Efforts by government and automakers to encourage electric vehicle adoption will shrink motor fuel use, weaken bond coverage ratios and force a broad reconfiguring of how states pay for transportation infrastructure.
That was the upshot of a report Moody’s Investors Service released April 3 after running a stress test on the $38 billion it rates of state highway revenue bonds backed by motor fuel taxes.
The rating agency doesn’t anticipate the risk will be high for the majority of bonds it rates, because most have debt service coverage many times greater than payments and it expects broader adoption of electric vehicles is likely more than a decade out. Many states also are considering alternative sources of revenue for transportation projects.
A rapid EV adoption, in which sales of gas-powered cars ceased in 2035, would cause difficulties for weaker credits, but the bonds’ maximum annual debt service coverage will generally remain strong, said Ted Hampton, a Moody’s vice president/senior credit officer.
“Even with a drop in fuel tax collections of 30% — more than we expect in the next decade — median MADS coverage would only fall to 4.8 times, based on our analysis,” Hampton said. “A few of the bonds do have weaker coverage, but benefit from factors such as a short time to maturity. State governments’ ability to add revenue from other sources also will mitigate bondholder risk.”
Analysts think a 30% revenue drop is unlikely, because a “large number of combustion engine vehicles will linger in use even after EVs become dominant in the new vehicle market,” Moody’s analysts wrote.
Fuel taxes account for just under half of pledged revenue for the 10 largest state highway revenue bond programs, they wrote.
Even among highway revenue bonds only backed by fuel taxes, debt service appears strong enough to cover a drop in fuel tax revenues, analysts said. Examples included the Rhode Island Economic Development Corporation’s motor fuels revenue bonds and the Pennsylvania Turnpike Commission’s oil franchise tax subordinate lien bonds.
Rhode Island bonds have a debt service reserve fund requirement and final maturity occurs in 2027, while Pennsylvania’s bonds have a more distant maturity in 2053, the ability to actively manage pledged revenue provides flexibility. In 2014-2016, Pennsylvania adjusted the tax rate and allocations to its turnpike commission, which Moody’s said benefited bondholders.
States can add mileage-based road user charges, a program already adopted in Oregon, or add other new revenue sources to support highway revenue, such as implementing taxes on public charging stations, or higher registration fees for electric vehicles, though the latter goes against the current trend of trying to incentivize the transition, Hampton said.
“I think a lot of states are experimenting with replacement revenue or implementing replacement revenue,” Hampton said.
He wouldn’t comment on whether the states’ efforts are enough to guard against the transition, but “we do think there will be some implementation challenges,” he said.
“For now, major declines in motor fuel and a drop in tax revenue is far enough in the future that states still have time to figure it out,” he said.
The report doesn’t predict when exactly analysts think a transition steep enough to affect gas tax revenues will take place, Hampton said, though it ran scenarios based on how much fallout would occur if carbon consumption fell by 6% in 2030 or 13% by 2035.
The analysis didn’t do a deep dive on what the trajectory of decline in motor fuel consumption would be on a state-by-state basis.
“We just tried to come up with a stress test nationally,” Hampton said. “We took a look at the bonds we currently rate and how much they could withstand a decrease in the motor vehicle gas tax pledged revenue.”
Overall, it doesn’t appear that the bonds are at great risk within the next ten years, because Moody’s doesn’t believe the transition will have fully taken hold by 2037, Hampton said.
Revenue bonds supported by specific state fuel pledges, and infrastructure and highway operating funding supported by gas taxes, bear more direct carbon transition risk, analysts wrote.
The risk to the credits accelerates if the move away from gas-fueled vehicles occurs more rapidly than currently anticipated, Hampton said.
“A rapid EV adoption scenario in which internal combustion engine sales cease in 2035 would eventually cause difficulties for weaker credits, if their bonds remain outstanding,” Hampton said.