mistake, the current crisis fits the (ahem) bill.
The collapse of the crude-oil and stock markets in conjunction with the nearly simultaneous onset of a global pandemic may appear like two or more black swans, but they are intertwined to the degree that they must be viewed as one event. It’s a rare intersection of exacerbating conditions.
And true to form, analysts are sure to ask in the coming weeks why we didn’t “see this coming?”
But for now, let’s drill down into that second black swan characteristic — enormous disruptive ramifications — and what it means for the fiscal condition of Wyoming.
Unfortunately, the state’s two most important sectors in terms of state revenue generation are directly impacted by these recent events. They are the vacation travel industry and the mineral sector, particularly crude oil.
To further complicate the future fiscal condition of Wyoming, the state relies heavily on returns from its investment holdings. For a number of years, these earnings have been crucial in balancing the state’s biennial budget — contributing about as much to the state coffers as the state sales tax. The interest returns, dividends and capital gains making up these investment returns are all likely to experience downturns at least in the current fiscal year.
The outlook for West Texas Intermediate crude prices took a sudden veer downward because of the near simultaneous reduction in the demand for oil accompanied by the sudden increase in supply. You don’t have to have a Ph.d. in economics to understand that tanking demand and spiking supply quickly results in a precipitous price drop.
On the supply side, rigid differences in opinion between large players in the world crude market triggered far-reaching outcomes. Briefly, OPEC, a cartel heavily controlled by Saudi Arabia, and Russia, who informally participates with OPEC, disagreed on output quotas. OPEC members wanted to further limit production to support current prices. Conversely, Russia wanted to increase production. Low-cost producers such as Saudi Arabia retaliated by promising a substantial increase in production, beginning in earnest by April 1. Those market expectations resulted in staggering drops in crude oil prices.
Couple this with the dramatic drop in world demand for oil due to COVID-19, and the result will be a worldwide surplus of oil. Recently announced plans to prop up oil prices by filling U.S strategic Petroleum reserves is only a short-run fix, according to oil analysts.
What does this mean for crude oil prices? The average price per barrel oil in the first quarter of 2020 looks to be somewhere in the $40 to $45 dollar range. Looking ahead, a very recent survey of oil industry experts arrives at a price of somewhat over $30 per barrel for the next quarter. These same experts predict a price of $37 for the full year and not much higher in 2021. However, there is so much uncertainty in today’s crude market — indeed in today’s world — that any forecast is likely to be subject to significant error.
Wyoming’s crude-oil-related revenues are subject to the same uncertainty. Budgets used a $50-per-barrel price estimate in crafting the state’s 2020 and 2021 spending plans during the recently adjourned legislative session. That seemed a conservative estimate at the time. But things change!
Given current output levels, a general approximation in Wyoming is that each dollar change in crude oil prices results in roughly a $12.5 million change in revenue, assuming production is static. While this approximation is reasonable for small changes in the price of crude oil, it is subject to error when the price movement is as large as a potential drop from $50 to $37.
When prices drop this dramatically, it invariably causes decreases in volumes brought to markets. Ignoring the likely decrease in production, the price drop alone would amount to a $162 million reduction in annual revenue to Wyoming. However, it is certain that the state’s projected annual production of 102 million barrels certainly cannot be sustained based on the new forecast price of $37 per barrel. In fact, it is now apparent that steps have already been taken by the industry to cut back production.
The travel and tourism industry is also critical to the fiscal wellbeing of Wyoming. That industry contributes an estimated $200-plus million in state and local taxes. By way of comparison, the state’s 4% sales and use tax is expected to generate $790 million in fiscal year 2020.
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The impacts of the recent events on the vacation travel industry are even more uncertain. There are a number of factors that are somewhat unique to travel and tourism. Some relate to COVID-19 and some do not. One important oddity associated with tourism volume over time is the impact of presidential elections. Past observation over many election cycles points to tourism volume decreasing in years when voters expect a close or toss-up election for president. Since the resultant reduction in travel and tourism volume due to the COVID-19 is occurring during an election year, there is no easy direct way to estimate the relative significance of these two negative factors.
International vacation travel is projected to slow substantially nationwide. Reasons vary. Some countries have imposed outright travel bans while others are expected to have lingering economic challenges that serve to limit vacation options. One very recent study indicates the impact of the virus will reduce visitations from China by 1.6 million people, with 56% of this drop occurring in 2020. In Wyoming, Chinese visitors make up a very small percentage of travelers except for areas in and near Yellowstone. Wyoming’s main source of international visitors is Europe, an area of the world COVID-19 has heavily impacted. However, only about 5% of the state’s travel volume is international travelers.
It’s still too early to accurately gauge the virus’s impact on travel. One disease pandemic that is somewhat comparable is the H1N1 Swine Flu of 2009. The swine flu pandemic resulted in more people being infected than are projected to be from COVID-19, but the mortality rate appears to be higher for COVID-19. The swine flu epidemic lasted about one year in the United States. It has not been determined how long the present pandemic will continue. In 2009, the Wyoming Travel industry volume dropped about 7.4%. Again, it is too early to make accurate comparisons of the ultimate impact of these two pandemics. Yet it is not hard to be convinced that this year’s decline in tourism could be more than 15%.
With the combined impacts of lower investment returns, the projected drop in the price of crude oil and the impending decrease in tourism volume, it is certain that the state’s near-term fiscal condition has declined substantially. The three factors considered here could easily account for a decrease in $300 million to even $450 million in revenue for each of the next two years.
Over $1.3 billion dollars was projected to remain in the state’s rainy day fund at the end of the next biennium on the day that the 2020 budget session adjourned. The economic events over the past three weeks point to the likelihood of using a sizable portion of this balance during the upcoming biennium.
But, after all, these rainy day reserves were designed with black swans in mind.
Mr Madden is spot on–unfortunately–his alarms will go unheeded by your elected ‘leaders.’
Wyoming’s problems are manifold and will remain unresolved due to a kind of cosmic mental-spiritual paralysis that permeates the state. Difficult to define but perhaps a part of the problem is geographical. The state is square shaped thus the square thinking of your ‘leaders.’ These squares are smug too–YOU pay their salaries and so they’re not suffering financially.
The ‘cowboy’ state is full of pride regarding their alleged ‘rugged western individualism’ which is of course a myth. A state that imprisons 1 of 48 residents; has the 2nd highest alcoholism and suicide rate has some serious problems. Perhaps theres a reason its the least populated state.
Is it time to shelter in place oil and gas, pending (a hoped for) market recovery? Today, Brent crude is well below $30 and has been for several days.
One might think that people would tire of an economic system that is characterized by greed and predictable, periodic, economic booms and busts. We could consider other alternatives.
The corona virus provided a useful and timely scapegoat for the current bust. which was overdue and would have happened anyway. Will we pick up the pieces, to the extent that we can, and continue to ride the roller-coaster of the current system? Will we continue to do so until our–and the world’s–finite mineral and hydrocarbon resources run completely out?
Experience and history suggest that humans rarely really learn much from past mistakes, especially when it comes to waging wars and choosing economic systems. But, oddly enough, humans truly do have the intelligence to actually learn from the past and make better choices for the future. Will we choose to do so? Or will we continue to choose greed as our god?
Dead on…If you have to bail out capitalism, then it is no longer a real market, just a socialized one.
Excellent analysis as I liked Mr. Taleb’s book when it was published. I would also take umbrage that the dotcom or the housing bubble could not have been foreseen? Both seemed obvious to me, but I was in tech at the time of that bust and I had been married to a mortgage broker before the housing bust. Both seemed to be a result of what Greenspan would coin as irrational exuberance. I will say I thought the mortgage industry seemed crazy, but I had no idea that Wall Street boys were packaging crap loans and dumping them on the investors. However, now that I am wary, I have seen similarities to those investing in oil plays.
With that said, the economy was already in poor shape as we have been borrowing large amounts of money to achieve an elusive growth rate and this borrowing binge has been exposed by this black swan. It seems in a moment of panic, the US is going to attempt to bail out capitalism again; thereby repeating the same mistake of 2008, when we bailed out business as usual and no one went to jail.
I would argue that Market and Environmental signals are telling the US and Wyoming that we cannot proceed as we have in the past and that things must change, but will we have the courage to confront the true issue in Wyoming – Sprawl. Wyoming and the world continue to require more expensive energy to justify drilling, but the consumer cannot afford to pay the price required to keep the drilling going as their real wages are declining. Our worldwide problem is the increasing costs of getting the same amount of energy needed year after year. This idea is known as the Energy Cost of Energy.
This was obvious to me in 2008 as it is now, but our response is going to be the same, attempt to blow the bubble again and then be distracted by the so called Black Swan that is really just the final straw that broke the camel’s back.
There are no black swans; it is really a function of the way government and business work in concert to drown out those that want checks on unchecked capitalism. We cannot afford to live the way we did, but I see no effort to address that truth.
I would suggest reading Dr. Tim Morgon’s analysis for further clarification.
Mike Madden does a fine job of laying out the likely truths of our fiscal future. If only legislators would do half as good a job of listening — and act accordingly.
I agree with Rep. Roscoe. Mr. Madden’s analytical skills are top flight.
Wyoming is lucky to have someone like Mike Madden that has the ability to put together the complicated elements of Wyomings economy into an understandable,essay. It is extremely valuable for currently serving Legislator’s, especially those on the Revenue Committee.
Rep. Jim Roscoe
Having worked with Mike as a county commission member while he was serving in the Wyoming Legislature, I learned just how knowledgeable and accurate he could be. It was a considerable loss when he decided to retire. He can still contribute a great deal by educating us all on the subject of revenue for state and local government.
Here I was thinking that the Revenue Committee wouldn’t need a basic education on Wyoming’s economic fundamentals and then you pop my bubble.
What Wyoming needs are bold brilliant leaders. Not sure Gordan is up to the task, or anyone making policy.
During my time in Wyoming, Mike Sullivan, 1987–1995, Jim Geringer, 1995–2003, Dave Freudenthal, 2003–2011, and Matt Mead, 2011–2019, all made lofty promises but failed to prepare Wyoming for anything different from the boom & bust energy economy. A rainy-day fund is a bet on our future failure, the bust. But it is also a bet on the recovery of the extractive industry. It is not an investment in diversity.
As for: “The travel and tourism industry is also critical to the fiscal wellbeing of Wyoming.”
Tourism is not going to pay Wyoming’s bills or pull it out of an economic downturn. Taxes need to rise if you’re betting on tourism. And not just the latest lodging tax.
Tourism is an industry with a few winners and many many losers. It demands mostly imported low-wage labor, In places like Jackson, that imported labor often displaces Wyoming residents. And the long-term costs of industrial tourism are often under calculated,
In America, we proudly export jobs and import labor, and then insist that that model is a solution to creating a dynamic economy for all. In reality, it creates all the problems we see now. Americans living paycheck to paycheck. And unable to pay for retirement, health care, higher education, and housing. Many were clearly struggling to stay afloat before the sinking weight of a pandemic began pulling them underwater. This is the future that Wyoming is planning for when it bets on tourism especially in towns outside of Teton County’s bubble of blindness.
Yellowstone and the Tetons are nearing their carrying capacity. That’s where Wyoming’s real tourism money flows into and out of. It can’t sustain its aggressive industrial tourism model and maintain its attraction to visitors while protecting the natural habitat and maintaining the future economic health of Wyoming.
If anything, the Black Swan is the industrial tourism model in Teton County: It’s enormously disruptive with widespread ramifications. And the observers are being lulled into complacency like a boiling frog. And the likelihood of seeing a pristine natural habitat for black swans or anything is diminishing with every new visitor.
Short-term thinking is what I expect from the State of Wyoming.