Wednesday, December 3, 2014

What to look for first in the Fall Revenue Sources Book ...

Sometime in the next few days the Department of Revenue (DOR) will publish this year's version of the Fall Revenue Sources Book, a history and forecast of the state's revenue picture that is a much anticipated annual event by those who care about these things.  When published the Book will be available here.

This year the first thing I will look for when the Book becomes available -- and what I would suggest others do as well -- is the oil price forecast on which the projections of current and future revenue are based.  Unlike in most other years when oil prices have remained relatively stable, that is going to be a tricky thing this year and will greatly affect the usefulness of the forecasts made in the Book.

As Dermot Cole reported at the time ("State budget deficit swells as oil prices swoon, challenging the oil oracles"), the price forecast contained in the Book usually is the result of an exercise conducted in early October.  Unfortunately for this purpose, this year October fell right in the middle of what many now are considering a paradigm shift in the oil markets.

To provide perspective, the following is the price of oil produced from the Alaska North Slope (ANS) over the last several months, as reported by the state here.

Jul 1, 2014:           $111.56
Aug 1, 2014:         $103.52
Sept 1, 2014:         $ 97.06
Oct 1, 2014:          $ 91.28
Nov 1, 2014:         $ 80.44
Dec 1, 2014:         $ 69.86

To highlight the issue, the oil price on October 1 -- about the time of DOR's price forecast exercise -- was roughly $91/bbl; now it's roughly $70/bbl, 25% lower.

The magnitude of the change in price over such a short period has caught many by surprise and resulted in a game of catch up throughout the forecasting community as the reasons behind the shift have become more apparent.

For example, in its October Short Term Energy Outlook (STEO), published at about the same time as DOR was conducting its price forecast meetings, the federal Energy Information Administration (EIA) predicted in 2015 Brent and WTI would average $102 and $95/bbl, respectively.

Reflecting on another month of data and a much better understanding of the forces at work, however, the November STEO substantially revised the 2015 forecast, revising EIA's estimate of 2015 Brent downward by nearly 20% to $83/bbl, "$18/bbl lower than forecast in last month's STEO."  The December STEO is due December 9, six days from now, and many are now predicting yet another downward adjustment in the 2015 forecast.

Alaskans -- particularly the new Administration and Legislature -- should be wary of the resulting future revenue projections contained in the Fall Book if, as anticipated, DOR uses a price forecast based on the price levels in the $90's or even high $80's prevalent or anticipated at the time the forecast was made. Budgets and decisions based on those projections will expose the state to continued deep calls on the state's savings if substantially lower oil prices, now forecasted by others using more current data, remain the norm.

There is precedent in previous years for redoing the forward looking part of the forecast when, as is occurring here, there are significant shifts in oil markets between the time the data is prepared and decisions based on it are to be made.  In 2008, for example, a "Preliminary Spring" forecast was prepared when the numbers prepared the previous fall were overtaken by events.

The Administration and Legislature should consider asking DOR to do the same thing here if, as anticipated, there continues to be a wide divergence between what the Fall Book forecasts and other, similar agencies are saying based on more recent data.  This coming legislative session and budget are going to be difficult enough.  They shouldn't be based on outdated data.