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.
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.