Ledes from the Land of Enchantment

New Mexico faces a budget abyss if oil and gas goes bust

With peak oil and gas production lurking on the horizon, New Mexico could face up to a $36 billion accumulated budget deficit by the mid-2030s, making tax and revenue-management reforms urgent, according to a new report by PFM Group Consulting.

The Pennsylvania-based financial consultant released his latest analysis about New Mexico’s over-dependence on oil and gas revenue Monday morning, following a previous study it published in 2020 about the issue. The new report warned of a potential budget catastrophe over the next 15 years unless lawmakers take aggressive action to diversify the state’s economy and broaden the tax base.

With nearly $3.6 billion in “new money” projected for the fiscal year that starts in July, today’s revenue windfall from oil and gas provides a unique opportunity to prepare for an inevitable decline in fossil fuel production in coming years, said PFM Director Ryan McNeely.

But lawmakers need to seize the moment.

“New Mexico policymakers have been riding the oil and gas revenue roller-coaster for decades, and this year are experiencing the highest up-slope, and subsequent excess revenue, in state history,” McNeely said in a statement. “Our report is not warning of doom and gloom, but rather urging policymakers to strike while the iron is hot and to prepare for the downturn while excess state revenue and federal opportunity allows for decisive and impactful action toward revenue diversification.”

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PFM scrutinized tax and revenue data from the Legislative Finance Committee to compare LFC projections on future income with industry expectations about oil and gas production over the next 15 years. It concluded that long-term LFC calculations on revenue flow may significantly overestimate realistic assumptions, potentially creating a $26 billion to $36 billion accumulated budget deficit by the mid-2030s if current tax structure and revenue-management strategies are left unchecked, McNeely told reporters in an online presentation Monday morning.

That’s because the LFC’s long-term analysis relies heavily on currently elevated oil prices and unprecedented growth in production, rather than calculations based on historical trends of boom and bust and future headwinds facing the industry.

Today’s boom reflects “once-in-a-generation” circumstances — including the pandemic and the war in Ukraine — which have distorted global supply and demand and kept fuel prices at sustained highs. But those unique conditions will disappear as the market recovers, and when the next industry bust comes, it could mark the start of a permanent decline in oil and gas production as the world moves away from fossil fuels, McNeely said.

Predicting when that happens is difficult.

“There’s no crystal ball,” McNeely said. “But at some point, oil and gas revenue will decline permanently, and that could begin sooner than folks project with little time for the state to respond.”

If New Mexico focused solely on tax reform to make up for lost revenue, it would need to raise gross receipts income 60%, or double personal income taxes, according to PFM.

Rather, the report recommends comprehensive reforms to both broaden the tax base and better target incentives to stimulate key industries and diversify the economy.

Lawmakers are already considering many mitigation measures, such as channeling more general fund revenue into new and existing permanent accounts, including the severance tax permanent fund and the early childhood trust fund that was created in 2021, said LFC Chief Economist Ismael Torres.

“Those mechanisms can build up state reserves and turn today’s surplus money into future money,” Torres told the Journal. “Shoring up the permanent funds will help offset oil and gas revenue losses in the future.”

But getting bipartisan legislative backing could be challenging, depending on what measures are pursued. In fact, even generating a sense of “urgency” may be difficult, since some legislators reject the premise of peak oil.

Republican Rep. Larry Scott, a longtime oilman from Hobbs, said modern drilling technologies have opened up a virtually inexhaustible supply of oil and gas in southeast New Mexico that could continue to generate abundant state revenue if state and federal regulations don’t cripple the industry .

“I have nothing against diversification — it’s an admirable goal — but given the economic conditions in this state, there is simply no substitute for the petroleum business,” Scott told the Journal. “There is no diversification effort I see now or on the horizon to supplant oil and gas money coming into state coffers. It’s foolish to think it’s even possible.”

New Mexico State University economics professor emeritus Jim Peach said such disagreements have blocked economic reform in the past and may well do so again.

“I’m not optimistic that the Legislature will respond very well to this report because they’ve been told this story time and time again,” Peach told the Journal. “The idea that this oil boom will go on for a long time is just false. Many legislators know that, but it doesn’t translate into the kind of fiscal reforms we need to do.”

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