Alaska Co-Investment: The Opening Round

In working on another matter today, I came across an article from last week's Petroleum News that caught my attention.  The article, entitled "AIDEA funds Mustang road," reports on the formation of a new joint venture between Brooks Range Petroleum Corporation and the Alaska Industrial Development and Export Authority, primarily to own a road which will be built to provide access to a Brooks Range prospect.  The joint venture is named Mustang Road LLC; AIDEA will own an 80% interest in the company.

While the entire transaction breaks new ground in terms of state involvement in upstream investment, one aspect in particular caught my attention.  Petroleum News reports that "Mustang Road LLC will also become a 1 percent working interest owner in the Southern Miluveach unit, allowing AIDEA to collect royalties on future productions."  If the characterization of Mustang's ownership interest is accurate, through AIDEA's 80% ownership interest in Mustang the State of Alaska for the first time (to my knowledge) will become an upstream co-investor in an oil and gas project. 

State co-investment in the upstream is something that I have written about -- and advocated -- previously on these pages.  In a widely-published piece earlier this year entitled "Our Oil? Then it is Time for Our Investment," a co-author and I suggested that such an approach would benefit Alaska's interests in several ways.  My regular bi-monthly piece in next month's Alaska Business Monthly will further explore the approach.

I have significant concerns about the state selectively co-investing in only certain upstream projects.  As I explain in the upcoming Alaska Business Monthly piece, one critical key to success where the approach has been used by other countries is co-investment in all of the country's upstream projects.  That approach spreads risk and ensures that the state does not develop a vested interest -- and as a result, a preference -- for some type of projects over others.

For example, the Petroleum News article says that  "AIDEA believes existing tax credits will constitute 46 percent of the total capital cost, totaling some $11.5 million and reducing AIDEA’s initial payments considerably."  While I anticipate that small amount will not affect the state's thinking, at larger investment levels dependence by one arm of the state on "existing tax credits," potentially could lead the Legislature to retain those type of credits simply because another arm of the state is dependent on them for its financial performance.

Moreover, selective investment potentially could lead at least to the appearance of impropriety as the responsible agency engaged in investments selects some projects over others.

Nonetheless, the state starting down the road to co-investment is a welcome sign.  Once the threshold issue of whether to do so is resolved, the debate can turn to how to do so most efficiently and effectively.

Alaska LNG| An important development ...

The Department of Energy released this afternoon the long awaited and much anticipated two studies (one from the Energy Information Administration and the second from private consulting firm NERA Economic Consulting) it had commissioned on LNG exports.  The studies were commissioned to evaluate the potential impact on the US economy of permitting exports of LNG from the Lower 48.

Early news reports indicate that the studies conclude, on net, that LNG exports are good for the US economy.  According to an article this afternoon in the Oil & Gas Journal

In what is perceived as a victory for the oil and gas industry, the US Department of Energy has endorsed the idea of liquefied natural gas exports as good for the US economy. A just-released study commissioned by the DOE states that the net economic benefit of LNG exports outweighs the downside even though it may bring higher natural gas prices to American consumers and manufacturers, says the agency. 

North American natural gas producers and midstream companies hoping to begin the lengthy process of building new LNG export facilities and retrofitting import terminals have welcomed the Energy Department report. They hope it will help sway the Obama administration’s decision on whether to approve more than a dozen proposed LNG export projects. The decision had been put on hold until the report was completed. 

The study delivers a solid endorsement of natural-gas exports at a time when the issue is hotly debated.

Alaska gas is not mentioned in any significant way in the reports.  By potentially broadening the competition for Asian markets and introducing a new, much lower (at the moment) pricing structure than previously has prevailed in the Asian market, permitting broad scale LNG exports from the Lower 48 may actually serve to undermine the export of Alaska LNG.

We will write more on this development in the coming days.

The reports are available through links at from the DOE website at the bottom of the following page:  http://www.fossil.energy.gov/programs/gasregulation/LNGStudy.html.

On Casey Reynolds tomorrow (Thursday) morning ...

I will appear on The Casey Reynolds talk radio show tomorrow (Thursday) morning in the 9:30 am slot to discuss Alaska oil and fiscal policy.  Casey was kind on his show this morning to my recent piece on the coming oil tax debate -- Five things to look for in oil tax reform ….  His take on the show's Facebook page:

Brad Keithley does what no one in the oil industry, Parnell admin, or legislature seemed capable of doing: Tell us what oil tax reform is needed and why.

We'll see if I can live up to that in person.  Follow along -- or better yet, call in -- on the internet at KFQD, or locally at 750 AM.

On Glen Biegel this afternoon ...

I will be on Glen Biegel's radio show this afternoon at 4:30p to discuss fiscal issues.  With the Governor's next budget due December 15, its time to start getting serious about moving to a sustainable budget model.

The Senate Majority appears to agree.  In a press release issued at the time the new Senate Majority was formed the Majority included as one of its "TOP THREE AREAS OF FOCUS:"

Develop sustainable capital and operating budgets for current and future generations.

Following on that I recently wrote a piece entitled "Alaska Fiscal & Oil Policy| Now the really hard work begins …" to help describe what moving to a sustainable budget will involve.  I will be on Glen's show to discuss.  Listen -- or better yet -- call in.  On the internet here; locally, on AM 700 KBYR.

A learning opportunity ...

December 3 and 4 (Monday and Tuesday of the first week of December), Law Seminars International, Inc. is presenting its eighth annual conference on "Energy in Alaska."  The conference is designed to cover both the development of Alaska's "cash" energy resources (oil, natural gas, coal) and meeting Alaska's internal energy needs.  Mark Johnson, the General Counsel of Chugach Electric, and I are Co-Chairs.

As the results of the recent elections unfold, we are making a few tweaks to the agenda.  One is the addition of Senator Cathy Giessel, the incoming Chair of Senate Natural Resources, as a speaker.  

We have worked hard to design a program that lives up to LSI's goal of making this a comprehensive conference on current Alaska energy issues.  Please join us if you are able. The details are available here.

The Senate gets it, the House ... hmmmm

In a companion piece published today I suggest that the hard work for those -- including me -- advocating a change in oil taxes lays ahead in the upcoming session, rather than behind in the elections.  The challenge is to make the hard decisions necessary to reduce spending to sustainable levels, both in order to preserve fiscal stability for future Alaskans and to avoid the short-run revenue reductions necessary to achieve long term revenue growth from undermining the first objective.

The key to achieving both goals is to retain focus from the outset on the primary objective, which is to keep faith with both current and future Alaskans by reducing spending to sustainable levels.  With that, the second goal -- achieving tax reform in order to build future production and future wealth -- becomes much easier.

It is a daunting but achievable set of goals, assuming that the focus remains on both.  

The new Senate Majority appears to understand the focus.  In the press statement following their initial organization, the new Senate Majority listed three goals:

• Increasing oil production in Alaska and, in turn, the flow rate of the Trans-Alaska Pipeline.

• Delivering affordable energy to Alaskans to their energy needs, as well as commercializing our vast supply of natural gas and exporting it to create a new economy in Alaska.

• Develop sustainable capital and operating budgets for current and future generations

The first and third points obviously hit the mark dead on.

The House Majority is much less clear on the second point.  In their release, the House appears to list five priority areas:

• Oil tax reform, 

• Affordable energy, 

• Quality education, 

• Public safety, and 

• Responsible investments.

Interestingly, despite the fact that one of the co-heads of last year's House Special Committee on Fiscal Policy is an incoming Co-Chair of House Finance, budget issues didn't make the top five.  Indeed, while it is not clear what "responsible investments" means, some speculate it is code for "capital items."

Certainly its early in the session and these are preliminary lists.  More importantly, if a split exists, it is more important for the Senate to understand the priorities than the House.  The most controllable part of the overall budget is the capital budget, and the Senate takes the lead on that budget.  If the House fails to find reductions in the operating budget sufficient to create room within sustainable levels for a capital budget, the Senate largely can enforce the result on its own by simply recommending no capital budget.

Of course, it will be better if both bodies are in alignment.  There is hard work ahead, and it will be easier on both -- and better for the state -- if both -- and the Governor -- are focused on the same objectives. 

$1.9 billion, $453.5 million and now more to go ...

Given the size of the Operating Budget, the room in a sustainable budget for capital spending from the General Fund this current fiscal year is roughly $100 million.  As the University of Alaska Anchorage Institute of Social and Economic Research ("ISER") put it in a recent report, spending above that level will increase the "fiscal burden" being shifted from this generation of Alaskans to those coming next.

Ignoring the effect on future Alaskans, the Legislature nevertheless passed and the Governor signed a $1.9 billion capital spending bill this year, plus a bill authorizing a vote on bonds to cover an additional $453.5 million in spending.  Supported by the Associated General Contractors of Alaska, American Council of Engineering Companies-Alaska and other special interests which benefit from the money, the bonds passed.  

Using the ISER analysis, the combined effect on future Alaskans creates a hole of approximately $2.3 billion in the "nest egg" that future Alaskans need for this generation to create if future generations are to enjoy the same level of government goods and services as this generation.  At current return levels and combined with the additional hole created last year, that likely translates into a reduction of approximately $500 million per year (out of roughly $5.6 billion) in revenue needed by future Alaskans if they are to maintain parity with the current generation.

Put another way, the actions of this past Legislature alone -- ratified by the Governor -- effectively have enacted a tax increase equal to roughly 10% of state spending if future Alaskans are to maintain parity with this generation.

Now, this morning's Anchorage Daily News reports that this year's capital spending spree not only is not over, but indeed, has probably exacerbated the claimed "need" for additional capital spending in future legislatures.

In an article taken from the Alaska Journal of Commerce entitled "Transportion bonds pass, but most projects will need more funding," the ADN reports:

While Bonding Proposition A provides a boost for all the jobs, many of them are still only partially funded. ... [Various] projects are further from meeting monetary goals, even with bond help. Current plans to expand the Port of Nome are expected to cost nearly $182 million. The port work will receive $10 million, which will be used primarily for conducting preliminary studies on the project .... 

The $30 million provided for Port Mackenzie's work brings secured funding to $146, or 54 percent of the project's total cost .... Even though more money is needed to complete his and other undertakings in Alaska, Von Dongen said Proposition A was a good start.

As the ISER report indicates, at current rates of spending Alaska is headed for a fiscal cliff of massive proportions within the next decade.  This morning's ADN article makes clear that past legislatures and the Governor not only have done nothing to stop the race toward the cliff, they have accelerated it.

The opportunity -- the only opportunity -- to stop the plunge is now, while the state continues to receive oil revenues in excess of what it needs to meet a sustainable budget.  Putting those excess revenues into savings will create the "nest egg" that the ISER report explains future generations require.

Instead of creating the necessary savings, however, past legislatures and the Governor have only made the problem worse.  Its time to change directions.

Read more here: http://www.adn.com/2012/11/11/2689370/transportion-bonds-pass-but-most.html#storylink=cpy

Read more here: http://www.adn.com/2012/11/11/2689370/transportion-bonds-pass-but-most.html#storylink=cpy

"Don't tax you, don't tax me, tax that fellow behind the tree ..."

For a time earlier in my life I lived in Louisiana.  During that period I became fascinated with the Long's -- Huey and his son, Russell, who during part of the time I lived in the state served as Louisiana's senior United States Senator.

Both Long's were the source of great quotes during their lifetime.  One of Russell's returned to me this morning as I was reading an article from yesterday's Fairbanks News-Miner.

The article -- Armstrong Oil and Gas chairman talks future of Alaska oil -- reports on recent remarks made by Bill Armstrong, chairman of independent oil producer Armstrong Oil and Gas.  The company is active in trying to develop new fields on the North Slope, and recently also developed a new field on the Kenai Peninsula.

As reported in the News Miner, Armstrong had this to say about the need for Alaska oil & gas tax reform

Armstrong said the political discussion has oversimplified the state of Alaska’s oil production. ... issues ranging from stringent regulations, tightly controlled infrastructure and yet-to-be-proven business economics of the new plays are all inhibiting a boom, but he said that, by far, the biggest factor is Alaska’s tax regime. ... “The North Slope of Alaska is not competitive.”

... But Armstrong says the ... $2 billion-per-year tax cut ... doesn’t get at the heart of the issue. ...  Instead, Armstrong advocates for a tax regime that incentivizes increased oil production from new oil fields, leaving traditional fields for a later discussion.

As I have explained elsewhere, there is vastly more oil potential remaining in the existing units located on the North Slope than in the new areas being pushed by Armstrong and similar companies.  As I also have explained, the current tax credit system, which Armstrong proposes to bias even further, is pushing Alaska farther away -- not closer to -- refilling the pipeline.

Essentially Alaska's current system taxes production from existing units higher in order to generate the revenue needed to fund "tax credits" (i.e., subsidies) for exploration activities in areas outside of the existing units.  Armstrong certainly understands that interaction; hence, his desire to leave the tax treatment of "traditional fields for a later discussion."

That is what brought Russell Long to mind.  Long, a longtime Chairman of the Senate Finance Committee, during a particularly combative hearing on tax policy summarized the position of someone testifying before the Committee as follows:

"Don't tax you, don't tax me," said Long, "tax that fellow behind the tree ..."

To Armstrong, the existing units are "that fellow behind the tree."  Unfortunately, Alaska's future is standing right beside "that fellow."  Armstrong evidently does not realize his shot will hit both.

Yet another reason to vote against Bonding Proposition A ...

Last week, we wrote a longer piece opposing Bonding Proposition A, which appears on next week's general election ballot. The proposition asks the following question:

“Shall the State of Alaska issue its general obligation bonds in the principal amount of not more than $453,499,200 for the purpose of paying the cost of state transportation projects?”

We suggested a "No" vote because, combined with the record level of capital spending already approved in this year's state budget, the additional spending proposed by the Bond Proposition is way beyond sustainable spending levels and just too much.

For those reading this column for the first time it is worth mentioning that, according to a recent national study, Alaska currently leads the nation in debt per capita.  At a state government debt level of $31,141 per resident, Alaska far outstrips even California, which for all of its faults, carries a state government debt load of only $16,386 per resident.

Bonding Proposition A proposes to add roughly another $625 per Alaskan on top of that, bringing the total debt total to over $31,750 per Alaskan.

While we took some flack for the position, we stood behind it and, in early voting last week, put our vote where our pen was.

Now, for those reading this piece that have not yet voted, this morning's papers bring another reason to vote No.

This morning, the Anchorage Daily News reported that

A federal agency says a new, still-unreleased study examining the troubled Port of Anchorage expansion project suggests that it shouldn't go forward as designed ....

The largest item in the Bond Proposition -- totaling $50 million, or over 10% of the bond issue -- is for the Port of Anchorage.  Voters cannot vote yes on some pieces and no on others; all of the spending is tied together.

When asked to comment on the report on the port, Anchorage Councilman Patrick Flynn said, "If that is in fact the case, that means there's a lot of rethinking to do about the project."

Flynn is right, there is a lot of rethinking to do about the project.  Even if everything else about the Bond Proposition was good -- which it is not -- this development alone would justify a No vote.  Until that rethinking is done and a clear way forward identified, no further spending -- especially spending that increases Alaska's already staggering per capita debt -- should be authorized.

Bonding Proposition A -- Too Much; Unsustainable; Wrong Time.  Vote No.

Read more here: http://www.adn.com/2012/10/29/2676171/feds-say-anchorage-port-study.html#storylink=cpy

Read more here: http://www.adn.com/2012/10/29/2676171/feds-say-anchorage-port-study.html#storylink=cpy

Fiscal Policy| Hell has frozen over ...

Hell froze over yesterday.  Former Wyoming Republican Senator Alan K. Simpson, as partisan as they have ever come, endorsed Democrat Bob Kerrey in the U.S. Senate race in Nebraska.  Why?  Fiscal Policy. 

According to Simpson, "[Kerrey] will place the national interest ahead of the howling special interests and be ready to make the hard, tough choices so needed today to rein in the destructive national debt and deficit ... and do it now - Before it’s too late.”

The equivalent Alaska race this year -- Lupe Marroquin, a Democrat, running against special interest backed Republican Bob Lynn.  A creature of union donations, in his last term Lynn voted for the two biggest state budgets in Alaska's history and last year, sponsored a bill that would have made Alaska's fiscal situation even worse, by returning to the same sort of defined benefit plan that already has put Alaska deep into debt.  (Largely as a result of the underfunded status of its current public pension system, Alaska currently leads the nation in per capita debt.)

As Ted Stevens once said, "To Hell with politics, do what is best for Alaska."  Alan Simpson took that philosophy to a national scale by endorsing Bob Kerrey; its time for Alaska to live up to the mantra on its own by voting Lupe Marroquin for State House.

Another Alaska Dispatch story ...

The Alaska Dispatch yesterday ran an article under the headline "Oil companies agree: TAPS operational at least another 32 years."  The story reported on a settlement reached by the TAPS owners and the state regarding the depreciation life to be used in calculating TAPS rates.  

Since it is World Series season, a baseball analogy comes to mind.  Having reported the facts, the story then sought to turn the "single" (the story) into a "double" (a thinly disguised editorial) by comparing the settlement to other statements about the life of TAPS.

Specifically, the story continued with the following:

... the settlement seems to conflict with arguments by Gov. Sean Parnell, who has said the trans-Alaska pipeline -- the 800-mile umbilical cord that symbolizes the state's lifeblood industry -- is running low on oil and could shut down in as soon as eight years under certain conditions.  

Parnell’s state website to support his tax proposal, “Stem the Decline -- Grow Alaska,” cites a U.S. Energy Department report that says the pipeline could stop moving oil sometime between 2020 and 2035, it was a report that was widely debunked by energy experts.

Of course, the story contains no cites or links to the supposed "debunking" of the EIA's report by "energy experts."  The fact is that the EIA's report focuses on the potential economic life of TAPS, and reaches its conclusion based on the possibility that, due to Alaska's tax rates and other factors, it may no longer be economic to continue operating TAPS within the time span covered by the EIA study.  The FERC settlement does not attempt to reach the same level of economic analysis.  It is just a settlement.

And, interestingly, the Dispatch story contains absolutely no mention of Judge Sharon Gleason's state court decision late last year, which the Dipatch previously has emphasized, and which found that TAPS potentially could remain in service until 2065.  If the settlement undermines the Governor's position, one would think that it undermines Judge Gleason's as well.

But most importantly, the Dispatch article fails to address the real issue facing the state today.  That issue is not the life of TAPS, it is the production rate going through it.  As Deputy DNR Commissioner Joe Balash said at the time of Judge Gleason's decision, even "a 300,000-barrel a day throughput scenario … would be a ‘disaster,’ because at that level, the state budget would be in a ‘dire deficit."

In short, even though TAPS might continue operating, the state's fiscal situation would be crumbling around it.  For a more thorough discussion (and cites to the above quotes), see "It's the production rate ...."

Whether the Dispatch's efforts to extend the single into a double were successful likely is in the eye of the beholder.  To me, however, an old Dizzy Dean observation applies -- the Dispatch was "out by a mile."

The Promise ... and the Reality ...

Yesterday I spent part of the morning reading my local candidate profiles as a way of preparing to vote -- I intend to take advantage of Alaska's partial move to electronic voting this year and had just completed my application. The website of one local candidate -- an incumbent R -- touts that he is a "fiscal conservative" and goes so far as to assert that "With [candidate's name] We Control State Spending."

That's the promise.

I must admit to starting off somewhat skeptical of the promise in any event.  Readers of these pages will know that the last two years the Alaska Legislature -- including the House, which clearly is controlled by R's claiming to be "fiscal conservatives" -- has passed the two largest budgets in Alaska history, both of which are well above sustainable levels and, indeed, are so large they now undermine the goal of oil tax reform.

Then, last evening, while catching up on the news from the day, I read an Alaska Dispatch story which crystallized the reality.  The story is about a new baseball field recently completed in Sitka.

“Frankly, it was a third-class baseball field,” said Sen. Bert Stedman of Sitka. “Some of us thought it was appalling.” 

So he stepped up the plate and hit a home run with the development of new Moller Field, the only all-turf field in Alaska. 

Stedman was the MVP of the multimillion-dollar project, identifying the need for a new turf field, driving home the point with other legislative leaders and securing the funding through the capital budget.

My local candidate voted for the capital budget.

• "Fiscal conservative" ... 
• "With [               ] We Control State Spending" ... 
• "[M]ultimillion-dollar baseball field," "the only all-turf field in Alaska," paid for by tax dollars through the capital budget. 

It is clear that the slogan has just become words.  That's the reality.

Required Reading: Roger Marks' "Unaware of unknowables: attempts at tax reform in Alaska"

A recent article in the Oil and Gas Finance Journal by former Department of Revenue oil economist, and now consultant, Roger Marks, should be required reading for those interested in Alaska oil and gas policy.

The article -- entitled "Unaware of unknowables: attempts at tax reform in Alaska" and available here -- discusses recent efforts to change Alaska's current oil tax structure and analyzes the reasoning that has been used thusfar to turn back those efforts.

One of the critical observations that Marks' makes is the role played by the Fiscal Note provided by the Department of Revenue in support of the Governor's proposed oil tax reform bill.  As Marks explains,

In looking at the fiscal (revenue) impact of reducing taxes, the Senate used the Alaska Department of Revenue (DOR) fiscal note .... The fiscal note used the same number of barrels under all tax plans. So a reduced tax could not but show a revenue decline.

[The consequence is that] the decline in revenues from the proposal in the fiscal note was depicted by many as a "giveaway," i.e., a tax cut that would result in no beneficial stimulus to production.

Talk about shooting yourself in the foot from the start.

The other observations made in Marks' piece are equally as significant.  The piece deserves a close reading and continued understanding.

It's the production rate ...

The Alaska Support Industry Alliance hosted its second Annual Fairbanks Update this past week; I made the opening presentation.  The slidedeck from my presentation is available here.  It is an update of a presentation I gave earlier this year both before the Anchorage chapter of the Alliance, and subsequently before the Senate Resources Committee.   The context of the presentation, and the events at the time to which it responded, are more fully explained in those posts. 

Alaska Political Insider| Conversations on a sustainable budget ...

Dorene Lorenz and Mark Colavecchio, hosts of ABC Alaska's talk show Alaska Political Insider, invited me to join them last week to discuss a recent commentary on these pages, "What is Alaska's Fiscal Plan ...."  The webcast is here; the segment begins at the 31:40 minute mark.

Mark and Dorene were excellent at asking questions to flesh out the issues, details and potential way forward and I thought the discussion went well.  If you want to see a good exchange on what is, why we should -- and ways of moving toward -- a "sustainable budget" for Alaska, this is an excellent place to start.

Senator Johnny Ellis was the guest for the first segment.  I appreciate his comments about my efforts at the end of his segment, before the one in which I appear begins.

Outside view of Alaska Senate races ...

For those with a subscription to highly respected national energy publication Energywire, reporter Margaret Kriz Hobson has written an interesting overall summary of the Alaska Senate races from an Outside perspective.  In a story in yesterday's edition entitled "State senators targeted in Alaska's oil tax fight," Hobson writes:

The November elections could mark a turning point in a raging political battle over oil taxes in Alaska, as production there continues to dramatically decline. Gov. Sean Parnell (R) wants voters to unseat several state senators who have blocked his proposals to slash the taxes that energy companies must pay when extracting oil from state lands. Parnell and three of the state's major oil companies -- BP PLC, ConocoPhillips Co. and Exxon Mobil Corp. -- advocate rolling back industry taxes by as much as $2 billion a year, which they argue will encourage oil and gas development on state lands.

The remainder of the article is available only to subscribers, but includes quotes that provide the range of perspectives gathered by Hobson.

"The Alaska tax structure is significantly higher than what you see in other states," said Bradford Keithley, an Anchorage attorney at Perkins Coie and co-head of the firm's oil and gas practice. "We've taxed the industry to the point that we have made the state less competitive for investments, and we're suffering the consequences."

But, revising ACES puts,

"[t]he whole future of the state ... at risk," said David Gottstein, head of an Anchorage investment firm ... "Don't get us wrong. We want to encourage the industry to explore for and produce our energy resources. We want them to make ample profits, but not more than they need to in order to make reasonable rates of return -- especially when it would imperil Alaska's fiscal future. ..."It's hard for people to imagine that a state that has $60 billion in the bank has serious problems, but for those of us who do long-range forecasting, it's not that complicated," Gottstein of Backbone explained.  "The key is that the $2 billion tax reduction represents a 25 to 30 percent cut in the revenue to the state of Alaska" he said. "It would immediately put us in a deficit mode. Instead of adding to our savings account, we would be immediately drawing it out."

On the other hand,

some conservatives want state lawmakers to offset the tax cuts by shrinking the state budget.  Keithley maintains that Alaska's declining oil production cannot continue to underwrite its growth in state services. "Our politicians should be talking about the need for budget reform," he said. "But not many of them are.'"

The Upside Down World of Alaska Oil Credits ...

An article that I caught up with over the weekend from a week ago Sunday's online edition of the Washington Post -- "Alaska pursuing unconventional shale oil development to fill its pipeline" -- reminded me again of how upside down Alaska's oil policy has become. 

One of the significant policy shifts brought about by the passage in 2007 of Alaska's Clear and Equitable Share ("ACES") was the increased reliance on tax "credits" to direct investment behavior.  Generally speaking, tax credits are a way in which government tilts business economics to incentivize some activities over others. 

Through credits, government favors one class of taxpayers by lowering its tax costs, sometimes to below zero (meaning they actually receive cash from the government).  The offset is that the credits necessarily penalize another class of taxpayers.  Because government does not generate revenue on its own, the credits necessarily are paid for by charging another class of taxpayers a higher level of taxes than would be needed in the absence of the credits.

In essence, credits are a way of substituting government's judgment for business in picking economic winners and losers.  Through tax policy, the government favors investment in some activities -- the winners -- and discourages investment in others -- the losers -- by raising their costs.

At a Federal level, think of wind and solar credits.  At the Alaska state level, think of ACES.

ACES contains a sweeping series of tax credits. As summarized in a recent presentation made by Department of Natural Resources Commissioner Dan Sullivan in Houston, Texas, the tax credits generally include (i) "any losses" on oil and gas operations, (ii) an amount equal to 20% of "capital expenses," and (iii) an amount equal to 40% of the costs of "greenfield exploration."  As used in the presentation, "greenfield exploration" means activity outside of an existing unit.

While the first two categories theoretically are available to producers located both inside and outside existing units, as a practical matter in the current environment only those with operations outside existing units are likely to incur losses.  By its own terms, the "greenfield exploration" credit clearly applies only to operations outside existing units.

As a result, under ACES the bulk of the tax credit structure is built to favor activities outside of existing units at the expense of activities inside of existing units.

As a recent state study concluded, "[t]he structure of the tax credits is such that exploration and new developments receive significant credits (up to 65 percent) and ongoing capital spending in existing fields receives fewer credits (20 percent)."  Alaska’s Oil and Gas Fiscal Regime – A Closer Look from a Global Perspective, Alaska Department of Revenue (Jan. 2012) at 24.

This is where the problem arises.

Usually, government aligns tax credits with its policy objectives.  Tax credits are designed to incentivize those activities that are consistent with government's policy objectives, and penalize those activities which are not.

Oddly given the importance of oil development to Alaska, ACES works in the exact reverse.  The tax credits embodied in ACES penalize oil investment that promises the most significant benefits to the state and, instead, reward investment that offers no clear path to improving state wealth.

As I explained in an earlier commentary in Alaska Business Monthly, there are roughly 24 - 30 billion barrels of known oil in place remaining in largely undeveloped intervals inside the existing North Slope units.  Because of the location of the oil inside existing units, the increased surface footprint required to develop that oil -- and, thus, the permitting burden to develop those resources -- likely is small.  The  economics also are improved by the fact that there is a large segment of existing infrastructure already in place on the surface to help develop and produce the supplies.

The size of the resource is significant.  Even at a 25% recovery rate, there are roughly 6 - 7.5 billion barrels of production potential that lie within these zones.  At the 40% recovery rate initially estimated for the Prudhoe Bay field, there are roughly 10 - 12 billion barrels of production potential.  At the 60% recovery rate now being achieved for Prudhoe, there are roughly 14 - 18 billion barrels of potential production.

Because these intervals contain much more viscous and heavy oil than the intervals which have been the source of Alaska's North Slope production to date, the challenges and costs of developing these resources are substantial.  Significant investments will be required to hone and then apply the new technology required to access the resources.  As the development and production of the even more technically challenging Canadian oil sands make clear, however, with the right investment economics, development is achievable.

On the other hand, the potential 0 - 2 billion barrels of "technically recoverable oil" (which means, even if it exists, the resource may or may not be economically recoverable) discussed in the Washington Post article is in a previously undeveloped portion of the North Slope, will require the installation of substantial and intensive new surface infrastructure and, as a result, will create an entirely new set of state and federal permitting and development challenges. 

Perhaps more importantly, even at its highest, the estimated potential of the new source of supply discussed in the Washington Post article is less than a third of the minimum potential of the heavy and viscous resources in the existing North Slope fields.

From a state policy perspective, the path would seem clear. 

Governor Parnell has said that increasing current oil production is Alaska's No. 1 economic objective.  As a result, if the state was going to favor either resource, the tilt should seem to favor the known and significantly larger resource located within reach of existing infrastructure.  Because of its location underneath an existing surface footprint, that resource holds the greatest promise of increased production in the near term, and because of the greater size of the resource, also over time.

In fact, however, current state policy tilts the playing field in the exact reverse.  Because the larger and easier to access resource is located within existing units, it receives a much smaller tax credit.

Because the smaller and harder to access resource is located outside of an existing unit, it qualifies for the significantly larger tax credit.  In short, ACES substantially tilts the economic playing field against investments in the known and larger resource, and in favor of investments in unknown resources located miles away from existing infrastructure.

The extent of this tilt is shown by its effect on Alaska's budget.  According to Commissioner Sullivan's Houston presentation, the "[c]redits can be used to offset tax liability for the current tax year, carried forward to offset tax liability in a future year, sold to another taxpayer, or refunded for cash."

The only producers claiming refunds in cash are those which otherwise do not have sufficient taxable income to recover the credits by offsetting them against their taxes.  In other words, the only producers claiming refunds in cash are those engaged in activities outside of existing units. 

Since the passage of ACES, the state has allocated over $1.8 billion toward credits to be paid in cash (FY 2013:  $400 million; FY 2012:  $400 million; FY 2011:  $180 million; FY 2010:  $180 million; FY 2009:  $400 million; FY 2008:  $250 million).  More no doubt have been claimed by the same entities by selling the credits to those taxpayers actually incurring tax liabilities.

In total, according to Commissioner Sullivan, the amount of tax "credits claimed since 2007 exceed $3 billion." 

Alaskans -- including the Governor and most legislators -- often express significant concern about the decline of throughput in TAPS and the resulting impact on state finances.  Yet, the tax credit provisions created by ACES have directly diverted at least $1.8 billion which, with the right economic incentives, could have been put toward projects involving known resources, to tax subsidies for the oil development equivalent of "Hail Mary" passes.

No wonder, despite remaining known resources within exiting fields as large in size as the original Prudhoe Bay field, Alaska is suffering continued production declines.  The state's tax policies have been built to discourage any other result.

Does Alaska OCS Development Really Help ... Alaska

Show of hands ... how many believe that Alaska state government revenues will increase as a result of Alaska OCS development? 

The Governor certainly has spent a lot of state time and effort talking and helping to litigate the issue.  In a discussion Senator Bill Wielechowski and I had on The Dan Fagan Show a few months ago, the Senator listed the OCS as one of the sources for the new oil that he asserted would help offset the continued decline in state production.  And the other day, the Alaska Dispatch had this to say in discussing the hurdles Shell has faced in its OCS drilling program:

The problems are a setback not just for Shell, but for the oil-dependent state of Alaska that has pinned its economic hopes on Shell for years. Oil production has been declining for years at the oil fields on Alaska’s North Slope. The state depends on oil tax to fund about 90 percent of its budget. It needs to keep oil flowing through the 800-mile trans-Alaska oil pipeline, and Shell is the great crude hope. 

The answer?  The State of Alaska will collect zero in revenues from Alaska OCS oil and gas production.  No royalty and no production taxes.

In a 2010 presentation, UAA's Institute of Social and Economic Research (ISER) Professor (now, Professor Emeritus) Scott Goldsmith analyzed the Alaska state take from various sources of supply.  The results are summarized on the slide to the left.  

While Alaska retains 100% of the royalty from production within 3 miles of the coastline, the royalty share declines to 27% in production from 3 - 6 miles offshore, and then to 0% at 6 miles and beyond.   Production beyond 3 miles also is exempt from production tax ("ACES").  Shell's Beaufort prospect is 18 miles offshore; its Chukchi prospect is 70 miles offshore.

Senator Begich and Senator Murkowski have proposed changes to the federal revenue sharing provisions, and recently Senator Wyden -- the incoming Democratic lead on the Senate Energy and Natural Resources Committee and, unlike his predecessor, from a coastal state (Oregon) -- has signaled some interest in the matter.   Whether those efforts mature into actual state revenues is doubtful given the federal government's own budget issues.

But even if there were changes and they stretched the current provisions governing the 3 - 6 mile area (where Alaska receives 27% of the federal government's royalty share) outward to the areas being explored by Shell, Alaska's income stream from OCS development would still be small.  The only revenue would be a moderate portion of the royalty received by the federal government.  As elsewhere in federal waters, state production taxes would not apply.

This is not to say that Alaska OCS is not important.  It produces Alaska jobs, develops new technology potentially applicable to development on state lands  and by keeping the industry active in the state, potentially lowers the costs for onshore producers. 

In no way, however, does it approach being a substitute for the development of state lands.  Development on state lands is the key to both Alaska's fiscal and oil future, and should be the continued focus of our Governor and legislators.

The first round ...

The first round of the Alaska elections produced gains in bringing an increased focus to state budget issues.  As I have written elsewhere on these pages, resolving state budget issues has become critically important also to resolving state oil issues.

Candidates stressing fiscal issues already well known in their communities and relatively well funded won Senate races in the Valley (Mike Dunleavy) and Kenai (Peter Micciche). Stressing only fiscal issues, a  previous unknown (Jeff Landfield) also produced significant results (44%) in a deeply underfunded effort against an entrenched incumbent in Anchorage, signaling dissatisfaction on the issue there as well.  Anchorage tax cap author Don Smith won his nomination also.

On the other hand, social, but not necessarily fiscal, conservatives won Senate nominations over candidates stressing fiscal issues in contested races in Fairbanks and the West Anchorage Senate district.   House results were somewhat mixed as well.   Nevertheless, the discussion on fiscal issues is strengthened and will continue into the fall.

Perhaps the most interesting event of the day from a fiscal policy perspective, however, was reading Representative Pete Petersen's (a liberal D) door hanger.   The first issue on the front page of the hanger was this:

"Fighting Wasteful Spending. Pete was one of only two legislators who had the courage to vote against the $3 billion capital budget. Pete gets it!"

 Then among the "Petersen Plan for Alaska" on the back, this:

"Reform the state budget process to eliminate government waste and pork barrel spending."

Interestingly, Petersen's Republican opponent recently signed on to the report from the House Special Committee on Fiscal Policy which, as has been discussed previously on these pages, raises concerns about the commitment, at least of the members of the Committee, to fiscal reform.

 

The Petersen flier appears to be an effort to take advantage of the fact that, over the last two years, House R's have approved the two largest budgets in Alaska's history, and that at least some do not appear to be concerned about the consequences, either to oil policy or future Alaskans. 

 

The flier suggests that at least some Democrats believe Republicans are vulnerable on the issue.  Personally, I believe that the assessment is correct. 

A Sidebar: Why Alaska needs to save now ...

Since publishing another piece on this page -- Alaska Budget Cutting:  Its Not Rocket Science ..." -- some readers have asked why Alaskans should be concerned about achieving a "sustainable" budget.  They suggest that, like other states, as long as spending within a given year does not exceed the revenues received in the same year there is no cause for concern and the current budget levels do not need to be reduced.

That issue will be the subject of a longer piece upcoming in the near future, but I am publishing the short answer now, as a sidebar to the "Its Not Rocket Science" commentary, so that readers are provided with a basic understanding of the reason while they are reading the related piece.

Alaska is unlike other states in a number of respects, but most important for this purpose is that Alaska currently funds virtually its entire General Fund from a single, ultimately non-renewable source -- oil.  On the other hand, in one way or another all other states fund state government largely with "renewable" sources -- such as property, sales or income taxes.  Such sources are classified as "renewable" because they continue to produce a relatively stable, predictable income stream as long as there is property, sales made or people located in the state.

That is not the case with Alaska.  As oil production tapers off over time, so will state revenues.

That is why spending revenues as they come in does not work the same for Alaska as it does other states.  In other states, that approach does not impair their ability to maintain spending at relatively consistent levels into the future.  Because future revenue levels stay roughly the same, those states are able to spend up to current revenue levels without being concerned about adversely affecting future spending levels.

The outcome in Alaska is different.  Without committing a portion of the current revenue stream to savings, future spending levels will look much different than today.  Unless there is some offset to the revenue declines which occur as oil production declines, future spending levels will be vastly lower. 

The approach reflected in the ISER studies referenced in the commentary calculates the level of savings required today in order to avoid this result and, like other states, position Alaska to maintain a consistent level of government spending into the future. 

Basically, the approach takes the balance in all current savings accounts (e.g., the Statutory Budget Reserve, Constitutional Budget Reserve, the Permanent Fund and various other accounts) that Alaska has accumulated to date, combines that with the additional surpluses (over the "sustainable" spending level) anticipated in the next few years, and invests the total (what ISER refers to as the "nest egg") in the same way the Permanent Fund is currently. 

The future income stream from that investment results in balancing out the future shortfalls in revenue from oil.  In essence, the income stream from the nest egg serves as a renewable revenue stream and enables Alaska to maintain a consistent level of state spending indefinitely into the future.

Some have suggested that Alaska already has enough savings, in the Permanent Fund, to provide a stable revenue stream for the future, or that the legislature already is putting enough additional savings aside to achieve the same objective.  As the future piece will discuss in greater detail, neither assumption is true.  Without substantially increasing the level of savings -- to what ISER describes as "sustainable" levels -- the revenue available for future Alaska spending levels will be much lower than Alaskans experience today.

Key to achieving those future benefits is to begin protecting the nest egg now.  Any delay reduces the nest egg -- and diminishes the level of revenues that future Alaskans will have available to spend.  As a result, instituting spending caps at the sustainable level now is critical to maintaining renewable earnings in the future.  Without maintaining and building savings now there will be insufficient renewable earnings tomorrow to maintain the same standard of living as oil revenues continue to decline.

Alaska Oil| Maybe the tide starts turning here ...

As we have made clear elsewhere on these pages ("The most important slide in this election ..."), given the spending spree Alaska's legislature has been on the past few years oil reform has to start with fiscal reform first. Achieving fiscal reform requires a change in legislative approach, if not in individual legislators. In summarizing some key legislative races going into the final weekend, the Alaska Dispatch suggests that the tide may be turning ...

Senate District K: Fiscal fur flies

If there were ever an election in which 27-year old upstart Jeff Landfield could rattle fellow Republican and incumbent Sen. Lesil McGuire, one of the most powerful and visible state senators in Alaska, this would be it. Moderate Republicans are under fire in this state, and McGuire hasn’t helped herself by spending lavishly on travel, and shepherding through what appear to be pet projects. And worse, she can come across as if she’s entitled to her seat. Landfield, who is a Ron Paul supporter, is smart enough and has worked hard enough to pry an opening there. His attacks have focused squarely on McGuire’s spending, her vote on former Gov. Sarah Palin’s huge oil tax increase, and that she along with other five Republican senators, joined the bipartisan Senate coalition.

The money, however, is still on McGuire, who’s a great debater and an articulate defender of her stances. Too, she’s much better at the fundraising game. His roughly $12,000 pales in comparison to McGuire’s more than $66,000, much of which comes from some of Alaska’s largest businesses and business titans.

Landfield, however, is counting on good old-fashioned door-knocking ....

The Solution to Alaska's Fiscal Issues ...

In listening this morning to the podcast of Glen Biegel's show from a couple of days ago, I was struck by the response of a couple of legislative candidates to Glen's questions about the state budget.  Glen started by asking each if they thought the current state budget was "sustainable."  Each answered "no;" so far, so good.

Then Glen asked how they would "fix" the budget.  With varying degrees of speed, both ultimately suggested using "zero based budgeting" to address the problem.  Not as good (in my opinion).

Generally speaking, zero based budgeting is a "method of budgeting in which all expenses must be justified for each new period. Zero-based budgeting starts from a 'zero base' and every function within an organization is analyzed for its needs and costs. Budgets are then built around what is needed for the upcoming period, regardless of whether the budget is higher or lower than the previous one."

In other words, zero based budgeting is a way of more deeply examining costs; it is not a way of setting overall budget levels.

For those of you remember (or more likely, have studied it as a history lesson), zero based budgeting first gained significant notoriety for use in developing government budgets during the Presidency of Jimmy Carter.  I recall because I was at the Pentagon at the time, and somewhat involved in dealing with the implementation of the approach on a few programs.

While President Carter touted the approach as a way of reducing government spending, it did not.  It took a little longer to develop the bdugets, but spending levels continued to grow.  The reason is that the approach only looked at programs from the cost side, requiring that the proponents justify each element of cost as they rebuilt their budgets.  Good people always can come up with justifications for programs and their related costs; after some "log rolling" ("I'll agree to your costs if you agree to mine"), the budgets were built and the spending levels continued.

Alaska's needs are different.  The first, and most important, step that Alaska needs to take going forward is to establish a hard cap on General Fund spending at the fiscally "sustainable" level.  Without that as a starting point, overall spending levels will never be controlled.  As now, well intentioned people will simply build good stories for why their program needs to be approved, and approve others in order to have theirs approved.  That explains how Alaska General Fund spending has exploded over the last six years from $3.0 billion for FY 2006, to $6.7 billion for FY 2012, and now to $7.6 billion for FY 2013.  And it also explains why spending will continue to match cash flow, at the expense of future Alaskans, until something is done.

By putting a hard cap on overall spending at sustainable levels, Alaska will control the end result from the start.  Once that is done, the various Commissioners, state agencies and legislators can work on prioritizing programs and projects within the cap.  Zero based budgeting to facilitate that approach may or may not be helpful; it can and should be used where it is.

But relying on zero based budgeting as the primary approach to control state spending is -- as the University of Alaska Athletic Director recently told me I was on when I suggested that there was a need to bring accountability to that program -- a "fool's errand."  I disagree with that characterization in that instance and will have more to say about it soon.  But that characterization is true when thinking that zero based budgeting is the primary solution to Alaska's fiscal issues.

A hard cap on overall spending is the most -- and possibly, only -- effective solution to Alaska's fiscal issues.  I hope that, as this election cycle continues, those appearing on Glen's show earlier this week and other legislative candidates increasingly think of that solution as their first line response.

Dear Governor ... The Future is Now

George Allen -- the Hall of Fame football coach (and the father of the former Governor and United States Senator from Virginia of the same name) -- had a favorite saying, "the future is now."  By that, Allen meant he coached to win in the coming year, not to develop players for the future.  Applying that philosophy, Allen was known for trading away draft picks year after year for proven, but older, veterans, to position his team to win in the upcoming year, rather than the potential to win somewhere down the road.  It was a successful philosophy; in 12 seasons as a head coach, Coach Allen compiled a regular season record of 116-47-5.

It is a philosophy that Governor Parnell would benefit from studying.  In a recent interview, Governor Parnell is quoted as saying "that he wants to rein in state spending."  But -- and this is the important part -- he also is quoted as saying "he hasn't yet set any parameters for agency spending."

As this page has discussed elsewhere, Alaska state spending has grossly exceeded sustainable levels for at least the last two budget cycles.  As calculated by the University of Alaska's Institute of Social and Economic Research ("ISER"), the current annual sustainable spending level from the General Fund is in the range of $5.35 billion.  The General Fund spending levels passed by the Legislature and approved by the Governor for the past two years, however, are in the range of $6.72 billion (FY 2012) and $7.6 billion (FY 2013).

As ISER has emphasized, spending in excess of sustainable levels passes on a "fiscal burden to future generations ....  The fiscal burden will grow every year ... at an accelerating pace, until the state reduces spending [to sustainable levels] or finds an alternative source of revenue.”   As I explain elsewhere, excess spending also has seriously undermined the Governor's priority of oil tax reform.

Reigning in state spending levels is an imperative.  ISER has made clear that failure to do so is adversely affecting future generations of Alaskans.  The Governor's own OMB Director has made clear that the failure to do so is undermining the Administration's efforts to reform oil taxes.

But just "any ol' level" of reductions is not sufficient.  To avoid continuing to transfer a fiscal burden to future generations of Alaskans, state spending levels need to be reduced to sustainable levels.  Any less simply panders to current Alaskans at the expense of the future of the state.  The Governor is responsible to both.

As George Allen used to explain, the "future is now."   Its not enough to say that state agencies need to reduce state spending in general; as the Chief Executive, the Governor needs to step up and tell them precisely what the overall target is, and then let them fill in the details within that guidance.

The maximum sustainable level of General Fund spending is $5.35 billion; that is the target.

Honored: Institute of the North Welcomes Three New Directors to Board

An honor to be in such company.  "The Institute of the North is pleased to announce the election of three new members to its Board of Directors – Matt Ganley, vice president of Resources and External Affairs at Bering Straits Native Corporation; Brad Keithley, partner and co-head of the Oil and Gas practice at Perkins Coie; and Karen Matthias, Alaska economic and political consultant at Matthias Consulting, as well as new officers. ... The new board members join the newly elected executive committee – Drue Pearce (chair), Duane Heyman (vice chair), Randy Hagenstein (secretary), Peter Scott (treasurer), Ira Perman (at-large); and current members Admiral Thomas Barrett, Dr. Jack Hickel, Brit Ashleigh Szymoniak, and Dr. Michael Sfraga. Emeritus members are John Hendrickson, Max Hodel, Gail Phillips, Steve Shropshire and Leif Selkregg."

The full release is available here.

State earns $983 million, ConocoPhillips $551 million from CP Alaska production in 2nd Quarter ...

The Anchorage Daily News ran an article yesterday on ConocoPhillips Alaska's quarterly earnings report.  The headline was "ConocoPhillips earned $551 million in Alaska in 2Q."  The headline, and story, was roughly the same also in the Alaska Dispatch ("Conoco turns $551 million profit in Alaska for second quarter") and the Juneau Empire ("ConocoPhillips produces strong Alaska profits").  The Fairbanks News-Miner and APRN, except for the Dillingham affiliate ("ConocoPhillips Alaska reports huge profits") do not appear yet to have a run a story on CP's quarterly report.

Here is what the headline should have read to accurately reflect the story ... "State earns $983 million, ConocoPhillips $551 million from CP Alaska production in 2nd Quarter."  That leaves a different impression, doesn't it?  What if it read, "State earns $983 million on no investment, ConocoPhillips $551 million on $100 billion investment from CP Alaska production in 2nd Quarter."  

But sadly, all that the ADN (and, for that matter, the Dispatch) reported in their headlines was CP's share.  That lack of balance is important -- and may explain much about why the general population thinks the oil companies are greedy.

"Understanding Alaska's Budget" May Explain Much More Than It Intends ...

The Alaska "House Special Committee on Fiscal Policy" yesterday released a new website focused on "Understanding Alaska's Budget."  The website may explain much more than the authors intend about how Alaska has worked itself into its coming fiscal crisis -- and why recent legislatures have made the problem worse.

The press release announcing the website provides the first clue.  The release quotes the Chair of the House Special Committee as follows:

“We’re in the cat-bird seat, financially, now, but with throughput this week under 400,000 barrels, and with a volatile oil price, we need to prepare people for the likelihood of lower revenue. That means also preparing to handle the challenges before we reach a crisis – that’s what this is meant for.”

Alaska is not in "the cat-bird seat, financially, now."  Alaska has a temporary cash surplus, the same way that you or I would if we treated as current disposable income the money that we otherwise need to put away for our children's college tuition or our retirement.  Spending it now means that our children -- and us -- will be worse off in the future as our income winds down but our spending needs continue.

As the University of Alaska Anchorage's Institute of Social and Economic Research ("ISER") has made clear in two recent studies, once adjusted for the savings levels that are required to fund tomorrow's state spending requirements once oil winds down, Alaska is not currently in the "cat-bird" or any other type of comfortable seat.  Instead, as I explain more fully in a recent piece (which relies on the ISER studies), Alaska is very much behind the curve and is spending away today at an alarming rate money that otherwise should be put away to handle future needs.

The fact that the "Special Committee on Fiscal Policy" thinks otherwise is not only disappointing -- it is downright alarming.  Thinking you are in the "cat-bird" seats leads to short term decisions that have very bad long term consequences.

The second clue that the website provides about how Alaska has worked itself into this situation is even more telling.  One of the things about the House website that holds promise is that it has a tab headed "Fiscal Gap," which attempts to explain Alaska's coming fiscal crisis and alternatives for dealing with it.

But then, precisely at the critical moment, the website -- and evidently the Committee, like the Legislature since 2006 -- goes soft and, just like the shortstop in the critical series, lets the hard liner go through its legs.  On the "Fiscal Gap" page, the Committee has a header entitled "What can be done" that lists various alternatives for dealing with -- and closing -- the Fiscal Gap.  The last two on the list are mirror images of the same step -- cutting spending (which actually is last on the list), and increasing savings.  Here is what the website says about cutting spending (which, of course, is necessary in order to increase savings):

"Budget cuts will likely be needed to address a fiscal gap, so it will be important to look for ways to cut out waste, trim non-essential services and find other ways to do more with less. However there is a limit to what can be done without gutting essential services that Alaskans rely on, and deep cuts are likely to slow the economy.

At the end of that paragraph there is a hypertext link that seeks to explain why "deeper cuts are likely to slow the economy."  That explanation is where things really spin out of control.  Here is the explanation given at the link (its long, but important; I have emphasized portions that provide the most significant insight):

Why not just cut the budget? 

Alaska’s operating budget has been increasing at about 9% per year for the last decade and is expected to continue on this path. Even with tighter budget control, the budget will need to increase as population increases and to adjust for inflation just to maintain current levels of service. Increases in future obligations due to an aging population are a part of fiscal gap calculations and one reason why Alaska is not alone in facing future budget woes. 

While deep cuts to state services could help the plug the fiscal gap, they would hurt the economy and Alaska families. State government not only provides needed services and infrastructure, it also plays a significant role in the state’s economy, directly employing around 7% of working Alaskans (24,000 people in 2011) and generating even more jobs by providing grants and contracts to the non-profit and private sectors and by being a major purchaser of goods and services from Alaska businesses. Without state funding some of those jobs will disappear. 

Often when people talk about cutting government spending they mean cutting out excess bureaucracy and paring back non-essential services. It will be important to find efficiencies and look for ways to trim waste, but there is a limit to what can be cut without cutting into basic services that many Alaskans rely on. Administration only accounts for 4% of the state operating budget. While there may be efficiencies that can be found, administration cannot be gutted since it includes core services like IT and telecommunications services, accounting and payroll that state agencies need to operate. 

In past years, the state has cut the capital budget when short-term deficits have occurred in years of low oil prices. Cutting the capital budget provides immediate savings but is a short-term fix that has its own negative impacts, such as higher future costs due to deferred maintenance on public buildings. Cuts to the capital budget also impact general contractors, engineers, and people working in the trades throughout Alaska who contract with the state to plan and build infrastructure projects. Maintaining public infrastructure, including roads, bridges, ferries and public health clinics is a core function of government that no one else is going to pay for if the state doesn’t do it. 

Budget cuts impact people differently. Cuts to education impact children and families, while cuts to the capital budget impact the Alaskans in the construction industry, and cuts to health and human services impact people with fewer resources. In one way or another, state spending improves the quality of life for all Alaskan. We are used to receiving high levels of service from our government. In a recent statewide telephone survey, Alaskans from all political parties chose maintaining state services over balancing the budget for nearly all state services.

I will write much, much more about the positions taken in this tab in future pieces, but for now let me briefly make three points.

First, the focus on the role of "government" as a source of jobs ("[w]ithout state funding some of those jobs will disappear") is something that one would ordinarily expect to hear from the far-left wing of the Democrat party, not a committee composed primarily of Alaska Republican House members.  What happened to the usual -- and economically sound -- principle that government should leave the role of job creation -- and more importantly, picking economic winners and losers -- to the private sector, and limit taxes in order to permit the private sector to create those jobs and make those choices?  This rhetoric sounds much more like that which justified the federal government's recent economic stimulus packages than anything normally associated with "fiscal conservatives."

Second, the size of the budget -- which the Committee now appears to argue cannot be cut without "hurt[ing] the economy and Alaska families" -- is a recent phenomenon.  As I explain elsewhere:

Prior to FY 2008 – the first budget of the Palin/Parnell Administrations – state spending levels were relatively moderate. During FY 2004 – 2006, for example, General Fund spending was only (.pdf) $2.3 billion, $2.3 billion and $3.0 billion. From FY 2008 forward, however, state spending has exploded. The comparable numbers for FY 2008 – 2013 are as follows (.pdf): $4.25 billion, $5.0 billion, $4.23 billion, $5.1 billion, $6.72 billion and $7.6 billion. While any one year might be excused as an anomaly, the succession of six such years in a row – and the fact that the numbers are escalating – leads to serious concerns about where the state’s fiscal policy is headed. 

In short, just six years after the fact, General Fund spending for this coming year alone (FY 2013) is budgeted to exceed the total amount spent in the three years from 2004 – 2006.

Certainly it isn't the case that the legislatures prior to 2006 were "hurting the economy and Alaska families."  Instead, what those legislatures were doing was balancing the needs of future Alaskans with those of current Alaskans.  The legislatures since 2006 appear to have abandoned that long-term view and focused increasingly only on pandering to the needs of current Alaskans.  The Legislature -- and the Committee -- should be concerned equally about both the current and future "economy and Alaska families."  Their comments provide a valuable insight into the fact that they aren't.

Third, the last sentence from the website -- "Alaskans from all political parties chose maintaining state services over balancing the budget for nearly all state services" -- is just nonsense.  Of course, current Alaskans choose to get as many government services as possible.  Government services to current Alaskans appear to be a "free good" -- Alaskans don't pay for them in the form of income, sales or even significant property taxes; someone else pays the costs.  As long as they don't have to pay for them, consumers always want "free goods," and the more of them they can get, the better.

Whether Alaskans want those free goods to continue isn't the right question to be asking.  As the ISER studies make clear, the goods in fact aren't "free," but are being paid for by future Alaskans by depleting the savings that they will need to maintain spending once oil winds down.

Thus, the right question to ask is whether Alaskans want more -- and more -- of those goods and services now at the expense of them having access to the same level of goods and services in their retirements, and their children and grandchildren during their lives.  That is the real question raised by the spending levels recent legislatures have approved.

It may be that current Alaskans planning on leaving the state in the next few years to spend their retirement elsewhere, and whose children have left the state and don't plan on returning, will continue to answer "yes."  But are those the people about whom the Legislature should be concerned?  I would suggest not.

If instead of asking current Alaskans whether they want to continue to receive free goods, the Committee asked whether current Alaskans want to do so at the expense of their -- and their children's -- future, my strong guess is that those who intend to remain in Alaska would provide a much different answer than what the Committee has assumed.

The simple fact is that future Alaskans can't afford the level of government services that current Alaskans are receiving.  The failure of the Committee to realize that -- and recognize that deep cuts are required in the level of government services being provided to current Alaskans in order to maintain a moderate level of government services to future Alaskans -- does much to explain how Alaska has worked itself into its current position.

In its press release, the Special Committee congratulates itself on the website being "visually stunning."  I don't disagree; its a bright, shinny new toy.  On the substance, however, the Special Committee has muffed the fly ball.  Instead of helping to explain to Alaskans that there is a need to become serious about retrenching the budget, the Special Committee instead tells them that Alaska is in the "cat-bird" seat currently, and doesn't have to -- indeed, shouldn't -- worry much about cutting the budget going forward.

Frustrating ...

Two news articles last week in the Anchorage Daily News caught my attention, and in combination, crystallize one of my significant frustrations with Alaska oil and fiscal policy.

The first, "State collects $170B in oil revenue over 35 years," reports on a recent study by the University of Alaska Anchorage's Institute for Social and Economic Research ("ISER").  That study, "TAPS at 35:  Accounting for the Oil Revenues," concludes that "Oil-wealth spending—both revenues related to production and earnings from funds created by those revenues — [has] accounted for 90% ($159 billion) of total [Alaska] state spending since 1977. ... The share [of General Fund spending supplied by oil revenues] in 2012 was 92%—the highest it has ever been."

The second article, "Parnell administration seeks to hire oil taxes consultant," reports that "The Department of Revenue is soliciting proposals for a consultant to provide expert economic analysis. The consultant will be asked, among other things, to identify issues with the current oil and gas tax structure that might limit industry investment in the state and to make recommendations for improving the existing system."

Reading both articles together reminds that Alaska's economic present and future is tied inextricably to oil, but at the same time that Alaska also is dependent on Outside consultants for developing its oil policy.  In my view, relying significantly on Outside consultants to set oil policy has been and continues to be a recipe for failure.  The state's continued reliance on that source of advice is seriously frustrating.

In many ways Alaska is unique economically, politically and with respect to many of the factors that affect oil investment and development.  It takes time (measured in years, not weeks or months) to learn the subtleties.  It also takes total immersion in order fully to understand the significant nuances that affect Alaska oil investment and development; occasional trips to the state barely scratch the surface.

In my view, a significant contributor to Alaska's inability to develop a coherent oil policy over the last several years has been the lack of in-state expertise focused on understanding Alaska's place in the world and developing -- and explaining to its citizens -- a successful, long-range plan for continuing to attract oil investment and development based on local knowledge.  Instead, Alaska has attempted to develop its approach to the industry based on a series of periodic recommendations made by a continuum of Outside consultants operating under short term contracts, some of whom have a significant understanding of the industry, but few of whom have developed anything more than a cursory understanding of Alaska.

Occasional -- and often inconsistent -- plans developed by Outsiders unfamiliar with Alaska have resulted in confused and often unrealistic proposals. Even when realistic, the proposals have lacked credibility because they are perceived to favor one side of the debate -- the side that hired the consultant -- or because the author is viewed as a short timer with an insufficient understanding of Alaska, or both.

Moreover, the authors of such recommendations have little incentive to develop more than a short term view. They have been hired by this Administration or that, or this Legislature or that, sometimes with implicit guidance about the recommendations they have been hired to develop and knowing, at the end of their contract, they will be on to the next project in another location and unburdened by living with the results of their proposals.

As a result, there has been little opportunity -- or reason -- for them to invest the time it takes to develop the long range, holistic view of Alaska necessary to develop real and sustainable solutions for the state.

Two years ago I encouraged Senator Lesil McGuire to introduce a bill to address this situation, by setting up a permanent, ongoing commission composed of a broad range of Alaskans designed to continually assess and make recommendations regarding Alaska's oil policy.  Basically, I argued that if "its Alaska's oil," then Alaskans need to develop the expertise sufficient to guide its development.

She responded and the result was proposed Senate Concurrent Resolution No. 4.

That Resolution would have established an “Alaska Oil and Gas Competitiveness Review Task Force,” an ongoing, non-partisan body composed of members of the Legislature, Administration and public, with the power to hire staff and develop and monitor on an ongoing basis a long-term oil & gas policy for the state.  The task force could have retained Outside experts, but their role would have been limited to educating the task force on world oil factors.  The task force itself would have been charged with developing the recommendations.

The result would have been Alaskans developing the expertise and making the recommendations necessary to develop a long term oil & gas policy for Alaska.  As I said at the time, "[i]f adopted — as it should be — the resolution has the potential to become one of the most significant pieces of long-term legislation passed this session."

By the end of the 2011 session, the resolution had evolved into Section 4 of the Draft Committee Substitute for S.B. 85, and in recognition of its intended long term life, the proposed body had been retitled as the "Oil and Gas Competitiveness Review Board."  The purpose and intended operation of the body remained the same as it had in the earlier Resolution.

That is where the story ends, however.  S.B. 85 did not make any further headway during the 2012 session and died, along with other unpassed legislation at the end of the session.  Meanwhile during the 2012 session, the Legislature went on to pass the biggest General Fund budget in Alaska's history and put an even greater strain on developing a coherent oil policy.

As I have written elsewhere, "it appears that Alaska’s most recent generation of political leaders ... is leading Alaska off the fiscal cliff."  Those leaders should look for ways to avoid that result; one of those ways is to develop a mechanism for creating -- and utilizing -- in-state expertise on oil policy.  Continuing to rely on Outside consultants to develop the way forward for Alaska will continue to travel down a dead end road.