his study investigates whether US oil-producing states can benefit from T hedging oil-production tax revenues using the crude oil futures contract at the New York Mercantile Exchange. Three strategies of coping with unanticipated declines in oil prices are analyzed and results reported. Hedges are constructed around a forecast target so that the state hedges against unanticipated price declines relative to the budget certification forecast. Specifying a forecast target means that this technique can be used in both rising and falling markets since oil prices can be less-than-expected in either case. Simulation results are reported and evidence is presented to support the conjecture that this technique will become more effective as implied volatility estimates become available from the recently created crude oil futures option market.
Unanticipated declines in the price of crude oil during the first half of 1986 have severely strained the budgets of US oil producing states. For example, the 1985 Texas State Legislature based its revenue projections for the biennium ending in 1987 on a $25 per barrel price for West Texas Intermediate (W.T.I.) grade crude oil. In early 1986 this same oil sold in the spot market for less than $11 per barrel resulting in an estimated revenue shortfall of $3.5 billion for the biennium. This shortfall brought with it severe political and economic consequences as 1986 was an election year and Texas law required "pay as you go" funding.