March 8, 2011 / 5:49 PM / 9 years ago

Analysis: Oil spike threatens deficit-laden states

NEW YORK (Reuters) - Rising fuel costs could further strain the budgets of deficit-laden U.S. states, cities and mass transit systems, raising the risk of more municipal spending cuts that could harm U.S. economic recovery.

A customer fills his Aston Martin DB9 car at a petrol station, in south London, March 2, 2011. REUTERS/Andrew Winning

The impact of higher fuel costs rests on what precautions municipalities have taken and whether higher energy prices put a brake on the U.S. economy.

Slower U.S. growth would pile pressure on municipal debt issuers struggling to erase budget gaps built up after the recession slammed revenues and drove up costs like unemployment benefits.

Cutbacks by U.S. states and municipalities are already expected to shave half a percentage point off U.S. gross domestic product growth.

Some local government may not have the fuel and cash reserves to ride out an oil price shock or have hedged against higher oil prices, Standard & Poor’s says.

“If higher fuel prices remain elevated for a sustained period, it will serve as another source of pressure on municipal budgets, which are already constrained in many cases,” the credit agency said.

Whether the revolt in Libya and other unrest in the Middle East and North Africa drives crude oil prices as high as the $147 a barrel record hit in July 2008 depends on how long the violence lasts and how long oil output remains depressed.

One of the main worries for states, cities and towns, which all depend on economically sensitive tax revenue, is energy price increases will puncture the anemic national recovery.

Federal Reserve Chairman Ben Bernanke has so far played down the impact of the oil spike on U.S. recovery and the consensus among economists is that it will be minimal.

Analysts are divided over how high gasoline prices have to rise to trigger a significant drop in demand.

“A significant change will have to wait until we hit a round number— $4,” said Neal Walters, a partner in A.T. Kearney’s utility and energy practice. “But I am not expecting prices to get much higher,” he said. The record was hit in July 2008 when prices hit $4.11.

The average price U.S. motorists paid has already hopped over the $3.50 barrier; gasoline cost $3.52 a gallon as of March 7, the U.S. Energy Information Administration said.

For many cities, the effect of the fuel price spike depends on whether buses and subways are an option for drivers and whether toll roads are used by commuters or long-distance traffic.

The Pennsylvania Turnpike, for example, gets about half its toll revenue from truckers. An ailing economy poses more danger to its budget than higher gasoline prices, according to spokesman Carl DeFebo.

Since the 2005 and 2008 oil spikes, some fuel buyers for railroads, police cars and the like have increasingly used hedges.

“Higher gasoline prices are really a double-edged sword, it will bring more riders to a transit system, but high fuel costs impact every transit system too,” said Virginia Miller, a spokeswoman for the Washington, D.C.-based American Public Transportation Association.

When New York gasoline prices hit $4.39 in July 2008, the number of people riding New York City’s subways rose 6.25 percent to 5.1 million riders, according to the Metropolitan Transportation Authority. In that year, the nation’s biggest subway system had its highest ridership since 1950.

But in January 2009, when gasoline prices slid to $1.85 a gallon, MTA ridership fell to just under 4.9 million people.

The MTA hedges some of its fuel costs and such hedges have become fairly widespread — and even profitable —though they typically are used mainly by bigger systems.

Tennessee’s Nashville Metropolitan Transit Authority has locked in diesel prices of $1.88 a gallon until June 2011, and $2.30 a gallon until June 2012, according to Chief Financial Officer Ed Oliphant.

Cincinnati-based Fifth Third Bancorp took the other side of the contracts, and “Other than about the first three months in 2009, they have owed us money,” Oliphant said. “From July 2009, to January 2011, the program has saved all the parties a little over $1.7 million,” Oliphant said.

Similarly, the Greater Cleveland Regional Transit Authority saved 93 cents a gallon on diesel in February with its hedges.

Another factor affecting the risk spiraling energy prices pose for governments is the accuracy of their forecasts.

The Texas Department of Transportation, for example, only expects its total fleet fuel costs in fiscal 2011 to climb by about 4 percent, to $39.5 million from $35.6 million in the previous year, according to Spokeswoman Kelli Petras.

Additional reporting by Selam Gebrekidan; Editing by Andrew Hay

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