Tuesday, May 17, 2016

What some are missing in the oil tax credit discussion ...


Some involved in the current Alaska budget debate -- potentially including some legislators -- appear fundamentally to be misunderstanding one of Alaska's clearest pending fiscal choices.

In a Twitter exchange over the weekend involving oil taxes, one of the most active participants in the debate -- the Alaska Support Industry Alliance (the "Alliance") -- appeared to be oblivious to the fact that the State of Alaska has at least one alternative investment opportunity available to it for the cash currently being paid out ("invested") in reimbursable tax credits.

The state can either (1) continue "investing" the money in some oil projects, by continuing the reimbursable oil tax credit program, or (2) not spend the money in that way, and by doing so, retain the money instead in savings, where it automatically is invested through one of the state's investment funds (the CBR or Permanent Fund). The latter investment option also produces revenue and those two choices potentially have significantly different outcomes.

The exchange began when the Alaska Senate Majority posted a quote from Senator Pete Kelly that said this "We have no business going down a road that's going to reduce production." The post reflected Kelly's view that reimbursable oil tax credits -- which are paid out of the state treasury -- should be continued simply because some of them may result in some production.

In response, Alaskans for Sustainable Budgets pointed out as it previously had elsewhere  that production itself is not the end goal. Instead, when talking about the Alaska budget, oil production is simply a means to the end of producing revenue for the state. If pursuing production costs the state more in cash than it returns, pursuing production actually worsens the state's fiscal situation.

That is when the Alliance weighed in, apparently arguing that production should always be the state's goal, regardless of the alternative. (The full exchange is available at the end of this post.)

That's simply wrong.

It is critical for those concerned about Alaska's fiscal situation to understand that Alaska has two choices with respect to the money currently being "invested" into reimbursable oil tax credits. The money can continue to be "invested" through the credits in chasing production, or the state can choose not to spend the money, in which event it will remain in the CBR/PFER and be invested along with the remainder of the state's similarly retained savings.

The fiscal consequences of the two are different.  According to the Permanent Fund Corporation (PFC) website, the PFC's "goal" is for the Fund "to produce an average annual real [non-inflation adjusted] rate of return of 5 percent over the long term."  Adjusted for current inflation levels that sets the "goal" at about an overall 7.5% annual return and, in fact, according again to its website, the PFC has earned "over 10% historically."

According to the DOR, the state has paid out ("invested") approximately $3 billion in reimbursable oil tax credits from FY 2007, the start of the reimbursement program, through the end of FY 2015. Using the PFC's averages, if that amount instead had been retained in savings and invested through the PFC it would now be producing somewhere between $225 million (at a 7.5% return) and $300 million (at 10%) annually in earnings (i.e., revenue) to the state.

In order for "investing" the state's money in reimbursable credits to be the right decision fiscally, the return on the credits reasonably must be expected to meet or exceed that goal. Because the fiscal results achieved by the credits are shielded from public disclosure due to competitive concerns, it is not possible to make a precise analysis.  But applying some reasonable assumptions it certainly is worth questioning whether they have.

Again according to DOR, of the $3 billion paid out since FY 2007 only $1.9 billion in credits have gone to projects that currently have production.  As a result, in order even to match on a current earnings basis the revenues which would have been achieved had the money instead been invested through the PFC, those projects would need to be producing an annual return of between 12.5% and 16% on the state's investment.

And the long run threshold is even higher.  If the $3 billion had been retained in savings and invested through the PFC, those annual earnings would have started immediately and continued long, long -- indefinitely -- into the future. Oil projects don't have the same earnings trajectory. Instead, revenues only start after the lag required to identify and develop the project and then end when the oil from that project plays out.

As a result, the project must produce a significantly higher return during its productive years -- 15 - 20% is a decent rule of thumb -- in order to achieve an overall net present value equal to that produced by simply investing the same amount up front in an alternative investment. Here the returns from the successful projects need to exceed even that range to match the alternative return offered by investing through the PFC because, at least using the results from FY 2007-15 as a guide, only $2 out of every $3 spent is resulting in production.

Given that the state is realizing a return on the investments made through the reimbursable credit program largely only through the portion of the additional production paid to the state as royalties, we think it is unlikely that the program is even covering its overall costs, much less producing a return which approaches the levels necessary to make it competitive with simply investing the money through the PFC.

In any event, it is unreasonable to argue that any production is sufficient to justify the program's continuation.  The program only can be justified if the financial returns to the state resulting from that production meet or exceed the returns which the state would otherwise receive through available alternative investments.

Frankly, this is not a call that the legislature is particularly well suited to make.  These sorts of "alternative investment" analyses are usually handled best by major investment funds.  Interestingly enough, one of the best in the world -- the PFC -- is located just a few blocks away from where the legislature is sitting now.

Perhaps the legislature should ask their advice on which alternative is in Alaska's best fiscal interests -- or in the words of the Constitution, produces the "maximum benefit" -- before continuing.

But in any event, no one should assume that taking steps which may reduce marginal production -- when that production occurs only because of state investment -- are automatically bad.  It depends on what the alternative use is which could be made of the money, and here -- because of the track record of the PFC -- we have a very good idea it would be positive.

For those interested, the Twitter exchange that triggered these thoughts follow.












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Monday, January 25, 2016

Is the PFD a right or privilege, and why that may matter ...

Earlier today I wandered into a fairly intense exchange over whether the money distributed through the PFD "belongs" in the first instance to the state's citizens (with the state acting only as a banker in making the distributions) or "belongs" in the first instance to the state and, so, is distributed to citizens at the state's beneficence (Dictionary.com: the doing of good; active goodness or kindness; charity).

This afternoon the same discussion broke out during the course of a discussion on Facebook using different terms:  is the PFD a "privilege" or a "right".

I anticipate writing longer on the subject at a later time, and also intend to discuss it during my regular Tuesday segment tomorrow morning at 7:15am on KBYR AM 700's The Michael Dukes Show, but for now thought I would share the afternoon discussion (because it is the one in writing) for those that are interested in the issue, and why it may matter in the upcoming debate on Alaska's budget.

The discussion follows (and is available directly here if you want to make any comments of your own, or follow along with subsequent comments of others).

Brad Keithley
7 hrsAnchorage
In response to a post earlier today some disputed that cutting the PFD (as proposed by Governor Walker and the GCI coalition) is a tax on Alaskans. The characterization isn't original with me; it is based on several recent opinion pieces by Clem Tillion, who was Senate President and a key player in the adoption of the PFD. This is how he explains the view: "Upon becoming a state we received a 100-million-acre land grant, much like the land grant schools and some colleges received in the Lower 48. This was to help provide an income base for a large area with a small population. ... The dividend, as envisioned by Gov. Jay Hammond, was to be a share of the earnings of oil and other nonrenewable resources that, unlike in the other 49 states [where the land is owned individually and, thus, royalty revenues are received directly], is owned by the people of Alaska. [In that context,] the dividend is more a return on what we own, like the return on AT&T stock, or as Jay preferred to call it, 'Alaska Inc.' It is not, and never was, meant to be welfare [and] [c]apping [the PFD] is in itself a major tax, and a tax paid only by Alaskans. ... " Here are three of Sen. Tillion's pieces that explain his view: http://ow.ly/XvR7S, http://goo.gl/zYBHms andhttp://ow.ly/XvRiR.
Clem Tillion: Quite a trick to blow through Alaska's savings then propose dividend cap
OPINION: All Alaskans must contribute to a balanced budget, but let's not gut either the dividend or the…
ADN.COM
Forrest Mcdonald likes this.
Comments
Taylor Bickford His argument, if I understand it correctly, is that capping the PFD is a tax, and a less desirable one than other options that are on the table. He does acknowledge that Alaskans will have to pay their way, so the implication here, I think, is that we should close the shortfall with another tax, like an income tax or a sales tax. I guess whether you view a PFD cap as a tax is actually insignificant, because he's not advocating against taxes per se. Protect Alaskans from the PFD cap tax by taxing them in other ways. Am I missing something?
LikeReply6 hrsEdited
Brad Keithley I think so. Because it is so regressive, is focused entirely on Alaskans and, because the PFD is so broad based, under some circumstances a PFD cut actually hurts the state economy more than it helps and when viewed as a tax it is the worst economically of all the options. I think some are trying to avoid that analysis by calling it something other than a tax. More on that tomorrow on my Dukes segment.
LikeReply2 hrsEdited
Taylor Bickford Well if we are simply weighing it as a tax vs. tax, that changes the conversation and should take a lot of the emotion out of it. I'm not a tax expert or an economist, so I'll be interested to see the arguments made by you and others to understand the relative economic impacts of all these various proposals (I think Gunnar Knapp is working on something like this for the Legislature). It's not just about economic impact, though - you also need to understand the relative impact each solution will have on the budget deficit. If you forego a PFD cap in favor of a sales tax, then you have more work to do on the deficit itself, which requires another solution with another set of economic impacts. Back to the tax discussion - in order to view a PFD cap as a tax, you have to believe that the money is *yours* to begin with. I know what the Constitution says, but I've always viewed the dividend as a privilege rather than a right, which is not the same way I view the money I take home from the fruits of my labor.
LikeReply1 hrEdited
Brad Keithley Ahhh, you tumbled quickly to the core issue ("privilege or right"), exactly the subject of my discussion tomorrow with Dukes and which leads us directly back to what Clem (and others, Hammond wrote on this some as well) had to say on the issue, since they were much closer in time to the issue than us.

As you will see from his writings, Clem believes that it is a right, and there is substantial support for that. Because individuals effectively are prevented from directly owning mineral interests in Alaska under the statehood act (something which is natural in every other state and a key to the economies of those states) , Clem and others believed that the PFD was the only mechanism available to them to convey a similar interest to Alaskans. It -- half of the earnings from the PF -- was, in essence, the royalty share due individual Alaskans (and the state's private economy) for the production from the lands Alaskans were compelled to own collectively, rather than permitted (as in other states) to own individually. Extrapolating from that, certainly it is your right to view it as a privilege and to give your share away, but it is not your right to make the same judgment and simply take it away from everyone else.

As for the economics, both Scott and Gunnar actually already have talked about that in a way. Here is Scott's take: "“[M]ost of the cash from dividends will ultimately find its way into the Alaska economy to increase employment, population, and income. … [If the dividend instead had been diverted to state government,] the most likely alternative use of the PFD would probably have been to increase capital spending by state government. … Capital spending would have generated less employment and increased income inequality.”http://www.iser.uaa.alaska.edu/.../bien_xiii_ak_pfd...

Here is Gunnar's: "Preliminary findings show, for example, that cutting $100 million by laying off state workers will cost the economy significantly more jobs and income than would an income tax to raise the same amount. ... " The article also discusses a sales tax. The option not mentioned (because it would do the most economic harm), cutting the PFD. http://www.adn.com/.../how-balancing-budget-could-harm...

I agree it may make the politics of resolving the deficit more difficult, but the Alaska economy isn't only about the government economy, more than half of the economy is privately driven and it is about to go through significant turmoil as well as oil projects start ramping down. We need to do evaluations based on what is in the best interest of the #overall Alaska economy. Retaining the PFD (to keep those dollars in the private economy) is part of that.
LikeReply56 minsEdited
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Saturday, December 26, 2015

Current Crude Oil Price Forecasts (as of 12.26.2015) ...



During a recent discussion I suggested that the oil price forecast embedded in the Administration's most recent 10-year budget plan was too low and, thus, tended to overdramatize the extent of Alaska's current fiscal situation.  Others challenged that view, suggesting instead that the Administration's outlook was too optimistic.

While a number of public and private entities publish oil price forecasts I have gathered above the most recent set of long-range forecasts made by a selection of organizations that I generally look to when assessing the current outlook for prices.  With the exception of the IMF (International Monetary Fund), I believe that all of the forecasts are stated in nominal (inflation adjusted) dollars and, with the exception of the DOR (Alaska Department of Revenue) forecast, all are focused either entirely or in significant part on Brent or comparable, waterborne crudes.

Adjusting the IMF number for inflation would put it slightly above the World Bank projection.  The price for ANS generally trades at a slight ($1-$2) discount to Brent, although in recent days sometimes it has been higher than the reported Brent price.

When making the comment I had in mind particularly the DOR forecast price for 2020 ($71), which is about $10 (or roughly 12%) below the most recent forecasts by the IEA (International Energy Agency) and OPEC.  Extrapolating from estimates included as part of the DOR's Fall 2015 Revenue Sources Book the difference is worth about $300 million in additional annual revenue to Alaska, certainly not enough to close the immediate cash budget gap, but a not insignificant amount when viewing the process as putting a series of pieces in place.

While I appreciate that the World Bank and IMF (both global financing agencies) have projected lower prices for the same period, my experience has been that the EIA, IEA and OPEC tend to have a better handle on future price trends and thus, when there are differences, tend to give more weight to them.
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Monday, November 9, 2015

A quick, but good, discussion about Alaska's choices ...

An exchange today with a "Facebook friend" led me to articulate my thinking on some pieces of Alaska's current fiscal situation as directly as I am capable of mustering.  (Some previously have suggested I have not been always and entirely clear on my points. Of course, I always think I am clear ... but then, I also think the Cowboys still have a chance of making the NFL playoffs this year.)

For those interested, I have included the exchange here. (For those not familiar with Facebook -- but really, is there anyone who reads this blog (all five of you) that isn't -- click on the "See more" link to see the full post, then click on the "comments" link below that to see the exchange.)

Want to understand one of the big differences between the Walker & Goldsmith/ISER fiscal approaches. It's apparent on...
Posted by Brad Keithley on Monday, November 9, 2015
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Sunday, August 9, 2015

Sunday Morning Note ...

Sunday mornings are normally the time that I sit back, make an extra pot of coffee, and catch up on some of the past week's data.  Since I am doing them in any event I thought I would start throwing them up here, both as another place to capture them and to make them available to anyone else who may find them of value.

Here are what the numbers represent:

Oil.  The numbers are the Friday close price, as reported on the CME Group website for the indicated month (in this case, September) for West Texas Intermediate (WTI) and Brent for the immediate, one-year, two-year and, just for grins, five-years forward.

Natural Gas.  The Henry Hub (HH) price is the same as for oil, the Friday close price, as reported on the CME Group website for the indicated month for the immediate, one-year, two-year and, again just for grins, five-years forward.  Because there is no publicly reported regular market price for Asian LNG I include a couple of numbers for reference.  The first is the price reported publicly on the CME Group website for Platt's JKM (Japan/Korea Marker).  Platt's JKM is regularly reported privately as part of Platt's subscription services.  I am not certain where CME Group obtains the data they use, but it is close enough to actual to serve my Sunday morning purposes.  The second number I include for reference ("BGK") is one of my own design, and simply is the average of the prices reported for the same time period of the WTI and Brent prices, divided by 5.55 (the number of million BTU's contained in a standard barrel of oil), in other words the average oil futures price for the same time period reported on a per MMBTU basis.  While I certainly would not trade on this number, it captures at least some of the JKM market characteristics, which generally price LNG as a factor of oil prices, and indicates directionally where LNG prices might be headed if they continue to be based on oil. (I would note that both the Singapore and Japanese OTC Exchange are currently attempting to develop liquid markets in LNG futures, but have not yet started publicly reporting the resulting prices.)


The final piece is any other data (or data related information) that I picked up and put in my "read later" folder during the week.  This week a report from earlier in the week by the Financial Times ("Oil falls to $50 a barrel") made it into the folder and is included here.


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Wednesday, July 22, 2015

Are the #AKLeg R's about to wimp out, again ...

In June, at the end of the Second Special Session, the Alaska Legislature passed HB 2001, the FY 2016 Operating Budget.  As passed, the legislation contained the following provision at p. 15, lines 25-28:
No money appropriated in this appropriation may be expended for services to persons who are eligible pursuant to 42 United States Code section 1396a(a)(10)A)(i)(VIII) and whose household modified adjusted gross income is less than or equal to one hundred thirty-three percent of the federal poverty guidelines.
Unlike others, this language was not preceded by the phrase "It is the intent of the legislature that ...," which commonly is understood to convey non-binding guidance similar to the passage of a legislative resolution.  Instead, as with the limitations on the use of state money for abortions immediately preceding this provision, the language is phrased in the strict prescriptive, "No money ... may be expended for ...."

At the time legislators explained that the language would prohibit the use of state funds to implement the Governor's proposal to accept Medicaid Expansion (which is made available under the referenced federal statute) without further action by the Legislature.  The reasons for such caution are manifest.  As the AP reported just this week, the costs of Medicaid Expansion in at least some states are skyrocketing beyond those anticipated at the time it was adopted (see "Medicaid Enrollment Surges, Stirs Worry About State Budgets").  In a state with significant budget issues already, that is the last thing Alaska needs.

Importantly, upon review the Governor did not veto the provision at the time he signed the legislation as he had the right to do under the second sentence of Art. 2, Sec. 15 of the Alaska Constitution ("The governor ... may, by veto, strike or reduce items in appropriation bills. He shall return any vetoed bill, with a statement of his objections, to the house of origin.") and which he did with other provisions.  Absent veto, the legislation became law at the time the Governor signed the bill.

Last week, the Governor announced that, despite signing the legislation specifically prohibiting the state from spending any state funds to do so, he intended to accept and implement Medicaid Expansion.  Just as I would anticipate in the event the Governor attempted to violate other provisions of the law, including the similar provision relating to state funding of abortions, I expected Legislative leadership, including the members of the House and Senate Finance Committees that vetted and inserted the language in HB 2001, immediately to file suit in court to prevent the Governor from going through with his intentions.  They enacted the law; they promised Alaskans they were protecting them by doing so. I would expect them to seek to enforce it.

Shockingly, however, they haven't.  None of them, not even the ones that promised Alaskans they were protecting them, have.  In doing so they have put at risk not only this legislation, but -- and focus on this John Coghill, Charlie Huggins and Mike Dunleavy -- also other, similarly enacted legislation, like the provision prohibiting state funding of abortions that immediately precedes it.

As I searched for an answer as to why legislators were failing to act to uphold their own legislation, earlier this week I had the following exchange with a former Majority Leader of the House of Representatives.


@kylejo574 Wait, we are going to rely now on Walker's AG and Juneau LegLegal to define legality? Isn't that what the courts are for?


Even more disappointing has been learning that some legislators who, as members of the Majority, voted for the legislation appear subsequently to have encouraged the Governor to ignore it.  This, for example, from KTUU's story on the Governor's action ("Walker expands medicaid without lawmakers"):
Sen. Lesil McGuire, R-Anchorage, said some legislators in her party are likely sighing with relief to not have to vote on the politically difficult but publicly popular issue. 
"Behind the scenes, there were many lawmakers that were encouraging him to go ahead and do it through executive proclamation," said McGuire, who has publicly supported expansion since her 2014 campaign for lieutenant governor. "It certainly takes the pressure off the Legislature. It puts the decision in the right person's hands."
As I have said on other occasions, personally I might vote also for Medicaid Expansion if done after or at the same time as the enactment of critically important Medicaid reforms and the costs fit within a sustainable budget.  Some in the Legislature adopted the same view and said they were providing for exactly that route by enacting the provision, deferring further action until reforms and limits could be put in place.

Now, however, just as they have before on other budget measures, legislative R's are proving that although they talk a good game, they come up woefully short when its time for the rubber to meet the road.

All of the so-called "fiscal conservatives" that voted for HB 2001, and now are rolling over as the Governor flouts the law they enacted, should be ashamed.  And now that the precedent is being established, those that think it will be different next time when this or a subsequent Governor ignores the abortion or other, similar provisions of future legislative actions, should think again.

As they did following the 2012 election when they vowed to enact sustainable budgets, the legislative R's -- all of them, because any of them could go to court to enforce the law they passed -- are about to wimp out by ignoring their own law.  If they do, explain to me why anyone should trust them again.
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