Wednesday, December 10, 2014

A second "Alaska disconnect" ...

As the state budget increasingly has grown over the last several years to unsustainable and record deficit levels I have spent more and more time focusing on what economists and others refer to as the "Alaska disconnect".

As explained in an exceptionally good primer on the Alaska economy by UAA Professor and ISER Director Gunnar Knapp, "An Introduction to the Economy of Alaska," the "Alaska disconnect" is this:
Alaska’s fiscal structure—specifically the fact that Alaskans do not pay any significant broad-based taxes—leads to a problem which has become known as the “Alaska Disconnect.” 
If economic developments creates more jobs, Alaska’s population grows. As the population grows, Alaskans need more schools and teachers for their children and the other services that state and local governments provide. 
Although the new Alaskans pay local sales and property taxes which support local services, they don’t pay broad-based state taxes to cover the cost of state-funded services such as education and roads. 
The new jobs create new costs for the state but not corresponding new revenues. As a result, except for oil development (which pays high state taxes), many kinds of economic development make the state’s financial situation more difficult.
A news story this past week suggests we also may be seeing the emergence of a second Alaska disconnect -- where even continued success in oil development does not guarantee the health of the state's fiscal situation.

The news story is a KTVA report on the potential effects of the oil price drop on the Alaska oil industry ("Oil projects in Alaska still on track despite declining prices").  The report quotes Kara Moriarty with the Alaska Oil and Gas Association, whose member companies represent most of the oil industry, as saying "Alaskans shouldn’t panic just yet. [Price fluctuations are] the nature of the business."  Even at lower prices, "Moriarty predicts 2015 will be 'a very positive year,' due to new projects and new investments."

But that is where the new, second "Alaska disconnect" comes in.  Because of significant increases in state spending levels over the last five years, even if the oil industry is able to continue to do well at lower oil prices, the state is not.

The reason that oil companies are continuing to invest even in the face of lower prices is because they have positioned themselves to continue to operate at lower price levels.

For example, BP Chief Executive Bob Dudley recently said “We have only sanctioned or approved projects based on an $80 oil price. ... “We’ve been doing that three or four years so there isn’t any project that we’re working on today, particularly those big capital projects, that we have any different view of.”

Exxon has been even more cautious.  Recently in an appearance on CNBC, CEO Rex Tillerson said that "because many of the company’s biggest projects take years to complete, Exxon Mobil tests its investment across a range of prices between $120 and $40 per barrel.  'All of the investment decisions we take have been tested across a range of pricing that accommodates these types of price swings. ... What you do is ensure that you can be successful at the bottom of the price swing.'”

The industry also is well positioned to make even further adjustments if necessary to maintain profitability lower price levels (see "Oil price drops:  don't panic, really").

Alaska is not, however.  At the beginning of Sean Parnell's run as Governor (FY 2011) the Alaska budget balanced at $78 oil.  During his term, however, he and the legislatures serving with him have allowed the budget to get away from them.  The current year budget, FY 2015, requires more than $117 oil to balance.  The "work in progress" FY 2016 budget that Parnell left for incoming Governor Walker requires $120 oil to balance.

Because of that difference between "break even" price levels, Alaska no longer is positioned to do well simply because the oil industry is able to continue to thrive.  As Alaska has allowed its budget to spin further and further out of control, it has put itself in a different position than the state's industry, one much more exposed to price downturns.

As a result, while Moriarty might be right about the industry -- and that Alaskans "shouldn't panic just yet" because the industry is positioned to weather the downturn -- the same does not apply any longer to state finances.

The industry and state have become disconnected.  At these price levels continued health for the industry does not mean continued health for state government.  Alaska state government simply has grown too large.