What Does the Post-COVID Natural Gas Market Mean for West Virginia?

By Brian Skinner, Esq.

The COVID-19 pandemic has resulted in a large-scale shutdown of the West Virginia economy. But of course, the state is not alone in seeing its economy stifled by the pandemic. Market disruptions and business interruptions have occurred world-wide. And, it is likely that the impact of the COVID-19 will continue well after the virus is under control. This includes the long-term impact on the global oil and gas industry which is expected to see nationwide disruptions in energy consumption patterns resulting in price volatility. 

Experts believe that uncertainty about future demand will slow industry growth and that we should expect an uneven, extended recovery that depends on a gradual improvement in oil and gas demand, backed by rebuilding of global economic activity. This is especially true in the key consumption markets of China, southeast Asia, and the U.S.

In West Virginia, the oil and gas industry is a significant contributor to the state’s economy. Natural gas production in the Appalachia region has increased by 10.8 million cubic feet per day since January 2012. According to the West Virginia Department of Environmental Protection, between 2017 and 2018, natural gas production grew 17% to 1.8 trillion cubic feet (Tcf), while oil production rose nearly 60% to 12 million barrels. This has resulted in oil and gas severance tax receipts of $200.8 million in 2019, up 30% from $138.8 million in FY 2018. Property tax contributions of $123.5 million in 2019 were up 25% from $88.6 million in 2018.  Ninety percent of the severance tax goes to the state, while 75% of the remaining balance is dispersed to gas-producing counties and the other 25% is distributed to all counties and municipalities throughout the state based on population.

Prior to the pandemic, the oil and gas industry expected continued production growth that would directly benefit West Virginians by spurring job growth, boosting state revenues and helping the state achieve some of the highest economic growth in the country. But COVID-19 changed all that. 

Recovery in the natural gas market will take time. And while it is likely that the U.S. natural gas market will benefit from slower growth in oil production, the currently oversupplied global markets for liquefied natural gas will hamper growth in the U.S. natural gas exports in the medium term, and will slow the construction of new export facilities, making natural gas prices more volatile and capping an eventual recovery in prices.

What does this mean for West Virginia? 

The state is already facing multiple years of budget gaps, including projections of $170 million in FY 2022 and $158 million in FY 2023. Losses in oil and gas severance taxes will undoubtably have a significant impact on state government revenues when combined with decreases in sales, personal income, and corporate income tax revenue all related to the COVID-19 economic shutdown. 

With much fanfare, Governor Justice announced that the state ended FY 2020 with a budgetary surplus of $28 million, while ending the first month of fiscal year 2021, with a $243.9 million cash surplus, despite the effects that COVID-19 has had on the state’s economy. However, despite the Governor’s rosy assessment, it seems axiomatic that the state will need to need to find a way to make up for the projected shortfall in state tax collections resulting from COVID-19. 

It might be instructive to look back at how state legislatures reacted to the 2009 recession. Many states passed legislation that created higher tax brackets for individuals, raised the rates on excise taxes such as cigarette taxes, and suspended or eliminated certain deductions, such as net operating losses and capital losses. States also proposed new sales tax laws designed to increase revenue. Consequently, it wouldn’t be surprising to see the West Virginia legislature consider raising top rates, suspending some deductions, and enacting new base-broadening sales tax laws to try to mitigate the decrease in tax collections resulting from COVID-19.

Of course, a faster-than-expected economic recovery or the rapid roll-out of a vaccine could result in not only a quick recovery of natural gas prices, but greater than expected collections of severance and property taxes. Nevertheless, high price volatility will keep the cost of capital high for the industry and will slow any recovery in capital investment. As a result, industry experts expect that although investment activity will rebound it will remain subdued because of the higher cost of capital, and uncertainty about the pace and trajectory of growth in demand.

If natural gas prices do not quickly rebound, the legislature may have to rely on the state’s Rainy Day Fund, which is currently funded at approximately $797.4 million. Additionally, the state could rely on the only two other options available to it — raising revenue and/or cutting spending. 

The Rainy Day Fund alone may not be sufficient to prevent the pandemic from wreaking considerable economic damage on state government. Historically, states have relied on cutting the budget during recessions, but unfortunately, education and Medicaid, two large budget items, are often the target of those cuts. A state like West Virginia can ill afford cutting either. In the alternative, the legislature might consider ending or even reversing the recent trend of reducing B&O tax rates and severance taxes.  

The state is only beginning to address the challenges to the state budget resulting from COVID-19 and the ensuing recession. Challenges that are likely to continue even after the virus is defeated. If the federal government is unable to provide additional federal relief, the governor and the legislature will have difficult choices to make as they seek to balance the state’s budget in the face of rising spending demands and falling tax revenues. 

Brian Skinner is the former counsel to the West Virginia House of Delegates Committee on the Judiciary and counsel to the West Virginia Senate Minority Caucus. He has over a decade of experience as an adviser to legislators on legal and political issues related to pending legislation; providing research and legal analysis services to legislative committees; and preparing bills, resolutions, amendments, and other documents for the West Virginia Legislature.