A second "Alaska disconnect" ...

As the state budget increasingly has grown over the last several years to unsustainable and record deficit levels I have spent more and more time focusing on what economists and others refer to as the "Alaska disconnect".

As explained in an exceptionally good primer on the Alaska economy by UAA Professor and ISER Director Gunnar Knapp, "An Introduction to the Economy of Alaska," the "Alaska disconnect" is this:

Alaska’s fiscal structure—specifically the fact that Alaskans do not pay any significant broad-based taxes—leads to a problem which has become known as the “Alaska Disconnect.” 

If economic developments creates more jobs, Alaska’s population grows. As the population grows, Alaskans need more schools and teachers for their children and the other services that state and local governments provide. 

Although the new Alaskans pay local sales and property taxes which support local services, they don’t pay broad-based state taxes to cover the cost of state-funded services such as education and roads. 

The new jobs create new costs for the state but not corresponding new revenues. As a result, except for oil development (which pays high state taxes), many kinds of economic development make the state’s financial situation more difficult.

A news story this past week suggests we also may be seeing the emergence of a second Alaska disconnect -- where even continued success in oil development does not guarantee the health of the state's fiscal situation.

The news story is a KTVA report on the potential effects of the oil price drop on the Alaska oil industry ("Oil projects in Alaska still on track despite declining prices").  The report quotes Kara Moriarty with the Alaska Oil and Gas Association, whose member companies represent most of the oil industry, as saying "Alaskans shouldn’t panic just yet. [Price fluctuations are] the nature of the business."  Even at lower prices, "Moriarty predicts 2015 will be 'a very positive year,' due to new projects and new investments."

But that is where the new, second "Alaska disconnect" comes in.  Because of significant increases in state spending levels over the last five years, even if the oil industry is able to continue to do well at lower oil prices, the state is not.

The reason that oil companies are continuing to invest even in the face of lower prices is because they have positioned themselves to continue to operate at lower price levels.

For example, BP Chief Executive Bob Dudley recently said “We have only sanctioned or approved projects based on an $80 oil price. ... “We’ve been doing that three or four years so there isn’t any project that we’re working on today, particularly those big capital projects, that we have any different view of.”

Exxon has been even more cautious.  Recently in an appearance on CNBC, CEO Rex Tillerson said that "because many of the company’s biggest projects take years to complete, Exxon Mobil tests its investment across a range of prices between $120 and $40 per barrel.  'All of the investment decisions we take have been tested across a range of pricing that accommodates these types of price swings. ... What you do is ensure that you can be successful at the bottom of the price swing.'”

The industry also is well positioned to make even further adjustments if necessary to maintain profitability lower price levels (see "Oil price drops:  don't panic, really").

Alaska is not, however.  At the beginning of Sean Parnell's run as Governor (FY 2011) the Alaska budget balanced at $78 oil.  During his term, however, he and the legislatures serving with him have allowed the budget to get away from them.  The current year budget, FY 2015, requires more than $117 oil to balance.  The "work in progress" FY 2016 budget that Parnell left for incoming Governor Walker requires $120 oil to balance.

Because of that difference between "break even" price levels, Alaska no longer is positioned to do well simply because the oil industry is able to continue to thrive.  As Alaska has allowed its budget to spin further and further out of control, it has put itself in a different position than the state's industry, one much more exposed to price downturns.

As a result, while Moriarty might be right about the industry -- and that Alaskans "shouldn't panic just yet" because the industry is positioned to weather the downturn -- the same does not apply any longer to state finances.

The industry and state have become disconnected.  At these price levels continued health for the industry does not mean continued health for state government.  Alaska state government simply has grown too large.

SMH ...

At one time or another, every state I have lived in during my life has claimed to hold the title of "craziest" state political scene.  Generally speaking, I have always considered Louisiana's claim to be the most accurate in that regard, but an event yesterday afternoon may finally convince me that Alaska has pulled into the lead.

As some will recall, I engaged in an independent expenditure effort this last election cycle focused on certain state legislative races, largely to help publicize the state's fiscal situation.  One of those I supported was Retired Army Col. Laurie Hummel, who was challenging incumbent Rep. Gabrielle LeDoux.  I supported Hummel over LeDoux because, after years of watching, I had become convinced LeDoux was part of the spending problem in the legislature, not the solution.

Somewhat understandably -- this isn't the crazy part, yet -- Rep. LeDoux struck back at my support of her opponent by issuing a press release (above left), among other things calling me a "bully," and on a local talk radio show, a "narcissistic bully."  OK, no one ever said politics wasn't a full contact sport.

But then yesterday -- and this is the crazy part -- I received an email from Rep. LeDoux (who had gone on to win the election, barely).  It wouldn't have been crazy if it had said something like, "nah, nah, na nah, nah, I won, you lost."  Again, no one ever said politics wasn't a full contact sport.

But instead, it said this:

I have quite a bit of campaign debt to retire -- and I need your help to do it. ... Will you join me in continuing to provide strong, conservative leadership in Juneau by visiting voteledoux.com and donating today? A donation of $25, $50, $100, or even $500 would help more than you know.

Hmmmmm, uhhhh, no, I don't think so.  Even if it wasn't for all the campaign stuff, explain to me again why I would want to support someone headed to Juneau to help deal with the state's fiscal crisis -- caused by the very deficit spending that Rep. LeDoux voted for -- that wasn't able even to balance their own campaign budget?  Reading it through the first time induced a sort of Wizard of Oz moment -- "don't pay any attention to that debt behind the curtain; only pay attention to what I say I am."

Even this morning, as I reread the letter again, one of Patsy Cline's greatest hits kept popping into my head.  

I think Alaska may have just pulled ahead of Louisiana.

Important numbers ...

Yesterday while discussing an article from the Wall St. Journal ("Saudi Arabia Sees Oil Prices Stabilizing Around $60 a Barrel") a reader observed at that price Alaska's revenues would meet only one-half the state budget.  The observation was based on previous pieces here that used $120-ish as the oil price required this year to balance the state budget, so half that in oil price means half in revenues also, right?

Unfortunately, no.  A significant part of Alaska's revenues are derived from its production tax.  Because that tax is based on net profits, revenues drop proportionately to the drop in profits, not price.  By the time price reaches $70/bbl, revenues from the production tax are almost gone and at $60 they are.  Largely all that remains at that point are revenues from the state's royalty share of production and roughly $500 million in non-oil related revenues received mostly from a variety of other taxes.

As I was contemplating how to respond to the reader's comment I stumbled upon a section from last year's Department of Revenue Fall 2013 Revenue Sources Book (at p. 88-89) that includes a very helpful chart for considering these things.  As you will see, at $60 oil the state's revenues (we are currently in FY 2015) decline to roughly $2.1 billion, about a third of this year's spend (not half).  While regardless of how low prices go the average for this fiscal year will end up somewhat higher (because the first few months were at significantly higher price levels), sustained lower prices from here forward ultimately will drag the average price down to very low levels.

Interestingly, in reviewing the chart I realized also that the $120-ish figure I (and Dermot Cole) had been using previously for this year's budget "break even" price is somewhat off.  This year's budget is $6.2 billion. Using the chart, that correlates to a break-even price of just slightly under $125/bbl.

Which leads me one more time to a comparison of Alaska's fiscal situation with other Petrostates.  Another Wall St. Journal article yesterday ("Analysis: Oil-Price Drop Adds New Element to Middle East Tensions") contained yet another analysis of the break even price of various oil-dependent nations, this time based largely on an analysis recently done by the International Monetary Fund.

The results are here.  While not the highest in the world (Libya apparently tops the list at $184/bbl), at $125/bbl Alaska's breakeven price nevertheless rests well in the upper tier, on par with Iran ($130), Algeria ($130) and Nigeria ($123), running well ahead of Venezuela ($117), Saudi ($106), Russia ($100 based on other analyses) and Iraq (also $100), and an order of magnitude above the UAE ($77), Qatar ($60) and Kuwait ($54).

Fiscally conservative?  That would be someone else.  During its 2013 session the Alaska Administration and Legislature rightfully spent a lot of time benchmarking the state's oil tax rates against those of other nations.  In the process, however, they overlooked benchmarking their own spending behavior against those of the same peers.

In FY 2011, Alaska's budget balanced at an oil price of $78/bbl. This year (FY 2015), just four short years later, it's $125/bbl.

Incoming Governor Bill Walker faces a huge challenge in moving Alaska back into the range of fiscal reality. Hopefully, these and other numbers they will hear during the coming session will move the legislature to help.

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.

"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.

Oil prices in three charts ...

The International Energy Agency yesterday published its November report.  Like the U.S. Energy Information Administration's November Short Term Energy Outlook (STEO) published two days before, the IEA's report catches up with the fundamentals fueling the recent, dramatic drop in oil prices and applies them going forward.

And, like the STEO, the IEA similarly sees a hugely changed outlook.

The EIA's November STEO makes one of the most dramatic month-to-month shifts in oil price forecast I recall seeing in my three-plus decades in the industry.  Just the month before, in the October STEO, EIA had predicted 2015 oil prices (Brent) would average $101.

After having the time to look at the shift in fundamentals driving the oil price decline, the November STEO now predicts 2015 Brent will average $83.

The IEA similarly sees a fundamental shift taking place. As reported yesterday in Platt's blog, The Barrel, the subscriber version of the IEA November report (which will be made public in two weeks), concludes this about oil prices:

 ... it is increasingly clear that we have begun a new chapter in the history of the oil markets.

The IEA regularly includes charts with its reports showing the fundamentals affecting the market.  The three charts included with this column are from the November report.  The one that is most striking -- and the one that explains it all to those who follow the industry closely -- is the second shown here, which tracks world oil supply.  Against increasing, but on a relative scale slowing demand, the ramp up in oil supply is remarkable.

Explaining why it believes oil markets have entered a "new chapter," IEA looks forward at both supply and demand.

On supply, IEA concludes, "While falling prices may well trim investment in US light tight oil (LTO), such potential cuts should not be misconstrued as a production drop, and indeed would likely pale in comparison with recent gains in LTO productivity.  Cost reductions and efficiency gains in LTO production have been constant, and price pressures would only provide more impetus for producers to cut costs further.”

In other words, says the Platts' summary, "the US shale boom is not going away;" the drop in prices will simply be taken out of the hides of the highly competitive oil field supply industry.

On the demand side, the IEA concludes, "Economic development no longer spurs oil demand growth as it once did, especially in the absence of wage gains. China, the top source of incremental oil demand in recent years, has entered a less oil-intensive stage of development ...."

With supply increasing and demand moderating, like EIA before it the IEA now sees an extended shift in price.  

“Our supply and demand forecasts indicate that barring any new supply disruption, downward price pressures could build further in the first half of 2015.... While there has been some speculation that the high cost of unconventional oil production might set a new equilibrium for Brent prices in the $80-$90/b range, supply/demand balances suggest that the price rout has yet to run its course.

As I have explained elsewhere, the consequences to Alaska of such a shift in pricing dynamics are huge.

Yesterday I heard an Alaska legislator try to discount that -- and justify continued state spending in the range of current levels -- because oil prices are going to "bounce back."  The EIA, IEA and other highly respected oil analysts increasingly are concluding that is not likely to be the case.  The legislator didn't cite any sources for the optimism.

Perspective: what if it was production instead of price ...

As I talk to others, some are having a difficult time envisioning the impact on state revenues of the recent drop in oil price.  Because of the recent Proposition 1 (SB 21) campaign, more are familiar with the potential effect on state revenues of changes in production than they are changes in price.

Following up on that, a reader asked me yesterday what the impact of the recent drop in price would translate to if it were in production instead of price.

After thinking about it a bit this morning, using information provided in a recent Dermot Cole column reporting on his conversations with state officials, and taken from the Legislative Finance Division's FY 2015 Fiscal Summary and the Spring 2014 Revenue Sources Book I calculated what the change would need to be if the impact on state revenues from the recent price drop were the result of a production drop instead.

The result?  Fairly staggering.  During the last legislative session the state estimated production this fiscal year would average around 500,000 (498,000 to be precise) barrels per day.  The effect on state revenues of the current dive in prices (assuming prices average out at $85/barrel for the year, which is an increasingly heroic assumption) is the same as if prices stayed the same as projected, but production fell instead to roughly 300,000 (293,000 to be precise) barrels per day (about 40% lower than current levels).

Think about that for a moment.  What would be the reaction if some morning the headline on the Alaska Dispatch News read "Oil Production Drops 40% Since September 1 With No Recovery in Sight."  

Yep, that is the equivalent of what is going on with price.  Does that help?

The next steps ...

As some readers are aware I have been running a radio spot this week in support of Alaskans for Sustainable Budgets (AK4SB).  The spot started the Wednesday following the election and will continue through Monday.

This is the first of what I anticipate will be a series of spots which will run periodically in the weeks leading up to and during the legislative session in coordination with with a series of commentaries and other presentations at ItsOurFutureAK.com.

With the state facing a historic revenue shortfall and budget deficits, it's time for Alaskans to become more knowledgeable and involved in the state's fiscal situation.  The purpose of the radio spots, commentaries and website will be to help educate Alaskans about the situation and to provide them with ways to become involved in bringing about change.

The effort largely will be centralized through the AK4SB website.  I encourage readers to follow along there if interested.

The audio of this week's radio spot is here.  The script follows:

Hi, I’m Brad Keithley. Like you, I’m glad the election is over. 

Now, it’s time to put Alaska’s fiscal house in order. 

During the campaign, the state’s fiscal condition didn’t stay still -- it got worse. The price of oil dropped dramatically. This year’s state budget spends about $6 billion, but at current oil prices, revenues will total only about 3 billion. That’s a deep hole. 

Getting out of that hole means making tough choices, and, we know, our leaders can’t do it alone. They’ll need the support of people like us, people who believe in a simple, common sense principle – that Alaska must live within its means. 

A couple of years ago I founded Alaskans for Sustainable Budgets so Alaskans could work together to help fix the budget. 

I pledge to work with the leaders we just elected – both those I supported and those I didn’t – as they address the state’s fiscal gap, and I’m asking for your help. 

Join us at ItsOurFutureAK.com to help put Alaska on the right track and to urge legislators to support sustainable budgets. We need to fix this. Working together we can. 

ItsOurFutureAK.com

The Alaska Dispatch News candidate questionnaire ...

In the closing week of the campaign the Alaska Dispatch News published responses to a questionnaire it circulated toward the end of the campaign to legislative candidates.  The questionnaire asked the candidates for their positions on various issues.

Several of the questions on the list relate to state fiscal policy.  The fourth question asks directly about sustainable budgets ("What amount of state spending do you believe is sustainable? If cuts need to be made, where should most of the money come from, the operations budget or the capital budget?").

Some of the responses to that question are surprising.  With the fall in oil prices, the Department of Revenue currently estimates that state revenues this year might not cover even half of state spending, leaving a gaping hole of roughly $3 billion in the state's budget.  Yet, when asked to identify where cuts can be made, State Senator Cathy Giessel responded:  "We cannot cut our way out of this."

Other answers are more realistic.  State Senator Anna Fairclough, for example, responds to the same question as follows:  "Our current budget funding state government, public safety, transportation, and other much-needed programs is not sustainable at our current revenue projections. The state needs a fiscal plan to work through different scenarios in order to identify where cuts would be most effective and efficient."

It will be useful to delve into the responses further once the elections are behind and the more difficult task of governing and legislating -- in other words, facing up to the real world -- lies ahead.  For now, however, if any are reading this column on election day and haven't voted yet the questionnaire and responses provide a useful resource worth reviewing before doing so.  Again, the responses are here.

Completing the record ...

In the final days of the current election campaign some supporting the current Governor and incumbent legislators have tried to make much of the fact that the state budget has been reduced the last two years. But that needs to be viewed in the context of the complete record.

As the chart at the end of this column makes clear, the budget increased the first two years following Parnell's 2010 election by $2.3 billion/year, a 42% increase (from $5.47 to $7.78 billion); in the two subsequent years it has been reduced by $1.6 billion (a 21% decrease), for a net overall increase over the four year period of roughly $.7 billion (13% percent).  During the same period inflation has risen only 9%.  In short, despite the reductions, the Governor and legislature haven't even reduced the budget to where it was at the beginning of Parnell's term, much less started to repair the damage that occurred in the meantime by making the additional reductions necessary to return the budget to sustainable levels (the ISER calculation of the sustainable level made before the beginning of the last session was $5 billion).

Some argue that the increase over the first two years was the fault of the Bipartisan Senate Coalition.

But Art 2, Secs 15 and 16 of the Alaska Constitution provide that "[t]he governor ... may, by veto, strike or reduce items in appropriation bills," which may be overturned only by a supermajority (three-fourths) of the legislature sitting in joint session.  Even in the "dark days" of the Bipartisan Coalition (many of whom were Republicans), the Governor would have been able to rally the support of 16 members from the House alone to uphold a lower, sustainable budget level. He didn't even try. Instead, he signed the highest and third highest budgets in state history.

Finally and as importantly, even though the Governor and legislature did reduce spending over the last two years, those reductions haven't even kept pace with the fall in revenues over the same period. From FY 2013, revenues have dropped from $6.92 to $4.52 billion (a fall of $2.4 billion).  During the same period, however, spending has only dropped from $7.8 to $6.2 billion (a reduction of $1.6 billion).  Focusing on only one line of the budget, the spending line, is similar to the sound of one hand clapping -- it produces nothing.  In order to paint an accurate picture, a consideration of both the spending and revenue lines is necessary.

Those focusing only on the spending line over the last two years are attempting to mislead voters into thinking the Governor and past legislature exercised sound fiscal judgement.  They didn't; the state is worse off financially than it was when the current Governor and the current legislature took office.  Completing the record tells the full story.

Alaska's Fiscal Situation: How bad it may become ...

As those that follow these and the related micro-blog pages (largely, here and here) know, over the past few weeks I have been closely watching the decline in oil prices, delving into the fundamentals (such as the oil price necessary to support the budgets of the various petrostates), talking to those that know these things better and trying to get a handle on where this situation may be headed.

The reason, of course, is because, like other petrostates, Alaska depends heavily on oil revenues both to run state government and to help drive its economy.  As the various articles I have discussed on these pages and elsewhere make clear, the price drops are real and, in other petrostates similarly dependent on oil revenues, are being treated with serious concern.

Thusfar in Alaska, however, the concern has been limited to the odd article here or there.  Early in the month -- when it appeared that oil prices might stabilize in the neighborhood of $90 -- Tim Bradner wrote a column which analyzed the potential effect on state revenues at that level ("North Slope prices down $20/barrel since July").  A week ago Dermot Cole wrote an article outlining some of the potential effects on the state of a deeper and more persistent drop ("World oil price decline creates multibillion-dollar budget risk for Alaska").  And this morning, the Juneau Empire is running an article by Katie Moritz that carries some reaction from the Parnell Administration about the potential effect of the price drop on state finances ("Slumping oil prices means widened budget gap").

But thusfar, most political leaders have looked like they are engaged in a game of dodge ball when the issue has arisen.  Yesterday morning, for example, Michael Dukes asked me at the end of a discussion between the two of us on his morning talk radio show what one question I would ask Gubernatorial candidate Bill Walker -- who was coming up in the next segment -- if I had the opportunity.  Following up on a column I had written on these pages a week ago ("The most important question of this election …."), I said the question I would ask was something along the lines of, "What steps will you need to take to govern in a world of $90 oil".  While Walker was complimentary of these pages in his response, he never actually got around to answering the question, nor for that matter has Governor Parnell or any of the legislative candidates I have asked or heard asked the same question over the past few weeks.

The fact is, however, I have become increasingly convinced "how does Alaska deal with $90 (or lower) oil" is going to be the key question that not only the state's political leaders, but in fact most Alaskans are going to be forced to confront at least over the next year.  

The size of the problem the state potentially is facing is staggering.  To start putting my arms around it, over the last couple of days I have put together a spreadsheet that analyses what happens to this year's budget at various oil price levels.  There are a couple of caveats that are important to keep in mind when reviewing the preliminary results.

First, it is important to keep in mind that the actual price which ultimately will determine the outcome will be the volume-weighted average price for the fiscal year (July 1, 2014 - June 30, 2015) as a whole.  Although experienced during low production months, the prices received for ANS stayed above $105/barrel through most of the first month of the current fiscal year, at or above $100/barrel for most of the second and at or above $90/barrel for most of the third.  Prices have fallen below $90/barrel since that time, however, closing Wednesday at $81.42/barrel and if that defines a new normal for the remainder of the fiscal year, the weighted average is much more likely to be in the $80's than anywhere else.

Second, it is important to keep in mind this quick look may slightly overstate the adverse impact on the state budget at lower price levels.  The analysis uses the standard rule of thumb that each dollar drop in the price of ANS results in a commensurate drop of $90 million in state government revenue.  As a result of the flattening of the production tax rate at lower oil prices, the revenue impact may decline slightly as oil prices go lower.  Directionally, however, this chart correctly captures the relative impact on the budget of lower oil prices.

Reading left to right, the chart determines at the price levels listed in the first column and at the level of state spending enacted by the legislature and signed by the Governor earlier this year (second column), the resulting total state revenues (third column) and deficit (fourth column) that will result.  The fifth column (Percent Deficit) reflects the amount of total state spending that will need to be financed by savings, the sixth (Remaining Savings) reflects the combined amount of the Constitutional and Statutory Budget Reserves that will remain at the end of the year after they are tapped to cover the deficit and the final column the number of years that the state's budget reserves will be able to continue to fund deficits of the resulting magnitude before being exhausted.

Click on chart to enlarge.

So, for example, if oil prices for the year end up averaging $90/barrel, the resulting revenues will be somewhere in the range of $3.2 billion (against spending of $6.2 billion), the deficit $3 billion, the percent of the budget necessarily financed from savings 49%, the amount of the CBR and SBR remaining at the end of the year $9.8 billion and the years that the state can afford to continue down that path before exhausting its savings 3.2.

For someone that spends a lot of time looking at numbers like these, the results are scary.  Unfortunately, they also are what Alaska is about to face in the real world.

Things worth reading ...

Two recent articles in Foreign Policy are worth reading.  The first, "When the Petrodollars run out," analyzes the ability of various global petrostates -- and let's not kid ourselves, Alaska is one of those -- to withstand what the writer views as a prolonged decline in global oil prices.   Unfortunately, Alaska is never directly mentioned in these sorts of articles, but normally I am able to come up with numbers for Alaska that enable me to place it in the analysis.

This article focuses on three factors to determine vulnerability -- percent of government revenue derived from oil, percent of GDP derived from oil and the size of the government's sovereign wealth fund.  The higher the first and second, and lower the third, the more vulnerable the government.

Alaska is off the charts in terms of percent of government revenue derived from oil.  At 90+%, Alaska easily ranks among the Top 5 in the world -- on a par (and actually, a little ahead) of Libya, Brunei, Kuwait, Saudi and Bahrain.

Alaska is somewhat better positioned in terms of of percent of GDP derived from oil -- although Alaska's number is a little misleading.  According to the most recent data from the Bureau of Economic Analysis, Oil & Gas Extraction represents "only" (remember that we are comparing this to other petrostates) roughly 25% of Alaska's current GDP, relatively low among its peers.

The challenge with Alaska, however, is that oil-related dollars also drive a number of other economic sectors, which if included, would make the number much higher.  For example, state and local government accounts for another 8% of GDP.  Because a large part of the revenues driving those activities are derived from oil, one could make a case for accounting for a significant part of that percentage in the oil column as well.  But that may be the case also for some other petrostates and so, rather than divert off on what could become a days -- if not weeks -- long exercise attempting to make certain everything is stated on an apples to apples basis, I am good with continuing to think of Alaska as somewhere in the middle of the pack on this criteria.

Alaska is also relatively well positioned in terms of the size of our sovereign wealth fund.  While not as large as Saudi's ($743 billion) or Kuwait's ($410 billion), at $50 billion Alaska's fund is larger than most of the rest.  Interestingly, on the three factors discussed in the article, Alaska most (and in fact, closely) resembles ... Libya.  That's not a good thing.  Read more here.

The second article from earlier this month, "Oil Prices Are Falling, Not Oil Regimes," somewhat examines the same issue, though more from the standpoint of budget issues.  Again, Alaska is not mentioned but can be inserted into the story.  Alaska's current budget has a breakeven price of $117/barrel, not the highest in the world -- Iran's is estimated to be $130 -- but, as with the percent of government revenue derived from oil -- in the Top 5 globally.  As the article points out, that is not a good place to be -- at all -- at this particular moment in history.  Read more here.

A conference (today) on "Alaska's Fiscal Future" ...

Today (Saturday, October 4) at Anchorage's Z.J. Loussac Public Library's Wilda Marston Theater, an all day conference on Alaska's Fiscal Future. Drop in for all or pieces either in person, or by tuning in at Hot Talk KOAN or KVNT Valley News Talk.  The agenda:

Parnell Claim: "Pants on Fire!"

Earlier this election cycle one of the websites that does this sort of thing -- the Tampa Bay Times' Politifact.com -- rated a Mark Begich ad as so false it deserved the organization's ranking reserved for only the most outrageous political claims -- "Pants on Fire!"  The claims which qualify for that rating are those where "the statement is not accurate and makes a ridiculous claim."

If Politifact were following the current Alaska Governor's race I anticipate they would give the same ranking to a claim made yesterday in an email blast sent out by the Parnell campaign.  The blast is below, with the claim circled.

The circled portion reads:  "With a balanced budget and record spending reductions I made with legislators, a Parnell-Sullivan ticket ensures we live within our means. We cut $1 billion in the 2013 legislative session and another $1.1 billion in the 2014 legislative session."

With one exception -- each of the budgets were made with legislators -- neither of the sentences are even remotely accurate and both make ridiculous claims.  

The state's unrestricted general fund (UGF) (the category on which analysts commonly focus when talking about state budget matters) in Parnell's last three budgets has been far from the commonly understood meaning of the word "balanced" -- where spending equals or is lower than revenues.  According to revenues taken from the Department of Revenue's latest Revenue Sources Book (2014 Spring) (Table 2-1) and spending taken from the fiscal summaries prepared by the legislature's Legislative Finance Division, with an adjustment made for FY 2015 as described below, the results of the last three budgets are as follows (in $billion):

None even remotely approaches "balanced" (except in a Juneau-speak world where they assert something is "balanced" if it can be covered by savings retained from previous years) and, in fact, the last two are the highest deficits in the state's history.  

Most of the second sentence is equally wrong.  Looking again at the spending column above (which is derived from the fiscal summaries prepared by the Legislative Finance Division, as adjusted), the spending cut made in the 2013 session (which considered and passed the FY 2014 budget) was approximately $500 million (far from the claimed $1 billion) and that in the 2014 session $1.1 billion.  (The spending level initially reported by Legislative Finance for FY 2015 is $5.83 billion, but needs to be adjusted to add back in $350 million for PERS/TRS in order to make the comparisons apples-to-apples.)  The Parnell claim reaches for various below-the-line cash flow adjustments made to reflect an assortment of transfers from and into reserves held in other accounts (such as various loan funds and AHFC) to claim other numbers.

Finally, not even Parnell's own Office of Management and Budget backs up the bulk of such claims.  In its own analysis of the enacted FY 2015 budget, OMB shows both the FY 2014 and FY 2015 budgets ending up in the red (deficits) even after including the below-the-line transfers.  Its analysis of the FY 2013 budget also shows a final, post transfer deficit.

As the state begins to face a future of significantly lower oil prices than previously forecast -- which alone may balloon this year's deficit from $1.6 billion to $2.5 billion -- it is important that the state's leaders speak honestly with voters about the condition of Alaska's finances.  Parnell's "Pants on Fire!" claims don't even remotely do that.  Alaska -- and Alaskans -- deserve better, much, much better than the inaccurate and ridiculous claims they received from the Governor in this email blast.

Alaskans deserve the truth.

This is what I know ...

For more information on "It's Our Future" click here.

I am working on a longer piece on the importance of fiscal policy in this election, and as usual when I start have prepared a list of the things to use as a reference. Here is the list:

• Bill Walker, Alaska Libertarian Party candidate Care Clift and Alaska Constitution Party candidate J.R. Meyers all have said they support putting in place a "sustainable" budget. That term has a clearly defined meaning, backed up by a series of papers prepared by UAA's Institute of Social and Economic Research (ISER). 
• Recently, Governor Parnell is reported to have said he supports a "balanced sustainable budget." "Balanced" and "sustainable" budgets are two different things.  Under a "balanced" budget government rides down revenues until there are none left or it creates other sources (e.g., through an income tax). Under a "sustainable budget" government deposits excess revenues received in good years (i.e., those years with revenues over the sustainable level) in what ISER refers to as a "nest egg" to produce earnings to supplement and sustain the same level of overall spending in later years (adjusted for inflation and population growth) when other revenue sources aren't sufficient. In the process government avoids the need to create additional revenue sources (i.e., an income tax) in later years as revenues from previously primary sources decline. 
• Moreover, in recent discussions Governor Parnell apparently has claimed to some to have submitted balanced budgets to the Legislature each of the last five years. Even his own Office of Management and Budget, however, admits that last year's budget was over $1 billion in the red when submitted, so not only is what he means by the term "balanced sustainable" unclear, it's not clear what Parnell means even when he uses the term "balanced."
• The current budget, which already is projected to finish $1.6 billion in the red, is based on an assumption of oil prices averaging $105/barrel over the current fiscal year (July 1, 2014 - June 30, 2015).  So far in the fiscal year, oil prices have been at or above that level only 30 days.  Oil prices currently are in the range of $95/barrel and both the futures market and a number of analysts are predicting continued softness in the months, if not years ahead.  
• At current production and tax levels, each $1 change in the price of a barrel of oil changes general state revenues by roughly $90 million.  If oil prices end up averaging $95 for the fiscal year instead of $105, the state budget will end up $2.5 billion in deficit, an all time record and after the previous reductions caused by the deficits and other legislative actions of the last two years, will eat through roughly 20% of the state's remaining unrestricted savings.
• In response to the above, Governor Parnell and his supporters generally rely on his "record" of having reduced the state's budget by $1 billion each of the last two years.  That is not entirely accurate.  Approximately $350 million of that reduction is attributable to ignoring one year's worth of payments generally made out of the operating budget to support PERS/TRS.  When those are added back in, as they should be to produce an apples to apples comparison, the reduction is only in the range of $1.6 billion.
• Moreover, the reductions are from the record budget levels that Parnell himself approved earlier in his term, and haven't even kept pace with the rate of reduction in state revenues over the same period .  Despite the claimed spending reductions, the current budget is still the fourth highest in state history and is estimated to produce a $1.6 billion deficit (the second largest in state history) which as noted above, may balloon to $2.5 billion if lower than projected oil prices persist.  Whatever reductions have occurred, they haven't been remotely enough to put the state back on the sound fiscal footing it was before the Governor started approving record budget increases.  
• Most important, the relevant question to the Governor (and any candidate) this election is not where the state has been, but where it is headed.
• The state's current track is threatening to undue quickly the gains in investor confidence achieved through SB 21.  On its current track the state will run through its remaining savings somewhere between five years from now (at the $2.5 billion/year deficit level) and seven years (at the $1.6 billion/year deficit level).  Investors reasonably anticipate that, when faced with the need to increase revenues (as savings run out), the state will increase taxes on industry first before moving on to other revenue sources.  Without a clear and reliable plan for dealing with the situation, investors already are leery of making significant new investments that rely on revenue streams to achieve anticipated returns lasting longer than four to five years at the outside.
• Beyond that, the state's current track also is leading directly toward what ISER predicts will be "institution of broad-based [income, sales or both] tax and use of a portion of the earnings from the Permanent Fund."  Essentially, on the current track future Alaskans will be left holding the obligation to pay for the bloated spending decisions made by this one.
• In my opinion, fiscal policy is the key issue at the state level in this election cycle.  ISER has said that, on its current track, the state is heading toward a "fiscal crisis" and "economic crash."  The consequences are severe and that track has to be changed now -- by the Governor elected this coming election -- in order to avoid those consequences.  

• The Final Point.  As of this writing, there are 35 days between now and Election Day.  Three candidates -- Walker, Clift and Myers -- need to tell Alaskans how they will achieve a sustainable budget,  within what time frame and how it will avoid the outcomes of the current track.  One candidate -- Parnell -- has to explain in the first place what his plan is for changing the current track that Alaska is on (i.e., what he means by the words he is using), then how he will achieve that plan, within what time frame and how it will avoid the outcomes of the current track.
• The clock is ticking:

Maybe Governor Parnell doesn't understand ...

... what the real fiscal issue is in this election.  It's partly about his past record -- the four largest budgets and two largest budget deficits in Alaska's history.

But that really is only the prologue to the real question -- what is each candidate's plan going forward for dealing with a situation that the University of Alaska-Anchorage Institute of Social and Economic Research (ISER), the state's best economic think tank, calls an approaching "fiscal crisis" and "economic crash" which, if not headed off, will result in the "institution of broad based [income, sales or both] taxes, and use of a portion of the earnings of the Permanent Fund,” just to maintain minimum levels of government services.

The reason the thought the current Governor doesn't understand the real issue crosses my mind is because of a brief Twitter "skirmish" that broke out this afternoon after I published a blog piece discussing a recent statement by Bill Walker that he will "[put] in place a sustainable budget" if elected.  As I discuss in detail in the piece, a sustainable budget is something the state should have -- and some promised to -- put in place two years ago before the legislature enacted and the Governor signed back-to-back the two largest budget deficits in state history.  If they had, the state wouldn't be facing as severe a problem as it is now.

But they didn't and Walker (as well as two of the other candidates for Governor, Alaska Libertarian Party candidate Care Clift and Alaska Constitution Party candidate J.R. Myers) recognize that, as it was two years ago, a sustainable budget remains the best option now -- especially when compared with an income tax and reduced PFD as alternatives.

After publishing the piece, someone with the Twitter handle @AKpolitico -- I don't know the person's real name and he or she doesn't disclose it on their Twitter page, but who from past tweets clearly supports and may be part of the Parnell campaign -- decided to play cute and attempt to score political points off my commentary.  The problem, however, is that they didn't come to the effort with any notion of what Parnell's going forward plan is for dealing with what ISER terms the coming "fiscal crisis" and "economic crash."  All they wanted to do was try to pick on Walker's.  I've played enough poker to know that you don't start the game until all sides have anted up.

As I have thought about it since and gone back to read some of @AKpolitico's prior posts I have come to the conclusion that maybe @AKpolitico is part of the Parnell campaign and maybe they couldn't engage because Parnell doesn't understand what the real fiscal issue is.  Now that is downright scary.

In any event, here is a replay of the "skirmish."  I will leave it to each of you to draw your own conclusions.  Mine are those above.

Bill Walker: “I will … put in place a sustainable budget.” http://t.co/4QfiNHzTaz #akgov #akelect #akleg
— Brad Keithley (@bgkeithley) September 27, 2014

@bgkeithley how do you reconcile that with his support from every big spending interest group? Already seen Walker talk out of both sides
— AKpolitico (@AKpolitico) September 27, 2014

Your time is better spent rationalizing record deficits under Parnell #actionsnotwords @AKpolitico: how do you reconcile ... #akelct #akgov
— Brad Keithley (@bgkeithley) September 27, 2014

@bgkeithley We know Parnell's record & can judge ourselves if cutting $1B in each of last 2 yrs is enough. Ask again: what would Walker cut?
— AKpolitico (@AKpolitico) September 28, 2014

Parnell's record? Four largest budgets, two largest deficits in Alaska history & #noplanforwardfromhere @AKpolitico: We ... #akelect #akgov
— Brad Keithley (@bgkeithley) September 28, 2014

The only apparent Parnell forward plan is spend until AK needs an #incometax #cutPFD @AKpolitico: We know Parnell's record #akelect #akgov
— Brad Keithley (@bgkeithley) September 28, 2014

@bgkeithley What's Walker's plan?
— AKpolitico (@AKpolitico) September 28, 2014

Walker says sustainable budgets, what's Parnell's? #incometax #cutPFD #ObamaHope? @AKpolitico: What's Walker's plan? #akgov #akelect #akleg
— Brad Keithley (@bgkeithley) September 28, 2014

Another, more personal way to look at state spending numbers ...

Yesterday after publishing an earlier piece listing "Four basic Alaska budget facts and a reminder ...," a friend and I engaged in an exchange about how to make the numbers meaningful to Alaskans not as immersed in the numbers as some.  Usually I resist spending much time on those endeavors, largely because I know what I am good at -- and that isn't one of them.  Because I still had the Excel workbook up where I have all of the data, however, I recalculated the numbers as our discussion went along and, at the end, have to admit that the result produced some interesting numbers.

As it went on, the goal was to restate state spending under the various Alaska Governors since 2000 (i.e., the last 15 years), adjusted for inflation (so that the spending levels are not distorted by time) and -- this is the part that my friend convinced me to use to put it on a more understandable level -- stated on a per capita basis, in other words the amount of state spending broken down by each Alaska man, woman and child resident in the state at the time the spending occurred.

The resulting spreadsheet follows, but the quick take away was this:

• During the Knowles Administration, Alaska state government spent $4,928 per Alaskan; 
• Murkowski: $5,777; 
• Palin: $8,579; and thus far during
• Parnell: $8,864.  

The final element was to add in on the same basis what the current level of sustainable spending is -- in other words the amount which, if spent today and the remainder of state revenues put aside for the future, could be sustained for decades into the future without the need for increased taxes or diversion of earnings from the Permanent Fund.  The result (based on current population):  $6,585.

I have to admit these are very interesting -- and useful -- numbers.

Some interesting dynamics at work in the #AKgov race ...

While Amanda Coyne and others in the past have rightfully cautioned against putting too much weight on Alaska polls conducted by Public Policy Polling, there are a couple of interesting results in PPP's latest, released yesterday, that have me intrigued.  The results are the responses to Questions 8 and 9, which are as follows:

The thing that intrigues me is the shift that occurs when the two third-party candidates for Governor are eliminated from the survey and those that otherwise are intending to vote for them essentially are asked to reallocate their vote between the incumbent and Bill Walker.  Tellingly, Walker's lead over the incumbent goes from 1% to 4%, apparently because of the movement of a significant portion of the third-party voters going to Walker.

Of course, neither of the third-party candidates are expected to drop out of the race before the election.  But the numbers nevertheless are intriguing to me because I remember well the 1992 Presidential election, when Ross Perot played a similar, albeit larger, role as a third party candidate.  Polls conducted early in the race put Perot at somewhat significant numbers.  Those dwindled, however, as the election date came closer and voters became concerned that, in a plurality take all contest, casting a vote for Perot instead of one of the top two candidates left the voter out of the decisionmaking process.  The result was a significant movement in the final weeks away from Perot and toward one of the other two, leading candidates.

But those voters took their issues with them and broke surprisingly strong toward the end for Bill Clinton as he increasingly warmed to the budget issues that had propelled the rise of Perot (and George Bush did not).  

Of course, those favoring the Alaska third-party candidates in the current poll are concerned about a number of issues, and some of their supporters are so firmly committed to the cause that it is unlikely they will be swayed to vote for one of the two frontrunners even toward the end.

But from all appearances at this point this election is going to remain close to the end and both of the frontrunners will be looking for every vote they can.  As they contemplate strategies on how to attract some voters away from the two third party candidates it will be important to remember that, like Perot before them, both third party candidates have put budget issues -- and specifically, achieving a sustainable budget -- at the center of their agenda.  See, e.g., "A Statement on Alaska's Future," by J. R. Myers, the Alaska Constitution Party candidate, and "Top Three Concerns for Alaska," by Care Clift, the Alaska Libertarian Party candidate.

Looking back on the 1992 election over time, I have come to realize that there are a number of ways for third party candidates to become successful.  One, like Angus King in Maine, is to be elected.  But a second, lesser preferred, but nevertheless good outcome is to have your issue become the defining one of the election.

A few years after the 1992 election, noted Presidential historian Michael Beschloss had this to say about Ross Perot's run:

“[Perot] was the first candidate really in a big way to float the idea that the deficit was a bad thing .... By the time Bill Clinton was elected that fall, if he had not done something about the deficit he would have been in big trouble and that was largely Ross Perot’s doing.”

In short, even though he wasn't elected, by running Perot put "the federal budget deficit, an issue previously ignored in elections," on the map, and made it "a major part of almost every presidential campaign since."

Care Clift and J.R. Myers are doing the same thing with budget issues in Alaska.  As the PPP poll indicates, the race is shaping up to be tight, with undecideds and third party voters positioned to play a major role.  In an effort to attract those voters both major candidates are going to have to deal with the issues that have propelled support for the third party candidates, and more than anything else those relate to the state budget.  As in 1992 at a national level, by the time this is over the winning candidate may well be the one that has articulated the best plan going forward for securing Alaska's fiscal future.

And that will be the result of Care Clift and J.R. Myers doing what they are doing now -- pressing the issue and continuing to give voters an alternative if the two frontrunners don't step forward with their own solution.  Even if they don't ultimately win the election, as Perot's in 1992 their campaign will have succeeded by creating an environment in which the winner will be in "big trouble" if he doesn't do something about state fiscal issues.

Four basic Alaska budget facts and one reminder ...

See "#AKbudget| Unfortunately, deficits matter … (addendum dated 4.25.2014)" for how this chart was constructed.

I was working on a longer piece today for publication elsewhere and kept coming back to four basic facts about Alaska budgets and one reminder.  I thought I would share them here:

1. Current Governor Sean Parnell has been responsible for five budgets during his years as Governor.  Four of the five are the four largest in state history and the fifth is the sixth largest in state history (number 5 was signed by Governor Sarah Palin).
2. Since 2000 the annual budget has finished in the red six times.  The last three of those (three of Parnell's five) have been signed by current Governor Sean Parnell and the last two of those, back-to-back have reflected the two largest budget deficits in state history.
3. Contrary to what some have claimed (that these deficits arose under the Bipartisan Coalition), the last two budget deficits -- the highest in state history -- were passed by the legislature elected in 2012, which produced supermajorities (75%) for the Republicans/Majority Caucus in both legislative bodies.
4. The current budget -- which already is projected to be $1.6 billion in the red -- is based on an assumed ANS oil price of $105/barrel (footnote 2).  The actual price of ANS oil has been below that level since July 31 (barely 30 days into the current fiscal year), has remained in decline since and most recently closed at $94.22/barrel.  Increasingly, most analysts are predicting that the price will either stay in the neighborhood of that reduced level or continue to drift downward over the next several months.  At the spending levels enacted by the legislature and signed by the Governor earlier this year, the actual current year deficit will exceed $2.5 billion if the current price level persists throughout the remainder of the fiscal year, exceeding the previous record state deficit by 30% and in one year alone draining nearly 25% of the state's remaining unrestricted general savings.
5. In 2010, current Governor Sean Parnell campaigned on the theme that the candidates should be judged by their "Actions, Not Words."  Parnell's actions -- and those also of the legislature elected in 2012 -- speak for themselves.