economic forecasting & industry report

Confidential | Copyright © 2018 IHS Markit Ltd

Economic Forecasting & Industry Report THE STATE OF NORTH DAKOTA

September 27, 2018

rtallman

Text Box

APPENDIX C

Economic Forecasting Report

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Table of Contents

I. PROJECT OVERVIEW

II. MAJOR ECONOMIC & DEMOGRAPHIC DRIVERS

a. US Macroeconomy

b. North Dakota State Economy

III. SPECIAL INDUSTRIES

a. Oil

b. Agriculture

IV. DEEP DIVE INTO THE TAX STREAMS

a. Sales and Use Tax

b. Motor Vehicle Excise Tax

c. Individual income tax

d. Corporate income tax

V. SCENARIOS

VI. DISCLOSURES


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I. Project Overview

North Dakota Legislative Assembly goals:

> The North Dakota Legislative Assembly sought the support of a professional

services firm with the capabilities to support the state’s revenue estimating and

economic forecasting efforts.

> The Legislative Assembly required that a consultant either have or develop the

economic modeling framework that can address how the economy impacts its

revenue streams.

> The end-product required of the Legislative Assembly’s consultant will be used

for updating the 2017-19 biennium revenue forecast and developing the 2019-

21 biennium revenue forecast.

> The information must be provided in context of both short- and long-term

economic behavior (out to 2021 and 2025, respectively) with forecast

expectations of the national economy as well as detailed economic forecasts

specific to North Dakota’s economy.

> All forecasted values will be provided in terms of a baseline, optimistic, and

pessimistic scenarios with probability assignments to each outcome. And

finally, in addition to their quantitative requests, the North Dakota Legislative

Assembly requires the qualitative assessment of both national and local

economic conditions and demographic trends that are driving these projections.

About IHS Markit

> IHS Markit is a leading source of information, insight and advisory services in the

pivotal areas that shape today’s business and policy landscape: economics,

financial markets, energy, chemicals, technology, logistics and transportation,

healthcare, geopolitical risk, sustainability and supply chain management.

> IHS was founded in 1959 and became a publicly traded company on the New

York Stock Exchange in 2005.

> In July 2016, IHS Inc. and Markit Ltd. merged to form IHS Markit Ltd. (NASDAQ:

INFO), a world leader in critical information, analytics and solutions for the major

industries and markets that drive economies worldwide.

> IHS Markit has more than 50,000 key business and government customers,

including 80% of the Fortune Global 500 and the world’s leading financial

institutions.

> By providing in-depth analysis and forecasts down to the local level, IHS

Economics team of over 300 of economists and analysts serve as valuable

extensions to our client organizations’ staff and provide the data and analysis

they need to make high impact business and policy decisions.

> As much as possible, IHS Markit has utilized our existing US Macroeconomic and

Regional modeling infrastructure to meet the Legislative Management's economic

forecasting requirements. This allowed IHS Markit to immediately begin the more

detailed work on behalf of the State tax revenue models and minimized the

development cost associated with building new models.


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II. Major Economic and Demographic Drivers in the

North Dakota Economy

US Macroeconomy

Fiscal stimulus is temporarily boosting US economic growth; trade wars are a

risk

> Buoyed by federal tax cuts and spending increases, real GDP is projected to

expand 2.9% in 2018 and 2.7% in 2019, pushing the unemployment rate down

to 3.4% and fueling inflation.

> In response to monetary tightening and capacity constraints, economic growth

will subside to 1.9% in 2020 and 1.6% in 2021.

> Tariffs now in place will have a slight impact on economic growth, but actions

under review—including 25% tariffs on auto imports and 10–25% tariffs on

$200 billion of Chinese goods—could be damaging.

> Consumer spending is supported by improving household finances and gains in

employment, real incomes, and home values.

> Business fixed investment will benefit from expanding global markets, an

easing of regulatory policies, and a more competitive tax environment.

> The Federal Reserve is expected to raise the federal funds rate to a high near

3.50% in 2020, overshooting its long-run equilibrium of 2.75%.

The US economic expansion will continue, pushing the unemployment rate

down to 3.4% in 2019

> The second half of this year will see robust GDP growth, solid gains in

employment, roughly 2% core consumer inflation, and rising interest rates. We

forecast 3.2% GDP growth in both the third and fourth quarters, close to the

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3.1% average rate of increase over the first half of the year. Second-half

growth in our forecast comprises robust growth of final sales to domestic

purchasers (consumption, fixed investment, and government), a large increase

in inventory investment, and large decline in net exports.

> The jump in inventory investment follows an inventory drawdown in the second

quarter, while the decline in net exports largely reflects an assumed reversal of

a second-quarter surge in exports of soybeans.

> With GDP growing above trend over the second half, payroll gains remain solid.

From August through December, we look for payroll gains to average about

220,000 per month, nearly identical to the average monthly payroll gains over

the six months ended in July (221,000 per month). Given the recent trend in

population growth, and assuming a flat participation rate, it would take payroll

gains of only 125,000 per month to hold the unemployment rate constant, so

our forecast of payroll gains continues the recent downward drift in the

unemployment rate over the balance of the year.

> Tightening labor markets, recent increases in oil and nonpetroleum import

prices, and new tariffs on some imports from China are keeping core consumer

inflation around 2% over the second half of this year. The 12-month increase in

the core personal consumption expenditure (PCE) price index was 1.9% as of

June.

Interest rates expected to rise

> With core PCE inflation running at 2%, GDP growth above potential, and labor

markets tightening, we expect the Fed to continue raising the funds rate target

range at a gradual pace, with the next tightening at the September meeting of

the FOMC. Expectations for further rate hikes are putting long-term rates on a

firming trend. The yield on 10-year Treasurys which has already risen from an

average of 2.76% in the first quarter of this year to about 2.90% currently, is

forecast to reach a 3.01% average over the fourth quarter (on its way toward

3.5% by 2020). This rising-rate environment is a challenging one for equities.

We expect a 6.8% increase in the S&P 500 price index during the third quarter

of this year to be the last sizable quarterly gain for some time.

Business fixed investment is solid in the forecast, and inventory-building is a

source of growth this year and next

> After rising 5.3% last year, business fixed investment picks up to growth of 7.1%

this year and 5.5% next year, before drifting down to 2.5% by 2021. Driving this

forecast is a pickup in growth of nonfarm business-sector output. As output growth

rises—from 1.6% two years ago to 3.6% growth this year—businesses step up

investment in plant and equipment so that capacity keeps pace with sales.

> There are other factors supporting growth of business fixed investment as well.

The recent upward trend in domestic oil prices has led to rising investment in

energy-related drilling structures. This helps to raise growth of business fixed

investment in structures from 4.6% last year to 6.7% this year and 6.6% next

year. Also supporting the investment outlook are incentives encoded in the Tax

Cut and Jobs Act, which are helping to boost growth of business fixed investment

in equipment from 6.1% last year to 7.5% this year. Investment in intellectual


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property products firms in our forecast, from growth of 4.6% last year to 6.8%

this year before slowing thereafter.

> Over 2016 and 2017, real inventory-building was soft by recent historical

standards, even as final sales were solid. This put the aggregate inventory-to-

sales (I/S) ratio on a downward trend. In the second quarter of this year,

inventories declined outright, an unusual occurrence for this expansion. We expect

inventory investment to rise rapidly over the next several quarters, to first stabilize

the I/S ratio and then move it higher.

Trade tensions between the United States and China continue to intensify

> The two countries enacted 25% tariffs on $34 billion of each other’s imports on 6

July. In early August, the United States announced 25% tariffs on the next $16

billion of Chinese imports to take effect on 23 August. This is assumed in our

forecast. After we finalized this month’s forecast, China announced it would

retaliate tit for tat.

> At this stage, the inclusion of these tariffs in our forecast has had little impact on

real GDP growth in the United States, as near-term momentum for growth remains

strong and financial conditions remain supportive despite rising trade tensions.

However, threats from the United States for further tariffs on even larger amounts

of Chinese goods with counter-threats from China continue to increase uncertainty

about demand for US exports, cost pressures, and global supply chains.

The US dollar is poised for additional strengthening in the near term

> Rising trade tensions have contributed to a sharp appreciation in the dollar over

recent months. Since early February, the nominal trade-weighted dollar has

appreciated roughly 9.5%, and nearly 8.0% since mid-April. Relative to the

Chinese yuan, the dollar has appreciated roughly 9% since early February, with

almost 7% of that occurring since mid-June, when the United States announced

the details surrounding proposed tariffs on imports from China. With robust growth

in the United States juxtaposed against slower growth in the Eurozone and other

major trading partners, the dollar is poised for additional strengthening in the near

term. In this forecast, the real dollar index rises further through 2020, before

beginning to ease. Recent fiscal stimulus from tax cuts and increased government

spending is another factor contributing to the strong dollar, which results from

higher capital flows into dollar-denominated assets as US interest rates are pushed

higher. The elevated dollar puts downward pressure on net exports in the forecast,

which after adding 1.2 percentage points to GDP growth in the second quarter of

2018, resume their downward trend in place since 2014.

The global economic expansion continues, but downside risks are increasing

> Global economic growth is expected to ease to 3.2% this year, 3.1% in 2019,

and 3.0% in 2020.

> Europe’s growth is slowing from an above-trend pace; policy risks in the UK

(Brexit), Italy, Spain, and Turkey will restrain investment.

> China’s growth will ease as the government aims to reduce excesses in

industrial capacity, debt, housing, and shadow banking.

> Asia’s other emerging markets are expected to sustain robust growth.


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> Emerging markets that depend on external finance (including Turkey,

Argentina, South Africa, and Brazil) are exposed to capital flight and currency

depreciation.

> Downside risks include trade wars, high and rising debt levels, Middle East

conflicts, stock market corrections, and monetary policy mistakes.

Bottom line for the US economy

> Boosted by tax cuts and additional federal spending, real GDP will expand 2.9%

in 2018 and 2.7% in 2019.

> Tariffs imposed to date will have only a slight adverse impact on GDP.

> Consumer spending will be supported by solid growth in employment, real

disposable incomes, and housing values.

> Business fixed investment will benefit from sustained growth in global markets,

along with an improving tax and regulatory environment.

> Wages will accelerate as the unemployment rate drops below 4.0%.

> The Fed will gradually raise the federal funds rate to a high near 3.5% in 2020,

overshooting its long-run neutral rate.

> Real GDP growth will slow to 1.9% in 2020 and 1.6% in 2021 due to labor-

supply constraints, tightening policies, and rising interest rates.

Percent change 2017 2018 2019 2020

Real GDP 2.2 2.9 2.7 1.9

Consumption 2.5 2.5 2.5 2.3

Residential investment 3.3 0.4 1.9 3.7

Business fixed investment 5.3 7.1 5.5 3.6

Federal government 0.7 3.5 4.4 0.3

State & local government -0.5 0.7 0.9 1

Exports 3 4.8 4.8 5.3

Imports 4.6 4.8 6.9 6.8

Percent change 2017 2018 2019 2020

Industrial production 1.6 3.7 2.5 1.9

Payroll employment 1.6 1.6 1.5 1

Light-vehicle sales (Million units) 17.1 17 16.8 16.6

Housing starts (Million units) 1.21 1.29 1.37 1.45

Consumer Price Index 2.1 2.6 2.3 2.4

Core CPI 1.8 2.2 2.3 2.4

Brent crude oil price (USD/barrel) 55 74 80 81

Federal funds rate (%) 1 1.8 2.8 3.4

10-year Treasury yield (%) 2.3 2.9 3.3 3.5

Real GDP and its components

Key indicators


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North Dakota State Economy

This year is a turning point for the North Dakota economy

> North Dakota is out of the energy-induced recession, but has a long way to go to

get back to its 2014 peaks. It is moving in the right direction, however, with

prospects to improve over the near term.

> The state of the US oil industry will be a dominant force behind the performance

of North Dakota’s economy over the next several years. The good news is that

the oil correction is behind us. This will be an important pivot point for North

Dakota as it moves from recession into recovery. Oil-related jobs were cut so

aggressively during the downturn that large-scale hiring will be needed as field

activity picks up.

> Employment will pick up markedly in 2018 and 2019 as the energy industry

begins to be a positive force on the state economy again and is expected to

expand at a 1.1% average annual pace from 2018 to 2023, outpacing national

average (0.6%)

> However, the rebound in Bakken activity has not been “V” shaped and is adding

an extra layer of volatility to the employment data. The Permian play in West

Texas has been attracting the greatest amount of investment post-2015

correction with the Bakken not seeing the same amount of interest.

North Dakota’s labor market has been up-and-down since early 2017

> Nevertheless, employment prospects have improved markedly from the

devastating losses in 2015 and 2016. Indeed, from late 2014 through 2016

employment fell by 38,000 jobs, or down to levels not seen since mid-2012.

> The dramatic downturn in oil exploration crippled the broader state economy

with sectors tied to the oil industry simply tanking. Those poor performing

energy-related sectors are finally trending higher again thanks to oil prices that

are well above the early 2016 lows and rig counts that have been increasing

since May 2016.

> Indeed, mining employment surged by 15% y/y during the second quarter of

2018 as activity picks back up in the Bakken. It is important to note that levels

are severely depressed (mining jobs are still at early-2012 levels), so the high

growth rates are indicative of a low base with a long way to go. The trade

sectors are also showing signs of life after being hit incredibly hard.

> Transportation and warehousing employment had a poor second quarter (down

0.3% y/y) but it had been one of the most consistently growing sectors since

early 2017. This looks to be a bump in the road as increased upstream activity

will inevitably lead to more trucking-related hiring as that sector rebounds from

double-digit declines over the second half of 2015 and all of 2016.

> The construction sector has yet to show sustained strength since the oil

downturn, but conditions are improving.

> Service sector growth has been disappointing but there have been signs of a

turnaround in the leisure/hospitality, finance, and professional/business

sectors, with all experiencing strong quarter-on-quarter growth from April to

June.


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The state of the US oil industry will be a dominant force behind the

performance of North Dakota’s economy over the next several years

> The good news is that oil prices have firmed and US oil production is ramping

up

> The Bakken, however, has not seen growth as robust as other areas, particular

the Permian in West Texas, which has been the epi-center of production growth

following the oil price downturn. With that said, rig counts in the Bakken are

on the rise, albeit slowly, with North Dakota rigs range-bound in the 50s from

July 2017 to July 2018 but well above the low of 22 in mid-2016.

> With oil prices remaining firm the state could break through the 50-rig ceiling

and climb higher in the coming quarters. Before the crash, rigs in North Dakota

peaked at 189 in late 2014, so there is a ways to go to get back to previous rig

activity.

> Production will be faster to rebound since efficiency has improved dramatically

over the past few years. Any way you slice it, the rebound in Bakken activity

has not been “V” shaped and is adding an extra layer of volatility to the

employment data. Conditions are slowly improving, which is a big plus for the

broader economy.

Labor force and demographics

> In 2016, North Dakota was the 47th-largest state by population. The state’s

total population increased by just 0.1%, to nearly 760,000. This is well below

the 2.0%-plus average seen during 2011–15 when the state was one of the

fastest growing in the nation. The mass in-migration sparked by the oil

industry was the main driver behind the outsized population growth, and there

was payback as oil field workers left the state. Population growth will pick up in

the coming years along with upstream energy activity.

> One trend that has not changed is the declining share of the state’s population

living in rural areas. North Dakota had been losing rural population steadily

since 1984, with rural residents’ share of the total population decreasing from

66% in 1975 to 56% in 2000. Most of this decline was during the 1980s farm

crisis, when both rural and metropolitan areas saw residents relocate to other

states. More recent data from the decennial census show that in 2010 this

share fell further, to 52%. Although this population decline has recently

decelerated, due largely to the influx of people to rural northwestern North

Dakota for the Bakken shale play, it is still under way because of ongoing

migration from rural areas to the state’s metropolitan areas such as Fargo and

Bismarck.

> North Dakota boasts a well-educated work force: its educational system has

the nation’s highest percentage (92%) of ninth-graders who go on to graduate

from high school; the national average is 82%. In addition, the state has a

significantly higher proportion of population possessing at least an associate’s

degree, which stood at 43% in 2016, in comparison to the national average of

40%.


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Economic structure

> North Dakota has one of the smallest concentrations of industrial jobs in the

country. In all, manufacturing firms make up just 6% of nonfarm employment,

versus the national average of 9%. Industrial activity is driven by a few

segments: agricultural and construction machinery; food products; printing and

publishing; transportation equipment; fabricated metals; and stone, clay, and

glass.

> Agriculture has a large influence on the state’s manufacturing economy,

affecting local agricultural machinery manufacturers, as well as transportation

providers. Major local manufacturers include Melroe/Ingersoll Rand, Imation,

Marvin Windows, and American Crystal Sugar.

> The most notable economic change is the recent explosion of growth in the

energy sector due to the Bakken shale. While the mining and natural resources

sector still accounts for only 5.0% of North Dakota’s total nonfarm

employment, this is up from just 1% 10 years ago. Although the Bakken shale

region has experienced quite a boom since the mid-2000s, the low-oil-price

environment that emerged in late 2014 and has continued through 2015 and

2016 has led to a dramatic decline in upstream energy activity although the

longer-term prospects remain relatively bright for the Bakken play.

> Fargo generates almost one-third of both jobs and gross state product. The

metro area serves as a center for farm-related trade, distribution, and

manufacturing, and has a large service sector that is highly concentrated in the

healthcare and other knowledge-based industries. Fargo’s low-cost structure

makes it ideal for the back-office operations of many financial services firms,

including Wells Fargo.


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III. Special Industries

Oil

North Dakota’s oil production sectors have grown significantly in their importance to the

state’s economy over the past ten years. As state legislation has been updated to better

reflect the industries’ importance and improve capture of related revenue streams in

royalties, extraction and production, oil price forecast accuracy is essential for stable

budget projections.

IHS Markit’s Energy division maintains a forecast on oil prices and production for much

of the world and updates models regularly to stay abreast of changes among operators

and within the industry. Following operator guidance (i.e., Continental, Oasis, Hess,

Whiting, and Marathon), IHS Markit expects year-over-year growth of benchmark crude

prices to persist through the end of 2018 and early 2019.

While North Dakota is out of the energy-induced recession, it still has a long way to go

to get back to its 2014 peaks.

> The energy sector is moving in a positive direction, with prospects towards

growth over the near term.

> The state of the US oil industry will be a dominant force behind the

performance of North Dakota’s economy over the next several years.

> While the oil correction is behind us, an important pivot point for North Dakota

is ahead, as the state transitions from recession into recovery.

> The oil-related jobs that were aggressively cut when oil prices fell in 2015 and

2016 are expected to transition into large-scale hiring as field activity picks up.

Employment is projected to increase markedly in 2018 and 2019 as the energy

industry begins to be a positive force on the state economy again.

> IHS Markit expects the energy industry to expand at a 1.1% average annual

pace from 2018 to 2023, outpacing national average (0.6%).


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Rig counts and mining employment

North Dakota’s oil and gas industries spur economic growth in the state due to supply

chain demands and employment-spurred consumer demands. Employment in

construction and mining jobs are set to grow at an average rate of 5.4% in 2019, while

total employment is expected to expand more slowly, at a rate of 1.1% y/y.

While we observed peaks in trends for revenue collection streams during the 2011/2012

expansion period, sales and use tax revenues were most strongly correlated with new

well counts. Increases in construction and investment spending related to the oil

industry overshadows other industry activity in North Dakota.

IHSM produces a forecast for both oil and gas production in the Bakken play, following

operator guidance on anticipated projects, expansions, and contractions. Following the

guidance of NDLM and local industry experts, and due to extreme uncertainty that

surrounds oil prices and production, we elected to provide a more conservative forecast

based on a flat monthly well completion trend of 80, in addition to IHSM’s more

optimistic well completion forecast. For reference, IHSM’s well completion forecast

ranges from 15% to 62% higher on a monthly basis over the 5-year analysis period.

“Operators set their capital budgets on an

annual basis. They will adjust to price

swings, but operator spending plans are

unlikely to change on a few dollars change in

oil price. The most important considerations

are current and projected price when

operator capital budgets are set, so 6 months

reaction time is reasonable.” --Imre Kruger,

IHS Markit-Energy


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Investment Outlook

The uptick in Bakken activity is expected to peak in 2019, over the short-term. From

late 2015 to present, the number of drill days reduced from 14 days to about 11 days.

Pad drilling is more common today, which enhances spud-spud rates for rigs as well.

Drill days have been flat at 10-12 days for the past 2 years, and we expect drill days to

remain flat. Recent efficiency gains that have reduced well costs by $50k or so won’t

affect investment behavior. Regardless of drill days, the overall drilling and completion

costs remain similar [to costs prior to efficiency gains]. However, with the most recent

efficiency gains, operators can do more with fewer rigs today compared with 2015-16.

Barrel per day production from the Bakken is expected to grow steadily through the end

of 2019, with up to a 10% y/y increase in daily production between August 2018 and

2019, peaking in winter 2019/2020, and then falling gradually through the remainder of

the biennium.

Local industry experts have highlighted risks specific to North Dakota’s oil and gas

industry, which IHSM has considered in its forecasts, among which are:

• High potential for workforce shortages • Changes to natural gas flaring regulations, which require capture/utilize rates

from 85% of natural gas produced to 88% starting in fourth quarter of 2018.

The challenges surrounding the development of gathering line infrastructure

have led to additional difficulty and cost among some operators, particularly

those drilling outside the core 4-county region, in meeting the new capture

regulations. Many operators are already complying with the 88% flaring

requirement, and most activity is expected to stay in the core area, so these

risks are limited. • Extreme weather, particularly in winter months.

IHS Markit Assumptions for Average Wells and Profitability

IHSM calculations for a second quintile well, a typical example for this region, (21-40%

performance ranking per lateral ft), with the following estimates:

> DRILLING AND COMPLETION CAPEX: $7-8MM

> WELL LIFE: 30 YEARS

> PAYBACK PERIOD: 27 MONTHS


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Agriculture

IHS Markit acknowledges the importance of the agricultural industry to the North

Dakota economy. Agriculture influences the state's manufacturing economy, most

noticeably in local agricultural machinery manufacturers but also among transportation

providers. CNH (Case New Holland) in Fargo, previously known as the Steiger Tractor

plant, is a tractor assembly plant which is an example of the interconnectedness - the

lines of equipment they build in the Fargo plant are seeing considerable strength in

2018, coming off of several down years that resulted during a weaker ag economy.

North Dakota’s agricultural mix is diverse with crops from soybeans to hay and pulse

crops all being important contributors to the Ag economy. We have provided the outlook

for some top 4 commodities for reference.

Oilseed

> North Dakota is a top producer of oilseed crops generating over one-third of

the states total agricultural receipts. Soybeans top the list of important crops in

the state bringing in over $2 billion. North Dakota’s canola crop is the country’s

primary domestic source of canola valued at $445 million in 2017. North

Dakota also ranks first in sunflower and flax seed output.

> USDA September 2018 World Supply and Demand Estimates (WASDE) report

projects a significant increase in US Soybean inventories by the conclusion of

the 2018 crop year (August 2019) due to record domestic production levels

and flat to lower trade prospects. Soybean prices are projected to decline about

10% or $1.00 per bushel compared to the prior season.


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> Despite some mixed weather reports across the Canadian Prairies, canola

production in Canada is projected to be the second-best on record, according

Agri-food Canada. Given the continued strong production outlook in Canada as

opposed to the dwindling domestic production estimates in the EU, Canadian

canola price softens in relation to the EU rapeseed price in the fourth quarter.

> In its September 2018 WASDE report, the USDA increased its global soybean

production for 2018/19 projections on increased production in the United

States.

> Drought, lowering yields, or a reduction of Chinese tariffs could provide upward

price pressure above current price projections for soybean and other oil seeds.

Soybean

Soybean crops have the highest presence in North Dakota, representing the largest

number of planted and harvested acres in North Dakota, and were valued at $2.1 billion

in production in 2017. While significant to the North Dakota agriculture industry, North

Dakota soybeans account for just 5.6% of total U.S. receipts for this commodity. Since

2013, on average, 58% of soybean demand has been through export markets.

> Despite new soybean records in 2017/18 for both the US and Brazil, drought in

Argentina reduced global annual production.

> IHS Markit expects a return closer to trend yields in Argentina in 2018/19,

while soybean area expansion in Brazil, which has become the global leader for

export, remains the driver for long term soybean production growth globally.

> China continues to be the go-to destination for soybeans as it imports 60% of

combined global soybean exports. The trade conflict with China is anticipated

to affect US soybean market.

> Current prospects for near record yield and record total production will add to

downward pressure on prices while inventories will continue to mount.

> The North Dakota soybean crop is currently expected to price in around $38

Bu/acre compared to $34 Bu/acre in 2017. North Dakota prices tend lower

given proximity to crush and export market challenges.

Wheat

Wheat crops account for nearly one-fifth of North Dakota’s agricultural cash receipts and

with a production value of $1.3 billion in 2017.

> North Dakota wheat producers are seeing exceptional yields in 2018 with

Durum production up 31% y/y and Other Spring are projected to increase

50%. Price prospects for the 2018 US wheat crop are favorable – up 10 to 20%

y/y for the new crop. As wheat is the most internationally diverse crop grown,

price strength generally last too long without event changes.

> USDA reduced global ending stocks estimates in 2018/19 crop year as rest of

world production has fallen and US production is doing well, indicative that the

current wheat crop should be very positive for ND farmers.


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> As of August 2018, the US Department of Agriculture (USDA) estimates the

price of US all wheat farm for 2018/19 at $5.1 per bushel and US Gulf wheat

price has risen to $236.2 per metric ton.

> The past 5 seasons have demonstrated that China ranks 5th as a buyer of US

wheat but that rank was heavily influenced by a one year spike in purchases;

they often drop out of the top 10. Therefore, trade policy with China will have

much less of an impact on wheat than other North Dakota crops.

Corn

Broadly, corn is the third most valuable crop in North Dakota, valued at $1.3 billion in

2017, but accounts for less than 3% of US agricultural receipts for corn.

> The US Department of Agriculture (USDA) indicated a new record yield for the

2018/19 US corn crop, and as a result corn prices continue to trade under

pressure.

> The USDA’s forecast for 2017/18 US corn price remains around $3.40 per

bushel, but new crop average price was revised lower to $3.6 per bushel. US

Gulf corn price averaged $156.3 per metric ton in July and has increased to

$164.9 per metric ton in the first three weeks of August. US weekly export

reports have been supportive to corn.

> USDA reduced global ending stocks estimates for 2017 and 2018/19 crop years

as rest of world production has fallen and US production is doing well.

> US and foreign feed grain stocks are expected to decline in both the 2017 and

2018 seasons – if realized this will be supportive of prices.

> Price prospects for the coming corn marking year (2018/19) call for about a

5% increase to about $3.60/bushel.

> North Dakota corn yields are estimated at 148 bu/acre up 10 bu from last year.

> Since 2013, 75% of demand for US corn comes from feed and ethanol

production, on average, with just 15% of US Corn production exported.

> While trade is important to all agricultural commodities, much of the US corn

crop is used at home for feed, ethanol and food.

> China does not typically purchase much, if any, corn on the international

market and, in some years, represents export competition.

Overall, net farm income is forecast to grow steadily in North Dakota from $0.2 billion in

2018 to $0.7 billion in 2019, but remain under pressure, nationally, on a net basis. The

USDA updated its historic farm income and wealth statistics for the 2017 calendar year

in September. Net farm income was revised higher from $63.8 to $75.5 billion and now

points to a much less overall bearish situation for US producers in 2017 and alludes to a

possibly better cash reserve position on average. Steady growth in farm income is

forecast to continue through the biennium, with high growth rates that outpace personal

income growth in the state. However, given uncertainty in trade and weather, forecast

change could be significant.


| 18

Personal and Proprietor's Income Outlook, North Dakota

($ Billions) 2014 2017 2018 2019 2020 2021

Proprietor's Income 4.9 4.1 4.2 5.0 5.6 5.8

Farm Proprietor 0.8 0.2 0.2 0.7 1.1 1.2

Business Proprietor 4.1 3.9 4.0 4.3 4.5 4.6

Real Personal Income 43.1 39.6 39.8 41.6 43.1 44.2

Pct. Ch. Ann. Rate 5.3 -2.0 0.7 4.5 3.6 2.5

Source: IHS Markit Short Term Outlook for North Dakota; June 2018 Forecast


| 19

IV. Deep Dive into the Tax Streams

To forecast the tax revenues for North Dakota, IHS has developed custom econometric

models for major sources of state tax revenue.

> The forecasted amounts are based on quarterly data with quarterly economic

drivers associated with the underlying economic activity. The economic drivers

were carefully selected after reviewing historical data and comparing economic

data to the tax collections.

> Quarterly forecast are aggregated into fiscal year totals and biennial totals.

> This is the first “run” of the models and the output from the models will continue

to be reviewed, and if needed, adjusted to make the forecasts as accurate as

possible.

> The forecast amounts will be updated in January and March to reflect the most

current information available for the economic outlook.

We are aware that the IHS Markit September 2018 forecasts for all major tax streams

are more optimistic than the 2017 legislative revenue forecasts (which had been

prepared at the close of the 2017 legislative session).

September 2018 Preliminary Forecasts

Revenue Source

2017-19 Biennium Forecast (Original)

2017-19 Biennium Forecast

2019-21 Biennium Forecast

Sales and use tax 1,701,747,285 1,703,892,406 1,805,141,200

-0.8% 5.9%

Motor vehicle excise tax 220,003,000 236,073,727 257,573,740

6.4% 9.1%

Individual income tax 698,728,000 747,698,159 802,602,207

12.2% 7.3%

Corporate income tax 102,088,415 186,241,185 194,056,153

11.7% 4.2%

Note: The percentages in the table reflect the change from the prior biennium

The specific market drivers and concept behind each of the forecasted tax steams are

provided in detail below.


| 20

Sales and use tax

> The primary market drivers behind the sales are use tax revenue forecast are:

(1) Bakken new well completions and (2) personal consumption expenditures

> There is a close (97%) historical correlation between sales and use tax revenue

in North Dakota and new well completions in the Bakken. (Please note that IHSM

provides well completion forecast for Bakken instead of North Dakota.)

> The estimated relationship between sales and new well completion is roughly

consistent with $250k per well.

> Due to labor force constraints and pipeline bottleneck, our forecast for new well

completions in the Bakken is flat at around 80 new completions per month.

0

50

100

150

200

250

300

350

400

0

100

200

300

400

500

600

700

Bakken well completion (left-axis)

Bakken well completion vs. Sales and use tax

Source: IHS Markit © 2018 IHS Markit

0

100

200

300

400

500

600

700

Bakken well completion

Bakken well completion forecast

Bakken well completion forecast (quarterly)



| 21

> In addition to new well completions, the model captures the effect of tax

revenue coming into the state due to other taxable purchases using personal

consumption expenditures (PCE) in the state of North Dakota. PCE measures

the dollar value of all goods and services purchased by consumers.

> Fueled by strong income growth, personal consumption expenditures in North

Dakota is expected to grow 4-5% year-over-year for the next couple of years.

Our model estimates that with PCE growing that strongly over the next couple of

years, sales and use tax revenue will grow by at least half of that amount.

> On online sales, IHSM calculates that Wayfair ruling will bring a one-time 2.5%

tax increase starting from 2018Q4.

> As a result, IHSM forecast a 5.5% growth in sales and use tax in FY 2019,

followed by 2% in FY 2020 and FY 2021.

-2%

0%

2%

4%

6%

8%

10%

12%

14%

personal consumption expenditure in North Dakota (YoY%)

personal consumption expenditure in North Dakota (YoY%) forecast

Personal consumption expenditure in North Dakota (YoY growth)


-

200

400

600

800

1,000

1,200

1,400

Sales and use tax Sales and use tax forecast

Sales and tax use forecast


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Motor vehicle excise tax

> The main drivers of motor vehicle excise tax are (1) new passenger and light

truck registrations for the state and (2) employment in oil related industry.

> New car registrations in North Dakota have declined from the 2014 peak and

while the normalization in number of registrations will continue through 2025

(see graph below), the value/price increase of new vehicles will continue to

improve in the forecast.

> ND has a significant proportion of workforce in the oil industry, therefore,

changes in the natural resource sector employment account for added impacts

of oil industry on the tax base. IHSM expects the hiring from this industry to

steadily increase through 2021 and stablize at around 50 thousand jobs after

that.

20

25

30

35

40

45

50

new car registrations in ND (thous)

new car registrations in ND (thous) forecast

New car registrations in ND (thous) forecast


0

10

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30

40

50

60

70

80

employment in oil related industry (thous)

employment in oil related industry (thous) forecast

Employment in oil related industry (thous) forecast



| 23

> Strengthening oil industry employment offsets declining new car registrations.

Overall, IHSM expects motor vehicle tax to grow 6.5% in FY 2019, 4% in FY

2020 and 2.7% in FY 2021.

-

20

40

60

80

100

120

140

160

Motor vehicle excise tax Motor vehicle excise tax forecast

Motor vehicle excise tax forecast


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| 24

Individual income tax

> To model and forecast individual income tax revenues, IHSM built separate

models for individual income tax submitted as withholdings versus as estimated

payments.

> Our model for individual income tax submitted as withholdings has a single

driver: (1) total wage income in North Dakota. As income withholding is

relatively stable and largely driven by total wage income in the state, the

elasticity of income withholding with respect to total income is approximately

one. This means that one percent growth of wage income will translate to one

percent of withholding. As a result, IHSM expects individual income submitted as

withholding to growth around 5% during the forecast horizon, driven by 5%

growth in total wage income.

-15%

-10%

-5%

0%

5%

10%

15%

20%

25%

wage income in North Dakota (YoY%)

Total wage income in North Dakota (YoY growth) forecast


- 50

100 150 200 250 300 350 400 450 500

Individual income tax: submitted as withholdings

Individual income tax: submitted as withholdings forecast

Individual income tax: submitted as withholdings forecast


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| 25

> The tax base of individual income tax submitted as estimated payments, on the

other hand, is more volatile due to the nature of capital gains realization. That

being said, a reasonable amount of variations in the tax base of individual

income estimated payments is captured by changes in the (1) state's property

income, i.e., personal rental income, personal dividend income, and personal

interest income. State property income is the single driver for individual income

tax submitted as estimated payments.

> IHSM forecast a 4-5% growth in property income during the forecast horizon,

and this leads to a 17% growth in estimated payments in FY 2018 (mostly a

result of strong year-to-date momentum), followed by 3% growth in FY 2019

and FY 2020, 1% in FY 2021 and after.

-10%

-5%

0%

5%

10%

15%

20%

25%

30%

property income in North Dakota (YoY%)

Property income in North Dakota (YoY growth) forecast


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100

150

200

250

Individual income tax: submitted as estimated payments

Individual income tax: submitted as estimated payments forecast

Individual income tax: submitted as estimated payments forecast


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> IHSM also made adjustments for Federal Tax Cuts and Jobs Act (TCJA). IHSM

expects that TCJA to have positive impacts on individual income tax in both

2017-19 Biennium and 2019-21 Biennium.

> Combined, IHSM expects individual income tax to grow at 5% in FY 2019,

followed by 3% in FY 2020 and FY 2021.

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100

200

300

400

500

600

700

Individual income tax Individual income tax forecast

Individual income tax forecast


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| 27

Corporate income tax

> The tax base of corporate income tax is affected by several factors including

corporate profits and apportionment rule. To untangle the compounding impacts

of changing apportionment rule on tax collection, IHSM selected (1) national

before-tax corporate profits with inventory valuation adjustment and (2) capital

consumption adjustment as the main drivers of corporate income tax collection.

(3) Crude oil price is another driver as it affects oil company's profits.

> IHSM expects that the current strong momentum of corporate profits will

continue through 2019 and then gradually normalize to 3%. WTI crude price will

increase from current level to $77 per barrel and stablize around that level.

IHSM corporate tax forecast also make adjustments for the elective single-sales

factor income apportionment method and the federal tax reform.

-15%

-10%

-5%

0%

5%

10%

15%

20%

25%

30%

corporate profits (YoY%)

Corporate profits (YoY growth) forecast



| 28

> Both apportionment method and TCJA have negative impacts on corporate tax

collection. As a result, IHSM forecast 2% growth in FY 2019 and FY 2020,

followed by 3% in FY 2021.

0

20

40

60

80

100

120

WTI crude price ($/barrel)

WTI crude price ($/barrel) forecast

WTI crude price ($/barrel) forecast


-

50

100

150

200

250

300

Corporate income tax Corporate income tax forecast

Corporate income tax forecast


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| 29

V. Scenarios

Given the significant fiscal impacts of oil price variations in North Dakota, IHSM

customizes high/low scenarios with crude oil price $10 above/below baseline, which we

assign as equal probability of occurance at 25% probability each. IHSM then simulates

the model to create forecast for major revenue streams.

Revenue Source

2017-19 Biennium Baseline

(50% probability)

2017-19 Biennium Optimistic

(25% probability)

2017-19 Biennium

Pessimistic (25% probability)

Sales and use tax 1,703,892,406 1,855,320,306 1,608,006,506

-0.8% 8.0% -6.4%


236,073,727 237,377,757 223,923,747

6.4% 7.0% 1.0%


747,698,159 750,061,545 737,823,157

12.2% 12.5% 10.7%


186,241,185 198,743,202 173,684,417

11.7% 19.1% 4.1%

Revenue Source

2019-21 Biennium Baseline

(50% probability)

2019-21 Biennium Optimistic

(25% probability)

2019-21 Biennium

Pessimistic (25% probability)

Sales and use tax 1,805,141,200 1,952,280,500 1,529,393,900

5.9% 5.2% -4.9%


257,573,740 265,103,690 229,512,160

9.1% 11.7% 2.5%


802,602,207 833,535,301 755,218,255

7.3% 11.1% 2.4%


194,056,153 239,382,058 149,293,668

4.2% 20.4% -14.0%

Note: The percentages in the table reflect the change from the prior biennium


| 30

0

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400

600

800

1000

1200

1400

Sales and use tax history Sales and use tax baseline

Sales and use tax optimistic Sales and use tax pessimistic

Sales and use tax forecast scenarios, $ millions


0

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40

60

80

100

120

140

160

Motor vehicle excise tax history Motor vehicle excise tax baseline

Motor vehicle excise tax optimistic Motor vehicle excise tax pessimistic

Motor vehicle excise tax forecast scenarios, $ millions



| 31

0

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200

300

400

500

600

700

Individual income tax history Individual income tax baseline

Individual income tax optimistic Individual income tax pessimistic

Individual income tax forecast scenarios, $ millions


0

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100

150

200

250

300

Corporate income tax history Corporate income tax baseline

Corporate income tax optimistic Corporate income tax pessimistic

Corporate income tax forecast scenarios, $ millions



| 32

V. Disclosures

The forecasts included in this report, including, but not limited to, those regarding tax

revenues, are estimates, which have been prepared on the basis of certain

assumptions and hypotheses. No representation or warranty of any kind is or can be

made with respect to the accuracy or completeness of, and no representation or

warranty should be inferred from, these forecasts. The tax revenue forecast contained

in this report is based upon assumptions as to future events and, accordingly, is

subject to varying degrees of uncertainty. Some assumptions inevitably will not

materialize and, additionally, unanticipated events and circumstances may occur.

Therefore, for example, actual tax revenues inevitably will vary from the forecasts

included in this report and the variations may be material and adverse.

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