Does Alaska OCS Development Really Help ... Alaska

Show of hands ... how many believe that Alaska state government revenues will increase as a result of Alaska OCS development? 

The Governor certainly has spent a lot of state time and effort talking and helping to litigate the issue.  In a discussion Senator Bill Wielechowski and I had on The Dan Fagan Show a few months ago, the Senator listed the OCS as one of the sources for the new oil that he asserted would help offset the continued decline in state production.  And the other day, the Alaska Dispatch had this to say in discussing the hurdles Shell has faced in its OCS drilling program:

The problems are a setback not just for Shell, but for the oil-dependent state of Alaska that has pinned its economic hopes on Shell for years. Oil production has been declining for years at the oil fields on Alaska’s North Slope. The state depends on oil tax to fund about 90 percent of its budget. It needs to keep oil flowing through the 800-mile trans-Alaska oil pipeline, and Shell is the great crude hope. 

The answer?  The State of Alaska will collect zero in revenues from Alaska OCS oil and gas production.  No royalty and no production taxes.

In a 2010 presentation, UAA's Institute of Social and Economic Research (ISER) Professor (now, Professor Emeritus) Scott Goldsmith analyzed the Alaska state take from various sources of supply.  The results are summarized on the slide to the left.  

While Alaska retains 100% of the royalty from production within 3 miles of the coastline, the royalty share declines to 27% in production from 3 - 6 miles offshore, and then to 0% at 6 miles and beyond.   Production beyond 3 miles also is exempt from production tax ("ACES").  Shell's Beaufort prospect is 18 miles offshore; its Chukchi prospect is 70 miles offshore.

Senator Begich and Senator Murkowski have proposed changes to the federal revenue sharing provisions, and recently Senator Wyden -- the incoming Democratic lead on the Senate Energy and Natural Resources Committee and, unlike his predecessor, from a coastal state (Oregon) -- has signaled some interest in the matter.   Whether those efforts mature into actual state revenues is doubtful given the federal government's own budget issues.

But even if there were changes and they stretched the current provisions governing the 3 - 6 mile area (where Alaska receives 27% of the federal government's royalty share) outward to the areas being explored by Shell, Alaska's income stream from OCS development would still be small.  The only revenue would be a moderate portion of the royalty received by the federal government.  As elsewhere in federal waters, state production taxes would not apply.

This is not to say that Alaska OCS is not important.  It produces Alaska jobs, develops new technology potentially applicable to development on state lands  and by keeping the industry active in the state, potentially lowers the costs for onshore producers. 

In no way, however, does it approach being a substitute for the development of state lands.  Development on state lands is the key to both Alaska's fiscal and oil future, and should be the continued focus of our Governor and legislators.

The first round ...

The first round of the Alaska elections produced gains in bringing an increased focus to state budget issues.  As I have written elsewhere on these pages, resolving state budget issues has become critically important also to resolving state oil issues.

Candidates stressing fiscal issues already well known in their communities and relatively well funded won Senate races in the Valley (Mike Dunleavy) and Kenai (Peter Micciche). Stressing only fiscal issues, a  previous unknown (Jeff Landfield) also produced significant results (44%) in a deeply underfunded effort against an entrenched incumbent in Anchorage, signaling dissatisfaction on the issue there as well.  Anchorage tax cap author Don Smith won his nomination also.

On the other hand, social, but not necessarily fiscal, conservatives won Senate nominations over candidates stressing fiscal issues in contested races in Fairbanks and the West Anchorage Senate district.   House results were somewhat mixed as well.   Nevertheless, the discussion on fiscal issues is strengthened and will continue into the fall.

Perhaps the most interesting event of the day from a fiscal policy perspective, however, was reading Representative Pete Petersen's (a liberal D) door hanger.   The first issue on the front page of the hanger was this:

"Fighting Wasteful Spending. Pete was one of only two legislators who had the courage to vote against the $3 billion capital budget. Pete gets it!"

 Then among the "Petersen Plan for Alaska" on the back, this:

"Reform the state budget process to eliminate government waste and pork barrel spending."

Interestingly, Petersen's Republican opponent recently signed on to the report from the House Special Committee on Fiscal Policy which, as has been discussed previously on these pages, raises concerns about the commitment, at least of the members of the Committee, to fiscal reform.

 

The Petersen flier appears to be an effort to take advantage of the fact that, over the last two years, House R's have approved the two largest budgets in Alaska's history, and that at least some do not appear to be concerned about the consequences, either to oil policy or future Alaskans. 

 

The flier suggests that at least some Democrats believe Republicans are vulnerable on the issue.  Personally, I believe that the assessment is correct. 

A Sidebar: Why Alaska needs to save now ...

Since publishing another piece on this page -- Alaska Budget Cutting:  Its Not Rocket Science ..." -- some readers have asked why Alaskans should be concerned about achieving a "sustainable" budget.  They suggest that, like other states, as long as spending within a given year does not exceed the revenues received in the same year there is no cause for concern and the current budget levels do not need to be reduced.

That issue will be the subject of a longer piece upcoming in the near future, but I am publishing the short answer now, as a sidebar to the "Its Not Rocket Science" commentary, so that readers are provided with a basic understanding of the reason while they are reading the related piece.

Alaska is unlike other states in a number of respects, but most important for this purpose is that Alaska currently funds virtually its entire General Fund from a single, ultimately non-renewable source -- oil.  On the other hand, in one way or another all other states fund state government largely with "renewable" sources -- such as property, sales or income taxes.  Such sources are classified as "renewable" because they continue to produce a relatively stable, predictable income stream as long as there is property, sales made or people located in the state.

That is not the case with Alaska.  As oil production tapers off over time, so will state revenues.

That is why spending revenues as they come in does not work the same for Alaska as it does other states.  In other states, that approach does not impair their ability to maintain spending at relatively consistent levels into the future.  Because future revenue levels stay roughly the same, those states are able to spend up to current revenue levels without being concerned about adversely affecting future spending levels.

The outcome in Alaska is different.  Without committing a portion of the current revenue stream to savings, future spending levels will look much different than today.  Unless there is some offset to the revenue declines which occur as oil production declines, future spending levels will be vastly lower. 

The approach reflected in the ISER studies referenced in the commentary calculates the level of savings required today in order to avoid this result and, like other states, position Alaska to maintain a consistent level of government spending into the future. 

Basically, the approach takes the balance in all current savings accounts (e.g., the Statutory Budget Reserve, Constitutional Budget Reserve, the Permanent Fund and various other accounts) that Alaska has accumulated to date, combines that with the additional surpluses (over the "sustainable" spending level) anticipated in the next few years, and invests the total (what ISER refers to as the "nest egg") in the same way the Permanent Fund is currently. 

The future income stream from that investment results in balancing out the future shortfalls in revenue from oil.  In essence, the income stream from the nest egg serves as a renewable revenue stream and enables Alaska to maintain a consistent level of state spending indefinitely into the future.

Some have suggested that Alaska already has enough savings, in the Permanent Fund, to provide a stable revenue stream for the future, or that the legislature already is putting enough additional savings aside to achieve the same objective.  As the future piece will discuss in greater detail, neither assumption is true.  Without substantially increasing the level of savings -- to what ISER describes as "sustainable" levels -- the revenue available for future Alaska spending levels will be much lower than Alaskans experience today.

Key to achieving those future benefits is to begin protecting the nest egg now.  Any delay reduces the nest egg -- and diminishes the level of revenues that future Alaskans will have available to spend.  As a result, instituting spending caps at the sustainable level now is critical to maintaining renewable earnings in the future.  Without maintaining and building savings now there will be insufficient renewable earnings tomorrow to maintain the same standard of living as oil revenues continue to decline.

Alaska Oil| Maybe the tide starts turning here ...

As we have made clear elsewhere on these pages ("The most important slide in this election ..."), given the spending spree Alaska's legislature has been on the past few years oil reform has to start with fiscal reform first. Achieving fiscal reform requires a change in legislative approach, if not in individual legislators. In summarizing some key legislative races going into the final weekend, the Alaska Dispatch suggests that the tide may be turning ...

Senate District K: Fiscal fur flies

If there were ever an election in which 27-year old upstart Jeff Landfield could rattle fellow Republican and incumbent Sen. Lesil McGuire, one of the most powerful and visible state senators in Alaska, this would be it. Moderate Republicans are under fire in this state, and McGuire hasn’t helped herself by spending lavishly on travel, and shepherding through what appear to be pet projects. And worse, she can come across as if she’s entitled to her seat. Landfield, who is a Ron Paul supporter, is smart enough and has worked hard enough to pry an opening there. His attacks have focused squarely on McGuire’s spending, her vote on former Gov. Sarah Palin’s huge oil tax increase, and that she along with other five Republican senators, joined the bipartisan Senate coalition.

The money, however, is still on McGuire, who’s a great debater and an articulate defender of her stances. Too, she’s much better at the fundraising game. His roughly $12,000 pales in comparison to McGuire’s more than $66,000, much of which comes from some of Alaska’s largest businesses and business titans.

Landfield, however, is counting on good old-fashioned door-knocking ....

The Solution to Alaska's Fiscal Issues ...

In listening this morning to the podcast of Glen Biegel's show from a couple of days ago, I was struck by the response of a couple of legislative candidates to Glen's questions about the state budget.  Glen started by asking each if they thought the current state budget was "sustainable."  Each answered "no;" so far, so good.

Then Glen asked how they would "fix" the budget.  With varying degrees of speed, both ultimately suggested using "zero based budgeting" to address the problem.  Not as good (in my opinion).

Generally speaking, zero based budgeting is a "method of budgeting in which all expenses must be justified for each new period. Zero-based budgeting starts from a 'zero base' and every function within an organization is analyzed for its needs and costs. Budgets are then built around what is needed for the upcoming period, regardless of whether the budget is higher or lower than the previous one."

In other words, zero based budgeting is a way of more deeply examining costs; it is not a way of setting overall budget levels.

For those of you remember (or more likely, have studied it as a history lesson), zero based budgeting first gained significant notoriety for use in developing government budgets during the Presidency of Jimmy Carter.  I recall because I was at the Pentagon at the time, and somewhat involved in dealing with the implementation of the approach on a few programs.

While President Carter touted the approach as a way of reducing government spending, it did not.  It took a little longer to develop the bdugets, but spending levels continued to grow.  The reason is that the approach only looked at programs from the cost side, requiring that the proponents justify each element of cost as they rebuilt their budgets.  Good people always can come up with justifications for programs and their related costs; after some "log rolling" ("I'll agree to your costs if you agree to mine"), the budgets were built and the spending levels continued.

Alaska's needs are different.  The first, and most important, step that Alaska needs to take going forward is to establish a hard cap on General Fund spending at the fiscally "sustainable" level.  Without that as a starting point, overall spending levels will never be controlled.  As now, well intentioned people will simply build good stories for why their program needs to be approved, and approve others in order to have theirs approved.  That explains how Alaska General Fund spending has exploded over the last six years from $3.0 billion for FY 2006, to $6.7 billion for FY 2012, and now to $7.6 billion for FY 2013.  And it also explains why spending will continue to match cash flow, at the expense of future Alaskans, until something is done.

By putting a hard cap on overall spending at sustainable levels, Alaska will control the end result from the start.  Once that is done, the various Commissioners, state agencies and legislators can work on prioritizing programs and projects within the cap.  Zero based budgeting to facilitate that approach may or may not be helpful; it can and should be used where it is.

But relying on zero based budgeting as the primary approach to control state spending is -- as the University of Alaska Athletic Director recently told me I was on when I suggested that there was a need to bring accountability to that program -- a "fool's errand."  I disagree with that characterization in that instance and will have more to say about it soon.  But that characterization is true when thinking that zero based budgeting is the primary solution to Alaska's fiscal issues.

A hard cap on overall spending is the most -- and possibly, only -- effective solution to Alaska's fiscal issues.  I hope that, as this election cycle continues, those appearing on Glen's show earlier this week and other legislative candidates increasingly think of that solution as their first line response.

Dear Governor ... The Future is Now

George Allen -- the Hall of Fame football coach (and the father of the former Governor and United States Senator from Virginia of the same name) -- had a favorite saying, "the future is now."  By that, Allen meant he coached to win in the coming year, not to develop players for the future.  Applying that philosophy, Allen was known for trading away draft picks year after year for proven, but older, veterans, to position his team to win in the upcoming year, rather than the potential to win somewhere down the road.  It was a successful philosophy; in 12 seasons as a head coach, Coach Allen compiled a regular season record of 116-47-5.

It is a philosophy that Governor Parnell would benefit from studying.  In a recent interview, Governor Parnell is quoted as saying "that he wants to rein in state spending."  But -- and this is the important part -- he also is quoted as saying "he hasn't yet set any parameters for agency spending."

As this page has discussed elsewhere, Alaska state spending has grossly exceeded sustainable levels for at least the last two budget cycles.  As calculated by the University of Alaska's Institute of Social and Economic Research ("ISER"), the current annual sustainable spending level from the General Fund is in the range of $5.35 billion.  The General Fund spending levels passed by the Legislature and approved by the Governor for the past two years, however, are in the range of $6.72 billion (FY 2012) and $7.6 billion (FY 2013).

As ISER has emphasized, spending in excess of sustainable levels passes on a "fiscal burden to future generations ....  The fiscal burden will grow every year ... at an accelerating pace, until the state reduces spending [to sustainable levels] or finds an alternative source of revenue.”   As I explain elsewhere, excess spending also has seriously undermined the Governor's priority of oil tax reform.

Reigning in state spending levels is an imperative.  ISER has made clear that failure to do so is adversely affecting future generations of Alaskans.  The Governor's own OMB Director has made clear that the failure to do so is undermining the Administration's efforts to reform oil taxes.

But just "any ol' level" of reductions is not sufficient.  To avoid continuing to transfer a fiscal burden to future generations of Alaskans, state spending levels need to be reduced to sustainable levels.  Any less simply panders to current Alaskans at the expense of the future of the state.  The Governor is responsible to both.

As George Allen used to explain, the "future is now."   Its not enough to say that state agencies need to reduce state spending in general; as the Chief Executive, the Governor needs to step up and tell them precisely what the overall target is, and then let them fill in the details within that guidance.

The maximum sustainable level of General Fund spending is $5.35 billion; that is the target.

Honored: Institute of the North Welcomes Three New Directors to Board

An honor to be in such company.  "The Institute of the North is pleased to announce the election of three new members to its Board of Directors – Matt Ganley, vice president of Resources and External Affairs at Bering Straits Native Corporation; Brad Keithley, partner and co-head of the Oil and Gas practice at Perkins Coie; and Karen Matthias, Alaska economic and political consultant at Matthias Consulting, as well as new officers. ... The new board members join the newly elected executive committee – Drue Pearce (chair), Duane Heyman (vice chair), Randy Hagenstein (secretary), Peter Scott (treasurer), Ira Perman (at-large); and current members Admiral Thomas Barrett, Dr. Jack Hickel, Brit Ashleigh Szymoniak, and Dr. Michael Sfraga. Emeritus members are John Hendrickson, Max Hodel, Gail Phillips, Steve Shropshire and Leif Selkregg."

The full release is available here.