When climate risk comes home

By Evan Sparks

The southern tip of the Rocky Mountains comes to a crest at the cliffs of El Capitan in Texas. The stunning and sheer walls of the Guadalupe Mountains were once the edges of an ocean reef, but continental uplift and ice ages caused the ocean floor below and to the east of the reef to dry out.

This geological legacy has become economic destiny for this expansive part of New Mexico and Texas. In the foothills of the Guadalupe range, seepage over eons in the soft limestone reef created spectacular caves like the Carlsbad Cavern. The cavern is one of just 24 UN World Heritage Sites in the United States, and it attracts as many as 500,000 visitors per year.

As the waters receded, they left behind rich layers of marine organisms. Over time, these decaying lifeforms became compressed in layers of rock, forming the other economic reality of the region’s pre-history: oil. This reality becomes clear looking at the tall drilling rigs and gently bobbing pumpjacks across the flat, treeless, scrubby plains.

After neighboring Texas, New Mexico is the nation’s second-largest oil-producing state, pumping out nearly 460 million barrels in 2021. And while New Mexico has long been a major oil state, new drilling techniques pioneered as part of the shale revolution have led to continued investment in its oilfields. According to the American Petroleum Institute, New Mexico’s oil and natural gas industry accounts for nearly 18 percent of the state’s economy and added $18.8 billion to its GDP.

But while the whole state benefits from O&G royalties from drilling on state lands and from a range of taxes paid, most of the state’s oil production is concentrated in Eddy and Lea counties in the state’s southeastern corner. There are 96 active drilling rigs in New Mexico, all but four of them in Eddy and Lea, according to March figures from Enerlead.

“The Delaware Basin is what they call the ‘sweet spot’ of the Permian,” says Jay Jenkins, president and CEO of CNB Bank. “They’re hitting exceptional wells in the Delaware.” And Carlsbad is the epicenter.

Founded as a ranch and farm community drawing water from the Pecos River, Carlsbad has a tidy and compact downtown centered around the county courthouse. But the oil boom has sent the town of 32,000 sprawling across the plains. In fact, Jenkins estimates that the latest Census count—itself up 23 percent from 2010—missed around 20,000 transient workers and others who contribute to Eddy County’s oil economy. “You can spend four light cycles getting through that intersection,” he says, gesturing at the building traffic volume as we head south of town shortly before the afternoon rush hour.

Oil drilling rigs dot the horizon in the Chihuahuan Desert scrubland south and east of Carlsbad.

Beyond the jobs themselves, the influx of workers has brought new levels of investment to Carlsbad. Kerri Fowler, owner of Dunagan Associates Real Estate, estimates that pre-COVID there might be up to a dozen new arrivals per week with relocation packages paid for by employers—indicating in-demand skills and high wages.

“We have some very smart engineer, Ph.D.-level individuals living in this town and that’s due to oil and gas and nuclear here,” notes Chad Ingram, CEO of the Carlsbad Chamber of Commerce. “Those individuals have huge impacts in this town.” The need for high technology in the oilfields also facilitates startups to provide these services locally. And then there’s the contributions oil and gas firms make to quality of life in places like Carlsbad. “The companies that are here invest in our community,” Ingram says, noting investments in local parks, recreational facilities and cultural amenities like Christmas on the Pecos.

Questions of safety and soundness

But while the oil majors and large producers contribute heavily to Carlsbad’s economy, they don’t rely on local banks for their direct financing. Much larger financial institutions are the ones who provide credit to these players to purchase leases and line up production, notes Ken Clayton, president and CEO of Western Bank in Artesia, about 40 minutes north of Carlsbad.

In the case of Carlsbad’s CNB Bank, it does some direct oil and gas lending, but much more in the service provider lending space. Likewise, in Artesia, “Western Bank’s heavy in the [oilfield]service industry,” Clayton notes—servicing local providers of water trucks and equipment services, fencing, vehicle fleets and even security, but not the production itself. “Oil and gas has a trickle-down effect in our community that is just so important,” Ingram adds.

In fact, a small bank in an oil town may not have a single oil and gas loan on its books—but in a sense, every credit is dependent to some degree on the health of the oil market. And the health of that market depends to a significant degree on the availability of financing from large lenders. If big banks pull back, Clayton says, and if oil producers “are limited in their ability to explore in the Permian Basin or to acquire production, then we don’t have anybody to lend to.”

Thus, when the Federal Reserve says—as Governor Lael Brainard told the Senate in January—that it won’t apply climate risk supervision guidance to community banks, that may not be the answer that counts. Community banks in towns like Carlsbad may face substantial challenges depending on the future shape of climate risk supervision at larger institutions.

In an interview shortly before her resignation as FDIC chairman, Jelena McWilliams said that—depending on how it is applied—climate risk supervision could “absolutely” pose risks to community banks’ safety and soundness. “In the end you want banks that are able to survive and go around doing the business of banking, right?” she explains. “So, if people are unable to pay their bills because they lost jobs, they will not be able to meet their obligations on credit cards, mortgages, car loans, and so it is something that frankly requires a lot more analysis than I felt was done in the preparation of the FSOC report” on climate risk.

The cost of a carbon transition

Oil towns have often experienced the ups and downs of the oil market. In 2020—when, due to unprecedentedly low demand, the price of oil briefly went negative and remained depressed for much of the year—Carlsbad’s housing market ended the year with inventory up 25 percent, Fowler says. “Even if you don’t want to buy or sell real estate, you do gauge how stressed you should be based on that market,” she explains.

Beyond the cost of transition to townspeople, one little-recognized transition cost is the challenge utilities face of generating reliable power without fossil fuels. While U.S. electricity consumption has been stable around 4 trillion kWh annually since the mid-2000s, according to the Energy Information Administration, the mix of energy sources has changed dramatically. In 2005, coal accounted for about half of U.S. electricity, with natural gas providing less than 20 percent. By 2020, natural gas provided 40 percent of U.S. electricity, with coal accounting for less than a fifth. Renewables’ share had doubled but still accounted for just 20 percent.

The growth of natural gas in power generation has helped hold U.S. greenhouse gas emissions down substantially. Burning natural gas has just 58 percent of the carbon footprint of burning coal, according to the EIA, and the Environmental Protection Agency has found that in 2020—which saw a steep downturn due to COVID-19 lockdowns—U.S. greenhouse gas emissions were 22 percent lower than in 2005 after accounting for sequestration.

“The proof is in the data,” writes environmental author Michael Shellenberger. “Fossil fuels’ share of global energy production remains unchanged at 84 percent since 1980. To the extent emissions in Europe and the U.S. declined, it was largely due to the transition from coal to natural gas.”

“If there were any kind of change in policy out of D.C. to curtail us loaning money to oil and gas, it would be devastating for Carlsbad,” says CNB Bank President and CEO Jay Jenkins.

Another key cost of the transition will be a fundamental restructuring of the tax revenue the state receives—with direct effect on the infrastructure and schools that local economies rely on. According to Eddy County Commissioner Ernie Carlson, “We’re the number one producer of revenue for the state of New Mexico and we’re 25th in money received. There’s quite a disparity in that.”

Carlson says that “just the oil and gas royalties coming out of southeast New Mexico that goes to the state land trust that funds our education system is $141 million per month. That’s just oil and gas royalties from state-leased lands, which is only about 20 percent of producing lands in southeast New Mexico. That doesn’t include production tax, severance tax, gross receipts tax, income tax—just royalties.”

Then, he adds with a wry grin: “When was the last time you saw a windmill or a solar farm cut a check to the state of New Mexico for royalties?”

A fluid situation

Some have compared the situation facing oil towns to that faced by coal towns in Appalachia that have declined in recent decades—but the situation’s not quite the same. Coal was to a degree outcompeted by other fossil fuels (principally natural gas) as an energy source. And in many coal towns that faced decline, some mines were exhausted. In places like Eddy County, there are still vast volumes of proven reserves left to tap.

Debate over climate risk supervision has amped up in Washington. Questions about the role of climate change in bank policy were one factor that prevented the confirmation of Sarah Bloom Raskin, President Biden’s nominee to be vice chairwoman for supervision at the Fed. But it’s a fluid situation.

During my last night in Carlsbad, Russian troops invaded Ukraine. Crude oil and gasoline prices spiked as the Russian economy and energy sector were sanctioned. The Biden administration pivoted to prodding federal oil lease holders to pump more. It remains to be seen how the priority of ensuring stable energy supplies and prices will balance with policymakers’ desire to manage banks’ exposure to climate change risks.

In his widely read annual shareholder letter, JPMorganChase Chairman and CEO Jamie Dimon added his own perspective. “The fact is we’re long past debating whether climate change is real,” Dimon wrote. “But we need to acknowledge that the solution is not as simple as walking away from fossil fuels. We will need resources such as oil and natural gas until commercial, affordable and low-carbon alternatives can be developed to meet all of our global energy needs.”

In towns like Carlsbad—and the community banks that call them home—are making their voices heard too. “Over 100,000 people in New Mexico are directly employed by the oil and gas industry, the majority of whom are located in the southeast,” says Rep. Yvette Herrell (R-N.M.) “These men and women are the foundation of the customer base for every small business in the area, banks included. I will continue to fight against any mandate forcing local banks like CNB Bank to stop working with their valued customers in the energy industry.”

Adds Jenkins: “If there were any kind of change in policy out of D.C. to curtail us loaning money to oil and gas, it would be devastating for Carlsbad.”

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About Author

Evan Sparks is editor-in-chief of the ABA Banking Journal and senior vice president for member communications at the American Bankers Association.