Tuesday, December 2, 2014

"Irrational exuberance" and the Alaska budget ...

Yesterday following the inauguration of his successor, former Governor Sean Parnell posted a farewell note of sorts to "Alaskans" which contained the following:
Budget Work Turned Over to New Administration
One of my last official acts included making sure a budget proposal was prepared for the incoming administration that is hundreds of millions of dollars lower than the current budget. The budget work I gave over to the Walker Administration includes about $700 million less in spending than a status quo budget. That means the budget proposal I put forward to the new administration currently hits a target of about $5.5 billion for FY 16 (down from status quo spending of about $6.2 billion). The budget work we turn over is a solid starting point for the new administration.
That was the first time I had seen numbers associated with Parnell's final budget proposal.  This morning I did some calculations to put that number in perspective.

At $5.5 billion, the proposed budget Parnell leaves behind is roughly equal to the first budget he had control over (FY 2011) when he began his run as Governor.  It also is the same level that ISER found would have been sustainable if held at that rate beginning with FY 2014.

The budgets in between his first and last, however, were considerably higher, in the aggregate spending in the intervening four years some additional $6.2 billion that otherwise could have been put into or retained in the state's nest egg if he had kept the budgets at the same level during his time in office.  The net result of that overspending is that the sustainability number plunged to $5 billion in FY 2015, and will be lower this coming year, even before factoring in the effects of the ongoing drop in oil prices.

The proposed budget also maintains Alaska's dependence on extraordinarily high -- and in the current oil price environment, vastly unrealistic -- oil prices.  Based on calculations done by the Legislative Finance Division at the beginning of each session, during Parnell's run as Governor the price of oil necessary to balance the Alaska budget escalated from $78/barrel for FY 2011 to roughly $120 for FY 2015.

While a more precise estimate can be made once the Department of Revenue publishes the Fall Revenue Sources Book in a few days, based on some preliminary analysis the proposed $5.5 billion budget appears to continue to require an oil price in the range of roughly $115/barrel to balance.  

In a world where the current price of oil is teetering around $70/barrel and the most optimistic forecasts go no higher than the $80's, continuing to base Alaska's budget on prices well in excess of $100 is the equivalent of what former Federal Reserve Board Chairman Alan Greenspan once termed in his day when talking about the stock market as "irrational exuberance."

To put it another way, at even $85/barrel (much less at current price levels) Alaska North Slope production for FY 2016 will need to exceed 1 million barrels/day in order to balance Parnell's final proposed budget.  At best, the likely projection of actual production for FY 2016 won't top half that.

Some have and likely will continue to argue that Parnell and the related legislatures acted prudently over the last few years in reducing the size of the Alaska budget.   But the cold, hard facts are that the budget spun out of control during Parnell's term and, even at reduced levels over the last two years, still has been far in excess of what Alaska could afford to spend.

Just as finally happened to Greenspan's irrationally exuberant stock market when it hit the wall in 2008, so has Alaska's budget come to a day of reckoning.

Former Governor Parnell has not done the incoming Walker Administration any favors in handing off a final proposed budget that still has not come to grips with the hard choices that Alaskans must face in light of current economic reality.  There is a long, long way to go before the Alaska budget returns to earth.  Hopefully, the new Administration and legislature will be up to the task.