Friday, October 24, 2014

Alaska's Fiscal Situation: How bad it may become ...

As those that follow these and the related micro-blog pages (largely, here and here) know, over the past few weeks I have been closely watching the decline in oil prices, delving into the fundamentals (such as the oil price necessary to support the budgets of the various petrostates), talking to those that know these things better and trying to get a handle on where this situation may be headed.

The reason, of course, is because, like other petrostates, Alaska depends heavily on oil revenues both to run state government and to help drive its economy.  As the various articles I have discussed on these pages and elsewhere make clear, the price drops are real and, in other petrostates similarly dependent on oil revenues, are being treated with serious concern.

Thusfar in Alaska, however, the concern has been limited to the odd article here or there.  Early in the month -- when it appeared that oil prices might stabilize in the neighborhood of $90 -- Tim Bradner wrote a column which analyzed the potential effect on state revenues at that level ("North Slope prices down $20/barrel since July").  A week ago Dermot Cole wrote an article outlining some of the potential effects on the state of a deeper and more persistent drop ("World oil price decline creates multibillion-dollar budget risk for Alaska").  And this morning, the Juneau Empire is running an article by Katie Moritz that carries some reaction from the Parnell Administration about the potential effect of the price drop on state finances ("Slumping oil prices means widened budget gap").

But thusfar, most political leaders have looked like they are engaged in a game of dodge ball when the issue has arisen.  Yesterday morning, for example, Michael Dukes asked me at the end of a discussion between the two of us on his morning talk radio show what one question I would ask Gubernatorial candidate Bill Walker -- who was coming up in the next segment -- if I had the opportunity.  Following up on a column I had written on these pages a week ago ("The most important question of this election …."), I said the question I would ask was something along the lines of, "What steps will you need to take to govern in a world of $90 oil".  While Walker was complimentary of these pages in his response, he never actually got around to answering the question, nor for that matter has Governor Parnell or any of the legislative candidates I have asked or heard asked the same question over the past few weeks.

The fact is, however, I have become increasingly convinced "how does Alaska deal with $90 (or lower) oil" is going to be the key question that not only the state's political leaders, but in fact most Alaskans are going to be forced to confront at least over the next year.  

The size of the problem the state potentially is facing is staggering.  To start putting my arms around it, over the last couple of days I have put together a spreadsheet that analyses what happens to this year's budget at various oil price levels.  There are a couple of caveats that are important to keep in mind when reviewing the preliminary results.

First, it is important to keep in mind that the actual price which ultimately will determine the outcome will be the volume-weighted average price for the fiscal year (July 1, 2014 - June 30, 2015) as a whole.  Although experienced during low production months, the prices received for ANS stayed above $105/barrel through most of the first month of the current fiscal year, at or above $100/barrel for most of the second and at or above $90/barrel for most of the third.  Prices have fallen below $90/barrel since that time, however, closing Wednesday at $81.42/barrel and if that defines a new normal for the remainder of the fiscal year, the weighted average is much more likely to be in the $80's than anywhere else.

Second, it is important to keep in mind this quick look may slightly overstate the adverse impact on the state budget at lower price levels.  The analysis uses the standard rule of thumb that each dollar drop in the price of ANS results in a commensurate drop of $90 million in state government revenue.  As a result of the flattening of the production tax rate at lower oil prices, the revenue impact may decline slightly as oil prices go lower.  Directionally, however, this chart correctly captures the relative impact on the budget of lower oil prices.

Reading left to right, the chart determines at the price levels listed in the first column and at the level of state spending enacted by the legislature and signed by the Governor earlier this year (second column), the resulting total state revenues (third column) and deficit (fourth column) that will result.  The fifth column (Percent Deficit) reflects the amount of total state spending that will need to be financed by savings, the sixth (Remaining Savings) reflects the combined amount of the Constitutional and Statutory Budget Reserves that will remain at the end of the year after they are tapped to cover the deficit and the final column the number of years that the state's budget reserves will be able to continue to fund deficits of the resulting magnitude before being exhausted.

Click on chart to enlarge.

So, for example, if oil prices for the year end up averaging $90/barrel, the resulting revenues will be somewhere in the range of $3.2 billion (against spending of $6.2 billion), the deficit $3 billion, the percent of the budget necessarily financed from savings 49%, the amount of the CBR and SBR remaining at the end of the year $9.8 billion and the years that the state can afford to continue down that path before exhausting its savings 3.2.

For someone that spends a lot of time looking at numbers like these, the results are scary.  Unfortunately, they also are what Alaska is about to face in the real world.