Friday, November 18, 2016

Why some self-proclaimed "Alaska fiscal conservatives" aren't ...

Over the last few days we have seen several posts linking to the following article from an upcoming issue of Forbes. Alaska And Oil: A Lesson In Biting The Hand That Feeds You,

Based on the article, many of the posts claim that the Governor "reneged" on promises made by the state, or in some instances, that the Governor "violated the law" by vetoing last summer several hundred million dollars in payments authorized in the budget passed by the legislature to be made to certain oil companies.

The posts are uniformly wrong.  

The Governor's veto decision did anything but "renege" on "promises" made by the state or violate the law.  Instead, his veto decision actually enforced a statutory limit the legislature itself was seeking to overlook and, as such, was a prudent response to Alaska's tightened fiscal situation.

Those who argue to the contrary are, at the very least, unwittingly arguing that Alaska should draw down its savings beyond the levels required by statute in order to bail out a few companies that don't like the position they have gotten themselves into.  Others are doing so knowingly, urging for various reasons that certain selected corporations should receive an unearned priority over Alaska's own need for additional revenue.

The genesis of the tension is not, as the Forbes article mistakenly suggests, SB 21, the law passed in "2013" that made Alaska's oil tax structure more competitive for those producing oil.  Instead, the law at issue is part of a separate piece of legislation that goes back much further, largely to era when Sarah Palin was Governor.

That law, codified largely at AS 43.55.028,, does provide that the state will reimburse producers meeting certain criteria some of their costs of production.

But that commitment by the state comes with a significant caveat.  The state's obligation is explicitly limited to the amounts available at any given time in an "oil and gas tax credit fund" established pursuant to the statute.  Importantly, the statute provides that the state is only obligated to fill the fund at a certain rate.

From the start, the statute has provided -- and potential claimants have been aware -- that the state is only obligated to fill the fund based on the level of the state's tax receipts and the price of oil.  At oil prices below $60 per barrel, the state is required annually to contribute 15% of the state's production tax receipts to the fund.  At oil price levels of $60 per barrel and higher, the percentage is set at 10%.  AS 43.55.028(b) and (c).

The reason for the limitation is explicitly to limit the level of contributions the state is required to make to the fund at any given point in time, particularly in times -- such as now -- when state revenues are low and the cash is needed elsewhere.

Because those limitations are clear in the statutes governing the program, the producers that have been involved are well aware of them and accepted the risk that contributions to the fund -- and thus, the rate of reimbursement -- would be slowed when oil prices were low.

Indeed, the statute expressly provides that there may be times when "the total amount of ... claims for refund exceed the amount of available money in the fund."  AS 43.55.028(g). In those situations, the statutes and regulations provide for the manner in which the available funds will be allocated.

What the Forbes article picks up on is an effort by some producers now to jump the statutory process and cause the state to put more money into the fund than required by the statutes, so that they are paid earlier than the law provides.

The producers effectively are not seeking enforcement of the statute; they are seeking to end run it.

In other words, now that the risks they knew were there and accepted at the time they entered the program have materialized, they want the state to hold them harmless from the consequences and continue to make payments as if the price of oil -- and thus, the state's cash flow -- had remained high.

The effect on the state of accommodating those requests is clear.

The size of the state's immediate deficit will grow beyond the levels contemplated by the statute, requiring the state to increase its draw from savings in order to transfer additional monies to the producers earlier than required.  Because of the accelerated draw down on savings, the effect also will be to increase pressure for additional PFD cuts and other taxes.

In short, the effect will be to give an extra-statutory benefit to some producers, at the direct expense of the state and its citizens.  

Some suggest the state nevertheless should make the additional payments quicker, asserting that the state will economically benefit from earlier than anticipated oil production. But those that make the argument apparently have not run the numbers.

By the end of FY 2017 the state will have paid out about $3.5 billion in reimbursements, almost 8% of the size of the Permanent Fund principal at the same point.  By the end of FY 2018 the state will owe an additional $1.15 billion.

If the program had not existed, those amounts would have been saved and invested, not only preserving the amount from loss, but also producing additional revenue to the state in the form of investment earnings.

Compared to that, to date the state has not even recovered a significant fraction of the $3.5 billion thus far invested in the program, much less any financial return on those payments.  Some argue that those returns may come in the future.  But that is speculative, while in the meantime if the money instead had been retained and invested along side the Permanent Fund it would be steadily producing a stream of earnings year after year.

The result is, on a net present value basis -- the way that investors weigh returns -- the state would have come out miles ahead if it had retained and invested the money.

By reducing the level of the state's savings even further, paying out the amounts owed under the program earlier than required as Caelus and others now urge will just make that difference bigger, and the state's fiscal problems that much worse.

Ironically, some now arguing to accelerate the payments beyond the schedule required by the statutes are among those that also argue the #AKLNG project is no longer worth pursuing because, in their view, the private sector has backed off investing its money upfront in the project in an amount proportionate to its interest.

The same reasoning applies to the oil credit program.  The program -- and the resulting state payments -- exist in the first place because the private sector has not found the prospects sufficiently robust to attract the needed level of private capital.  If the test for state investment is whether the private sector is interested in putting up its own money equal to its ownership interest, this program fails as surely as does the #AKLNG project.

We have argued previously that the oil tax credit program should be terminated.  Why we need to halt the reimbursement of oil credits — and how  Because it hasn't, the state is continuing to pour money into it rather than alternative investments that would produce better returns.  By foregoing those better returns, the oil tax credit program is making the state's fiscal picture worse, not better.

Now, some urge a course of action that would make that already bad decision even worse, by accelerating the drain on the state's savings even faster than the statutes require, in order to transfer more money more quickly to private corporations than the statutes require.

Those corporations knew the rules and the risks of the game when they started their projects.  Now that some of the risks are coming home to roost, they want to change the rules to bail themselves out at the expense of the state.

While they continue to make the claim, in our view those that support the efforts to change the rules aren't fiscal conservatives. Instead, they are simply "crony capitalists" -- those who seek to manipulate government rules to benefit themselves over others -- of a different sort.  See Alaska's Crony Capitalists