December 23, 2018

The Permian Basin Continues to Boost New Mexico’s Tax Revenue

New Mexico is benefiting from increased tax revenue from oil and gas in the Permian Basin. A spokesman recently affirmed that the state coffers would be brimful with tax dollars despite the recent downturn in oil prices. This seems fortuitous for the new Democratic Governor-elect Michelle Lujan Grisham who campaigned on promises of upping investments in public education and subsidies that facilitate universal access to preschool. She takes over the office at the start of 2019. New Mexico’s revenue substantially outpaced expenditure in 2018 by some $1.4 billion. According to three state legislatures, around $1.1 billion surplus is a doable number for the next 12 months. Put all this together and the state financial reserves are estimated to be $2.5 billion by June 2019 – equivalent to 40 percent of annual general fund spending. Conservatively speaking, 25% is a prudent reserve holding, thus leaving around $1 billion of free cash flow for public service improvement. This is an inviting gift for the new governor to fund her stated projects within months of her entering the office. As far as allocations go, Governor Grisham's pet projects are on the top of the list. She has cited that short staffing in state agencies, services for the disabled, and early childhood education as high attention areas. Others in the legislature point out that roads and infrastructure in the southeast corner of the state require urgent repair. Also, students from low-income and minority families have been identified as a big aid target next year. A legislature will begin in January to present the case to expand resources to this underprivileged group. There is also a motion to increase teacher pay as a first step in improving preschool education. Notably, the Governor doesn’t hold back on her views that all these discretionary dollars are largely a contribution of the recent oil boom and therefore we shouldn’t get too excited. She cautions that the latest downturn in oil prices could seriously disrupt expectations of state revenues remaining buoyant in the long run. It’s quite true that New Mexico can attribute its ongoing cash flow to the Permian Basin. Energy resources accounted for approximately 80% of the state’s revenue built on severance taxes, royalties, and rent – not to mention secondary taxes on sales and business-to-business transactions. So, yes, there is a concentrated dependency on oil and gas, and alarm bells ring every time prices head down as margins and revenues look pressured. Yet despite the recent drop in oil prices, key NM legislatures haven’t altered their surplus predictions of $1 billion for 2019. Here is some compelling evidence that indicates why the Permian Basin will continue to generate large amounts of tax revenue for years to come: 
  • There has been a prolific fracking expansion in the shale fields that have resulted in 114,000 wells being established over a decade. When oil prices dipped a few years back, oil-service executives worked overtime to generate new ideas for reducing extraction and exploration costs. These ideas were converted into new technologies and now many of the Permian Basin wells remain profitable even if prices drop to as low as $30.
 
  • At the same time, many OPEC members require a much higher cost floor to meet their budgetary needs. These member states cannot continue loss leading for too long, and their likely response is to cut their energy output. OPEC’s decrease in oil production will open the door for Permian Basin drillers to pick up the slack and further increase their market share.
 
  • Now when supply drops it generally pushes prices back up again delivering the Permian its newfound increased market share very profitably. However, even if OPEC doesn’t act out as expected, the Permian with its $30 price has enough financial stamina to stay the course for as long as it takes.
 
  • Finally, there’s no reason to believe that the innovation trend has abated. This means that down the line cost of exploration may drive down further, thus keeping the Permian Basin profitable for the foreseeable future.
 In conclusion: The fortitude of the Permian Basin, today the world’s 3rd biggest energy producer behind only Saudi Arabia and Russia, should not be understated. In terms of ROI at current prices, it is arguably ranked #1 against all-comers. It looks like New Mexico has a bright future thanks to the tax benefits provided by the oil and gas industry in the Permian Basin.

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