Louisiana’s Revenue Estimating Conference was rendered obsolete and the state’s finances thrown into a tizzy yesterday when the price of oil plunged to a negative $37.63 per barrel from the (adjusted for inflation) high back in 2008 of $148.93, a swing of more than $186 per barrel. Stephen Winham, retired State Budget Director, explains what it all means in his analysis below:
By Stephen Winham
If I offered to sell you 5,000 gallons of high quality gasoline (no ethanol) at 20 cents a gallon, but you had to take all of it today, would you take it? Before you say yes, ask yourself, “Where would I put it?”
Oil is traded as a commodity on the open market. Traders buy contracts to take oil at a price guaranteed for a specific period of time. These are futures contracts and they expire on a date certain. If an oil buyer or trader cannot sell the contracts to purchase by the deadline they have to take possession of all the oil for which they contracted. Current contracts for May delivery expire today (April 21).
A contango exists when the contracted price of oil exceeds the spot (current) price. This, of course, makes the contracts valuable only if the buyer thinks oil prices will rebound enough to justify taking it at the contract price – and, equally important, if they have someplace to store it. Because there is too much oil on the market with no place to put it, we entered the uncharted territory of, not just low, but negative prices.
Oil for delivery in May was being traded at over $18 per barrel Friday (April 17) and at $15 per barrel Monday morning. These were extraordinarily low prices, but by the afternoon sellers had to pay buyers $37.63 to take their contracts for May delivery. Again, these contracts expire today (April 21). Traders holding oil futures were paying buyers to take contracts off their hands at the risk having to take physical delivery of the oil, which most are incapable of doing. The only way traders can store oil is to lease facilities which are already at a premium because most are full. It is possible there will literally be no available commercial storage space by the end of this month.
Monday’s crash, while shocking, was temporary and some say largely technical because trading on May contracts was relatively light. Most trading yesterday was on oil set for June delivery. However, the effects and implications of the oil glut are real and have serious implications for both the near and longer range future.
OPEC has already agreed to production cuts and Russia and Saudi Arabia have supposedly agreed to do so in May. The U. S. government plans to buy as much oil as possible for storage in our strategic reserves. These things should help, but prices for June delivery will settle in the low $20/barrel range. Some oil producers, already suffering, cannot survive, even in the short run, if they have to sell that low.
Although December 2020 futures contracts are currently trading in the low 30s, that’s pretty low and the rise in actual prices is currently unpredictable because we don’t know when, or how fast, the negative effects on consumption of the coronavirus will let up. Consider that oil futures traded at over $65/barrel as recently as January and it is easy to see why futures at $30 are a bleak prospect for producers.
To the limited extent we need it, we are enjoying low pump prices. Nobody knows how long they, or some oil producers, will last.
[AN ASIDE: This crash we are talking about is in West Texas Intermediate crude, the U. S. benchmark. Not all oil futures contracts are negative. Brent Crude (the European benchmark) futures contracts, though also going down, traded at over $25/barrel Monday, but storage is less an issue with Brent because it is stored in oil tankers that can travel anywhere in the world.]
Louisiana Voice 
Stephen, do you recall the old days before the REC? When a group of legislators would meet in an apartment at the Pentagon and unilaterally determine the price for a barrel of oil. Using that price to determine revenue estimates.
The comments about the REC are Tom’s, but I remember the old days all too well and the billion dollar hole created in the budget inherited by Buddy Roemer as a result of simply making projected revenues meet desired expenditures – I became budget director that year and worked in the group that put together the package to fill that hole and created a package of budget reform legislation of which the REC was the crown jewel. It is truly unfortunate that it has become politicized – a slippery slope that could take us full circle carried to its extreme. As an outsider, I have observed the REC going from its apolitical origins through liberal interpretation of its intent to, it seems to me, ignoring its critical provisions – including when the conference is supposed to meet toward what purposes.
This is tragic to Louisiana, to Texas, the Dakotas and to the thousands employed in the industry and to all support industry, and the ripple effect will be tragic. This will affect property values, sales tax collection, income tax collection as well as government budgets. I pray no one starts dumping oil in oceans or even on land.
Does anyone know enough about this to explain the implications for the state budget? The feds sent the state almost $2 billion in the CARES act, but the annual budget is more than ten times that. Are those numbers about right? As state revenue continues to dry up after a month of retail shut down and low oil prices, what will happen? Will state agencies have the cash to be able to function? Can the state draw on the rainy day fund?
They wouldn’t do that, Zoe. Then they would be subjected to millions in fines on top of their losses.
Thank you. Quite educational. One of the first things I learned about the stock market (way, way back when) was not to invest in commodities unless you know darn well what you’re doing. I took that to heart and never had to learn the lesson the hard way. Thank goodness.
Thank you Mr. Winham for this excellent explanation. And thank you Tom for turning to such an expert for this information.
Excellent post Stephen. Thank you for the explanation.
My major concern for the last few year has been Louisiana’s incredible corporate welfare. It is easy to understand with two simple facts:
1. Louisiana has 10 to 16 TIMES as much Industrial Tax Exemption Program, ITEP, tax exemptions as the regional and national averages. ITEP is approved based on the companies promising to expand their businesses. ITEP tax exemption is the same as the state giving that business the money to help them be able to expand.
2. Louisiana business growth is in the bottom 20% among US states, maybe in the bottom 10%.
The exact figures are not necessary to understand the problem. Louisiana is distributing about a BILLION dollars a year in ITEP tax exemptions and getting very little in return. That is the definition of welfare. The insanity of continuing to award huge tax deductions while getting little growth seems obvious.
The basic solution is equally obvious. In general terms, approve ITEP based on a five or ten year business plan. But each year’s ITEP tax exemption is only available if you come close to meeting your growth plans for that year.
The hard part would be to immediately terminate most of the existing ITEP exemptions. I think the state approves the exemptions for five years at a time. The state would normally never “break” its promises. But when the coronavirus economic disaster is piled on top of an existing oil glut, these are anything but normal times. Most of the companies had broken their promises to grow their businesses before these disasters started. That justifies the state action of cancelling the tax exemptions.
Most of the companies are eligible for federal assistance so they will not go out of business because of this change.
Even if the federal government saves the state budget for this year and next year, The ITEP corporate welfare MUST STOP.
The best video I have ever seen about why Louisiana stays poor is from Dec. 17, 2018 and can be seen at http://www.togetherbr.org
It is about 15 minutes, but I will assure you that this presentation is more than worth watching. You will not regret it.
Did not regret it. It’s frightening. I think JBE made some changes to the ITEP to give the locals some say so.