Alaska's Financial Foundation Is Built on Oil. That's a Huge Problem.

by | March 16, 2015

By Dermot Cole

Oil taxes and royalties have been the source of about 90 percent of Alaska's unrestricted general revenues, but with oil prices flagging and production way down, they're not coming close to matching state spending. Alaska is staring down a $3.5 billion deficit and the state's long-term prospects are bleak.

One bright spot: Investment income from state savings has shown remarkable resiliency and has overtaken oil-production taxes in their value to the state. But the deficits will require the Legislature to spend down those savings accounts, eliminating any help they could provide. Only one giant savings account is protected by the state Constitution: the Alaska Permanent Fund.

Veteran Alaska Dispatch News reporter Dermot Cole has written extensively about state spending and the Permanent Fund from his base in Fairbanks. Now, in this three-part series, he examines how we got to this point and what we can do to move forward.

A chartered United Airlines DC-8 lifted off from Anchorage International Airport on the most bizarre run to the bank Alaskans have ever seen. The jet took off at 7:05 p.m. Sept. 10, 1969, for a nonstop flight to New York.

The cargo? Checks valued at about $180 million, more than $1 billion in today's dollars, written by the world's major oil companies that day for the right to look for oil on the North Slope.

In that distant time before Internet banking -- a decade after statehood and seven weeks after Neil Armstrong walked on the moon -- the bankers delivered the checks to New York the next morning, allowing the state to start collecting $41,000 a day in interest.

Since that first windfall, supplemented within days by the rest of the $900 million from the big 1969 North Slope lease sale, the state's fortunes have risen and fallen with the cycles of the world oil market.

The pattern of spikes and crashes has played out many times through the decades, with a predictable response each time from Alaska -- euphoria when oil prices rose and cries for cutbacks and fervent promises to become frugal when oil prices collapsed.

Alaska, still more dependent on oil than any other state, has been stunned in recent months by a revenue collapse, at a loss about what we should do next.

The collective pause stems from the speed at which assumptions about the economic foundation of Alaska have crumbled in the face of world events. Legislators and the Parnell administration signed off on the 2015 the budget last spring, portraying it as a model of conservatism, fully confident oil would stay near $100 a barrel.

While they ran for office last summer and fall, no one warned of oil prices in the $55 range or that a collapse was coming.

The state budget analysis did not include oil price predictions below $90, which seemed reasonable at the time. It's apparent now they were not.

In his State of the Budget address, Gov. Bill Walker had some somber words about the need to adapt.

"If prices stay low next legislative session, we will need to discuss more traditional revenue options."

The Legislature has so far shown no desire to start discussions on "traditional revenue options," a euphemism for taxes. Legislators prefer to wait.

While general talk of the need to cut back "some day" is more popular than ever, specific remedies that involve immediate pain in the form of spending cuts or tax increases are less plentiful.

It's no surprise some lawmakers have invested more time in marijuana regulations and ending daylight saving time than in preparing for the likelihood that, if oil prices don't rise, the next step will be a giant one off the fiscal cliff.

It's easier to fume about federal overreach or hope the problem will just go away than fill a budget hole that amounts to about $5,000 per Alaskan per year.

Cutting spending, increasing taxes and dipping into the earnings reserve of the Alaska Permanent Fund are not without political consequences. And of course, oil may bounce back to the prices seen last summer and give the state a reprieve once more.

The state's long-range revenue forecast is founded on that assumption, with prices in the $118 range expected by 2018.

But in a presentation to legislators about financing options for a gas pipeline in February, an executive of Lazard, an international consulting firm, said of those assumptions, "This looks optimistic to us."

If the predictions are overly hopeful, the state will need to reassess every aspect of its finances and its revenue sources during the next year or so. David Teal, the director of the Legislative Finance Division, told legislators early this year they ought to be talking about raising revenues now.

A division report said it is no more practical to balance the budget immediately than to hope oil prices will save the state once more. He said delaying action in raising new revenue increases the odds state reserves will be gone in a few years.

"You don't have a lot of time left, in terms of reserve balances, at $60 oil," Teal told legislators. "Your choice now is fall off a cliff or build a ramp."

Legislators are likely to leave Juneau this spring with the state closer to the cliff with no sign of a ramp because none of the exit strategies are painless.

A finance report said new taxes take time to implement and they are "almost universally unpopular with citizens," which makes them almost universally unpopular with legislators.

"Cut spending first" is a common refrain, but the largest parts of the budget are dedicated to education and Medicaid. Cutting education means increasing class sizes and cutting Medicaid means decreasing services for the most vulnerable members of the population.

When vague talk becomes a tangible reduction plan, it becomes a controversy.

One early signal of the challenge occurred when Republican members of the House Finance Committee grumbled Feb. 12 about a move by the Walker administration to reduce the amount set aside or future education spending by 10 percent for fiscal year 2017.

Budget director Pat Pitney said it was not an attempt to cut future education spending in 2017 by $100 million, but to discuss later this year whether the formula needs to be revised.

"The administration said we're not going to forward fund as much and we'll wait for the discussions over the student formula that are anticipated this summer," she said.

But Rep. Mark Neuman, the co-chairman of the finance committee, said he had not heard that anyone wants to talk about the education formula this summer.

Rep. Lance Pruitt said lawmakers aren't ready to take a move of the magnitude proposed by Pitney.

"I think anyone that ever assumes that we're going to solve that over the summer has not followed this process. That is the bloodiest thing you can get yourself into, is a formula discussion," he said.

If oil prices stay down, it's not clear where the money would come from to pay for the entire education budget in 2017.

The state revenue forecast envisions oil revenue will nearly double from 2016 to 2017, topping $3 billion. It is based on the assumption oil will average $93 in 2017.

If oil prices stay in the range of $50 to $60, the easily accessible state reserves will be spent in two or three years. If prices rise to about $85, that timeline may be extended by a year or two, the budget office estimates.

In years past, the roller-coaster ride on the Alaska economy typically featured a terrifying descent and a reassuring climb with a return to prosperity.

The big difference this time is oil production rates are far lower than in years past and a much higher oil price is needed to balance the budget -- meaning the chances of a prolonged deficit are far higher than ever before.

One indication of a gap between public attitudes and political options of the budget choices came during a public hearing in Fairbanks in early February, when dozens of people spoke about restoring programs for the needy, while there was little talk of budget cuts or raising revenue.

Only one person, retired Denali Elementary School Principal Tim Doran, suggested changes to the Permanent Fund Dividend should be considered as a way to fill the gap, and one person spoke about revenue in a roundabout manner to avoid saying the word "tax."

"To go to a revenue system, pre-pipeline days, it's OK with me as long as you guys don't waste the money," said that person, veteran vocation-education teacher Roger Weggel. "I didn't want to say the dirty three-letter word."

What complicates the budget discussion in Alaska more than any other factors is expectations are often wrong, and we remain tied to the world price for a single nonrenewable resource.

The predictions about what might happen with oil prices today may be no more accurate than those upon which the state relied last spring. But as Alaska struggles to come to grips with the latest price plunge, the perennial dream of a budget model that is more sustainable, less dependent on the price of oil becomes a necessity.

That hinges in part on abandoning old notions of what constitutes Alaska's financial assets.

One of the most consequential changes is, with the collapse in oil prices and the decline in production, the state is making more money today from investments than oil -- complicating the challenge of resource and financial management.

(c)2015 the Alaska Dispatch News