How does she say this with a straight face ....

In her recent newsletter to constituents Rep. Lora Reinbold had this to say about the recent legislative session:

Fiscal Responsibility

The legislature approved an operating budget of $9.1 billion in total funds in state services and programs.  Non-formula agency operations, what most people think of as "state government" operations, were reduced by $52.4 million in unrestricted general funds (UGF) from FY14, a 2.2 percent reduction.  In addition, the FY14 capital budget also was reduced by $250 million in general fund spending.  Last year we held the line, this year we turn the tide.

In years to come the appropriations of state funds must be reduced in order to put Alaska on a long term sustainable path.  We would like your input on reducing state funding.  Please contact me with any suggestions you may have.  [Bold and italics added.]

I am not sure what "line" Rep. Reinbold has in mind that she held this past session, but it certainly wasn't a fiscally conservative one.

In its two years (2013-14) the 28th Legislature passed -- and the Governor signed -- budgets that represent the two largest spending deficits in Alaska's history (FY 2014: $1.9 billion, FY 2015: $1.67 billion). More importantly, combined with its actions on PERS/TRS in two short years the Legislature drained $6 billion (or 35%) of the $17 billion in the state's savings accounts that they found when they walked in the door at the beginning of their term.

By engaging in those practices, the Legislature dramatically has lowered the long term sustainable revenue level (the level of annual revenue which future generations of Alaska would have available to spend if the current generation limited their spending to the same level) from $5.5 billion, a level at which this generation could have left a strong legacy for future generations, to $4.75 billion -- an astounding drop in just two short years of $750 million (that's three-quarters of a billion dollars) in the promise of annual revenue for future Alaskans.

Accounting for those actions, the legacy that the current generation of Alaskans are on the path to bequeath future generations is one which the University of Alaska-Anchorage's Institute of Social and Economic Research (ISER) has said will be characterized by “institution of a broad based [sales or income] tax and use of a portion of the earnings of the Permanent Fund” — in other words, taxes and a reduction in the PFD.

As I have explained elsewhere, far from holding any sort of "line" this Legislature in fact was "the most fiscally reckless in Alaska’s history." If indeed there was any sort of line involved, it was the legislative equivalent of the infamous Maginot Line, the defensive line that the French built at considerable expense after World War I in order "permanently" to deter German aggression, but which the Germans subsequently skipped around in a matter of mere weeks at the beginning of World War II.

A more accurate version of a report to constituents covering the past session on this issue would have been this:

The truth is that we failed at being fiscally conservative these last two sessions.  While we reduced spending some, revenues fell faster resulting in substantial deficits that we did not adequately address.   Regrettably, the deficits have also eaten away significantly at the long term sustainability of current levels of state spending.

I know that I promised constituents during my campaign to vote against unsustainable budgets, but early on I decided to join the Majority Caucus which required me to commit to vote in favor of whatever budget was approved by the House Finance Committee and, ultimately, prevented me from keeping my commitment to my constituents.  I recognize that my commitments to my constituents should come first and won't be making that mistake again.

  We have some hard choices ahead.  We need to significantly reduce spending -- by over a billion dollars more (or nearly 20%) -- this coming year in order to repair the damage that has built up over time and culminated in the bad decisions of the last two years.  But in my opinion we have to do it.  If we don't, we likely are going to face in the very near future, and certainly will leave to future Alaska generations, the need to adopt broad based (sales and income) taxes and use a portion of the earnings from the Permanent Fund just to maintain a moderate level of state services and spending.

Reducing spending at that rate will require all of us in the legislature to step up and make very hard decisions, and I will need your support and efforts to prevail on my colleagues to join me in those decisions.  I recognize that I may not succeed, but I commit to you I will cast the vote you have entrusted to me in the legislature in support of that effort and that I will not put myself again in a position where I am prevented from doing so.

But that's not what she wrote.  Instead, she substituted a rhyme that was on par with "no decline after '99" (some of you will remember that), which turned out to be about as equally factual.

The last Legislature dug a very deep financial hole, with long term implications, that future legislatures are going to need to work very hard to offset.  That effort needs to start with telling constituents the truth instead of making up stories about "lines" that never existed.  I hope that she does better in future newsletters or if she can't bring herself to do it, that her constituents start looking around for someone that can.

My first legislative contribution of this election year ...

While I anticipate I will make others as the various candidates start to better define their positions, yesterday I made my first, issue based legislative candidate contribution of the current election year.  

The candidate is District 19 (Mountain View/Airport Heights) Libertarian candidate Cean Stevens.  The reason I have added my support is because of her stand on fiscal issues.  Her platform on that issue is clear and concise:

STOP Runaway Spending: 

In the past two years the state legislature has engaged in severe deficit spending, in the process draining $6 billion of the $17 billion in state savings that existed in 2012.  The University of Alaska-Anchorage’s Institute of Social and Economic Research (ISER), the state’s think tank, has predicted at the current rate of state spending Alaska “does not have enough cash in reserves to avoid a severe fiscal crunch soon after 2023, and with that fiscal crisis will come an economic crash.”  What can we expect when the state reaches that point?  Again to quote ISER, the “institution of a broad based [sales or income] tax and use of a portion of the earnings of the Permanent Fund,” in other words, taxes and a reduction in your PFD. 

My opponent in this district voted for each of those budgets and, in fact, for amendments that would have increased spending even beyond those levels and thus, for an even a deeper raid on your future PFD. 

I commit to working to change the downward spiral the state is on while there is still time, by voting against any future spending in excess of sustainable levels and for the immediate transfer of the remaining $11 billion in the state’s savings accounts into the Permanent Fund where it will be protected by the state constitution from further government raid.  And, I will not join any legislative caucus which limits my ability to make those crucial votes.  Just as we do as families, Alaska needs to learn to live within its means and stop the raid on our economic future, including on our future PFD’s.  Any other approach heads us toward an economic train wreck.”

While others in past and in the current election cycle have claimed to be "fiscal conservatives," Stevens' commitment is different in two critical respects.

First, she has committed to voting against any future spending in excess of sustainable spending levels. Second, she has committed not to join any legislative caucus which would limit her ability to fulfill the first pledge.

In the past some candidates have sort of made the first commitment, but it has turned out to be meaningless without the second.  Why?  Because under the rules of the legislative caucus they have joined, they have committed from the outset to vote on the floor for whatever final budget emerges from the Finance Committee.

The result is that while they have talked a good game during the campaign about how they would cast their vote on fiscal issues, by joining the caucus they essentially gave their vote to legislative leadership when it came down to crunch time.  And how did legislative leadership perform at crunch time?  Here is the take on it from the Alaska Business Report Card, prepared jointly by the Alliance, RDC, Alaska Chamber and Prosperity Alaska:

... as with the House Majority and the Governor, the Senate Majority allowed unsustainable unrestricted general fund spending. ... the State’s fiscal cliff looms large. As a result, the grades of the members of the Senate leadership team (President, Majority Leader, and the co-chairs of Finance and Rules chair) [and House leadership team, Speaker, Majority Leader, co-chairs of Finance and Rules chair] were downgraded.

The net result is that while the candidates have talked a good game up front, they have failed to match their words to actions when the rubber met the road.  By delegating the vote their constituents entrusted to them to others, their vote has ended up being directed in other ways than what they told their constituents.

Stevens is different because she has committed up front not to join a caucus, if doing so puts her in a position where her vote may be used to support other than a sustainable budget.

Making that commitment takes courage.  She may get less help during her campaign from those who benefit from the current caucus system than if she indicated she was willing to join a caucus.  And it may be, if elected, she will have fewer privileges than other members who join a caucus -- at least until more join the same cause.

But unlike others, she will be positioned to meet the commitments she makes to her constituents during the campaign.

Frankly, as long as the current system operates to produce unsustainable budgets eating away at the fiscal position this generation is handing down to the next I think Stevens' approach may be the wave of the future, not an isolated event.  As constituents realize more and more that the legislators they elect based on the statements they make are in fact delegating their vote to others once they reach Juneau, I believe voters will reward candidates like Stevens who are willing to do what it takes to fulfill their pledges rather than "go along to get along."  As other candidates realize that is the will of the electorate, they will act like Stevens and adopt similar commitments to put their constituents first.

Cean Stevens is the first to step out on this issue.  It takes courage and it takes a commitment to putting her constituents first.  She is doing both and as she puts it, "standing up for what's right."

I am proud to support her in that effort, urge others to do the same to reward that level of commitment, and frankly urge other candidates to consider doing the same in their campaigns.

Working to understand global "Best Practice" ...

In a previous column on the main page I discussed a fact-finding mission to Norway arranged by the Institute of the North to meet with various components of the Norwegian government responsible for the development of Norway's oil and gas resources.  As is largely the case with Alaska, there the oil and gas resource is owned by the government and the resource is managed to produce the maximum benefit for its citizens.  The meetings are at the end of next week, June 19 -20 in Stavanger and Oslo.

As I said in the original column, Alaska may have something to learn from Norway's approach.  "By partnering with industry, Norway has both successfully slowed the decline curve in oil and gas production and successfully developed a global gas and LNG industry. In addition, Norway is maintaining a strong exploration program at a time that, even under SB 21, Alaska’s continues to struggle."

Central to Norway's approach is co-investment by the government along side industry in development of the state's oil and gas resources.  Under the approach the state takes a direct financial interest (what the government terms a State Direct Financial Interest or "SDFI") throughout the value change, from the field through the midstream and marketing.  As I have explained previously, this delivers a number of benefits that Alaska's more passive, royalty based approach does not.  The state's financial interest is held and managed through a non-political corporation named Petoro that is similar in many respects to Alaska's Permanent Fund Corporation.

In preparation for the meetings I have developed a set of questions to help focus the discussion and my thought process.  I share them here to provide an opportunity for readers of these pages to provide additional thoughts.  As some readers may anticipate, a number of the questions follow up on meetings that occurred on an earlier fact finding mission to Norway sponsored by the Institute.  For background, a number of the results from those meetings are captured in a previous column available on these pages ("Legislative Presentations on Norway Oil & Gas Policy").

I would note that, if anyone is so inclined, the opportunity remains to add one or two to the meetings.  Anyone interested should contact Nils Andreassen, the Executive Director of the Institute at phone: (907) 786-6324, or email: nandreassen@institutenorth.org.

If you have thoughts about the questions, or additional questions that you believe are worth exploring, please do not hesitate to leave them as comments to this column, or email them to me at bgkeithley@keithleyconsulting.com.

The questions:  

Background: Alaska historically has used a royalty approach to upstream activities on state lands. The government is in the process of evaluating whether to become a co-investor in the midstream sector, but preliminarily maintaining a royalty approach in the upstream sector. The purpose of a number of the following questions is to evaluate the benefits also of becoming a co-investor (undertaking a "State Direct Financial Interest" or "SDFI") also in the upstream sector and, if so, how to transition from the royalty approach. Other questions are intended to identify other steps that the government takes which appear to have the effect of directing exploration and development dollars to Norway that otherwise might go elsewhere (i.e., improve its competitive positioning).

1. Effect of SDFI on oil & gas exploration and development.

a. Has SDFI resulted in more oil & gas exploration and development in the Norwegian sector than would have occurred under a royalty approach? If so, why and are there any studies on the issue.

b. Has Petoro resulted in more oil & gas exploration and development in the Norwegian sector than would have occurred under continued Statoil management of SDFI? If so, why and are there any studies on the issue.

c. Would the effect on oil & gas exploration and development have been different if SDFI had been limited to midstream investment (pipelines and liquefaction plants) and a royalty approach had continued in the upstream sector?

2. SDFI.

a. What were the reasons for the change in the government’s approach from taking a royalty interest to SDFI? Was there at the time (or has there been since) any analysis of whether government revenues under SDFI have been greater or lesser than they would have been under a continued royalty approach?

b. How did the government handle the transition from royalty to SDFI for fields that originally started with a royalty interest? How was the SDFI interest in those fields determined at the time of the transition?

c. How did the government fund the transition from royalty to SDFI (i.e., how did it fund the working capital required to pay for the first few years of SDFI until the investments went cash flow positive).

d. How does the government determine what the SDFI percentage will be in each field? What role does Petoro play in that decision process?

e. What consideration, if any, is given to production tax rates in the determination of the SDFI percentage?

3. Operations of Petoro.

a. How is Petoro organized? Does it supplement staff with the use of outside consultants and, if so, for what?

b. How is Petoro’ s overall budget set? How does it decide on which projects to fund?

c. How does Petoro interact with the other license holders? Is it included on the operating and other committees, and in all meetings as the private investors?

d. Are there any limitations on the manner in which Petoro may use the data derived from its involvement on those committees. What confidentiality provisions apply to the data?

e. Is Petoro able to propose projects to the other licensees? If so, are its proposals given any special status, or are they treated the same as if made by any other non-operator? Is there a usual percentage required under the relevant operating agreements for projects to proceed? Does the NPD or other agency have the right to require licensees to pursue a project that otherwise has not received the required vote? 

f. How does Petoro market its share of production?

g. What steps does Petoro take that it believes helps drive investment dollars to Norwegian projects that otherwise might go elsewhere?

4. Other issues

a. How are license areas identified and licensees determined? What are the selection criteria? 

b. What policies or steps does each agency take (Ministerial, NPD, Petoro) that it believes are key to helping drive investment to Norway over other areas. What role does tax policy play in that? 

c. How have tax rates been set and what analysis was done to determine the effect on investment levels?

UVA Law and Alaska ...

Click here for article.

The feature article in the Spring 2014 edition of the UVA Lawyer focuses on the effects of climate science on law and business:  Beyond Policy:  How Climate Science is Changing Law and Business.  I am proud to be included as part of the discussion with the opportunity to talk about the effect of climate issues on Alaska in general, and oil development in particular.  In some ways it is an opportunity to follow up on an earlier piece in UVA Lawyer on energy policy in which I participated four years ago.

The article does not try to solve the debate around the causes and appropriate responses to climate change.  Instead it focuses on the ongoing impact of that debate on law and business.  As UVA Law School Dean Paul Mahoney says in his forward to this edition, "while academic researchers can wait to draw conclusions until we have adequate evidence [about the causes of climate change], lawyers and clients do not have that luxury. They must anticipate and adapt to evolving regulations and even shape industry standards."

As demonstrated by the increasing use of the Arctic and its waters, Alaska is on the cutting edge of climate evolution, regardless of its cause.  As I am quoted as saying in the article, there have been "three 'huge changes' in the [oil and gas] industry" since I graduated from the Law School.

First, the end of the Cold War opened access to many areas of the world, notably China, the Soviet Union and large parts of Africa.  Second, advanced technology allows the industry to develop resources that it previously never considered.  And the third, the advent of development in the Arctic. 'It's the emerging story of untapped resources.  But it's very challenging trying to access it in the right way to minimize risk and avoid huge costs.'

I have been fortunate to be a part of the legal, regulatory and commercial response to all three developments. It is an honor to be included in an article discussing the most recent, certainly the most challenging, and most importantly, the most significant to Alaska of the three.

The Anchorage Daily Planet gets it very, very, very wrong ...

Generally speaking I like the Anchorage Daily Planet.  Powered largely by Tom Brennan and Paul Jenkins, the Planet usually is a good source of information and opinion.

But a recent unsigned editorial got things very, very, very wrong.  The editorial -- entitled "Right Direction" -- praises the Governor and this year's legislature for the outcome of this year's budget.

Gov. Sean Parnell signed a $12.8 billion budget that happily reduced unrestricted general fund spending from the $7 billion of last year to $5.9 billion this year – and he did it without deploying his veto pen once. It is a start. 

With declining revenues and dwindling oil production a growing economic problem, at least for the short-term, the shrinking budget is a good sign. For his part, the governor gave credit to the legislative leadership for its frugality.

The problem with the editorial?  It is premised on the wrong facts.

The budget approved this year is not $5.9 billion; in fact it is $6.17 billion.  As I have explained elsewhere, the Governor claims its a lower figure only by leaving out a category of cost.

But that is only the tip of the iceberg.  While it is true that spending has been reduced over the last few years, revenues have fallen faster than spending.  As a result, deficits -- the difference between current revenues and current spending -- have grown dramatically.  In the last two sessions (2013 and 2014) the Legislature has approved and the Governor has signed back-to-back budgets containing the two largest deficits in Alaska's history.

And even that doesn't tell the full story.  In addition to running record deficits the last two years, this year the legislature also approved the transfer of $3 billion from the Constitutional Budget Reserve (CBR) to the PERS/TRS account, dramatically reducing the level of state savings.  Combined with the deficits, the result is that in two short years this Governor and Legislature have drained 35% out of the state's two primary savings accounts, leaving less than $11 billion of the $17 billion in the accounts that existed at the beginning of the 28th Legislature.

The editorial seems to take comfort from a previous study by the University of Alaska’s Institute for Social and Economic Research, which estimated that "the state could afford to spend about $5.5 billion a year in unrestricted general fund money over the long haul."

But that study was premised on the level of the state's "nest egg" as it existed before the start of the current Legislature -- in other words, before $6 billion was drained out of the state's two primary savings accounts.  After the first session of the Legislature -- and the first record deficit year -- ISER revised the number from $5.5 down to $5 billion.

Next year's sustainable spending number, which will be based on an even lower "nest egg" as a result of this year's budget and the PERS/TRS related transfer from the CBR, will likely be in the range of $4.75 billion.  Using that as a base, even using the Planet's own logic no congratulations are due to a Governor and Legislature that just approved $6.2 billion in spending.  The resulting gap between "sustainable" and actual spending levels is as high as it was when the budget was at $7 billion.

There is good reason why the Alaska Business Report Card downgraded both the Governor and legislative leadership at the end of this Legislature.

Governor Parnell has been far less successful in trimming the size of state government and reducing its unsustainable unrestricted general fund spending. ... the State’s fiscal cliff looms large. Alaska needs more leadership from the Governor on this very important strategic issue. We hope he will step up to that need with some significant vetoes in the FY2015 operating and capital budgets, together with a clear message explaining the need for them.

 The Governor didn't do it.  The existing business community -- and in my experience, investors looking at the coming fiscal gap being created by the state's ill advised fiscal policy -- are clearly and deeply concerned.  Hopefully, once the Planet editorial board better educates itself, it will be as well.  If not, by encouraging this Administration's continued spendthrift policies, the Planet is just as dangerous to the state's future as the "leftist" view on SB 21 it disdains.

____________________________________________
Note:  To their credit, this column was republished here by the Anchorage Daily Planet on June 6, 2014.

Short Takes| Before we (Alaskans) start complaining about EPA's new "existing power plant" regulations ...

... take just a moment to consider that one of the greatest beneficiaries of the new rules is natural gas.

Why is that important to Alaska? Even though Alaska gas is not headed directly to the L48 market, at the margin increased L48 demand will reduce the extent of the L48 gas surplus looking for alternative markets (in competition with Alaska LNG) and help support L48 price, which, again at the margin in an increasingly interconnected world, will help support global price levels. In short, a rising tide (or in this case, gas demand) lifts all boats.

 For more background see "Obama Said to Propose Deep Cuts to Power-Plant Emissions," Bloomberg (June 1, 2014) and "Obama EPA Issues Coal-Killing Rules To Cut Carbon Emissions 30 Percent," Forbes (June 2, 2014) ("The effect of the rule will most likely be the dramatic expansion of natural gas as a fuel for power generation").

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