Over the next couple of days, I will post a three part series about the current oil price environment in Alaska.
It is well known that Alaska’s economy is highly sensitive to the price of oil. Billions of dollars in investment capital flow into the state each year as energy companies both explore for new oil and maintain their existing fields. This activity has an enormous positive multiplier effect on the rest of the economy as major service industries including trucking, construction, finance, legal, engineering, retail and countless others see a direct benefit from the contracts and employment required to support this massive effort.
The current low price environment has many people rightfully concerned about the possible impacts on Alaska’s economy. However, based on currently available information and analysts’ estimates, prices should begin to increase this year. The over-supply of oil that led to the recent price drop should moderate as higher cost producers are not able to operate profitably. Continued global demand for energy is expected to move prices higher by this summer when excess inventories are consumed. Prices in the $60 to $80 range should keep long-run capital investments from the energy industry stable.
Arguably, the most impacted by a decline in the price of oil is the State of Alaska government. We are the most structurally imbalanced government in the country in terms of the diversification of revenue sources. In fiscal year 2014, 88% of the state’s unrestricted spending came from oil taxes and royalties. On a positive note, this does not include the $11.5 billion in revenues from other sources such as Federal government contributions to the state and returns from our investment portfolios. If you include all revenue sources, including those restricted by law or by tradition to be spent on specific purpose like the Permanent Fund, than the oil contribution was only 33% of all revenues. This is smaller than a typical year because returns on investments in the stock market were higher than normal.
It is important to concede that oil prices are highly volatile. Variance is normal and future predictions are nearly impossible to make with a high degree of certainty. Therefore, making conservative budget estimates and spending decisions is the only safe way to avoid the fallout from sharp price declines, which at some point are inevitable due to global circumstances that are outside our control in Alaska.
We have been experiencing an unprecedented good run of oil prices over $100 a barrel for over 3 years. The state tax rates were changed to rise progressively with the price of oil during the Murkowski administration. Tax rates were raised further during the Palin/Parnell years. A modification was made prior to the fall in oil prices that raised the base tax rate, but reduced the relation to prices. This helped protect the state from losing even more revenue during the current low price environment. The current price drop would have been even more severe if the voter initiative on oil taxes had passed. At lower oil prices the current law earns hundreds of millions of dollars more in production taxes. These changes led to a windfall of billions of extra dollars for the state government over the last decade due to high prices and high taxes, despite falling oil production levels.
The problem has been the level of government spending is not sustainable unless prices stay over $100 a barrel and continue to rise in the future. That never seemed likely, despite Department of Revenue predictions that the Legislature used to justify high spending levels in the operating and capital budgets. Now it is likely that tough decisions will need to be made to control spending levels, which will inevitably be a drag on the statewide economy.
Of all 50 states, Alaskans receive by far the highest amount of state and federal government spending on a per capital basis and also pay the least in taxes. We even go one step further and receive a cash dividend of over $1,000 per person back from the State. This has been possible only because of our vast energy resources and our small population. Over $52 billion has been saved in the Permanent Fund and it grows despite the roughly $800 million a year spent on dividends due to investment returns and continued deposits from ongoing natural resource projects in Alaska.
Additionally, the state has over $50 billion saved in other investment accounts. The largest portion, $28 billion, is reserved for the retirement system obligations for state employees. Other funds are dedicated to specific department operations, such as $1 billion for airport bonds, $1 billion in the power cost equalization endowment fund, $586 million in the public school trust fund and many others. To balance an estimated $3 billion budget deficit this year the Legislature can draw from the $11 billion Constitutional Budget Reserve, $3 billion in the Statutory Budget Reserve, and $5 billion was in the General Fund at year end 2014.
The current budget deficit is expected to force the Governor and Legislature to freeze the growth in the operating budget and cut the capital budget. Research from UAA’s Institute of Social and Economic Research (ISER) has confirmed the widely held belief that the state government has been spending in excess of its long-term sustainable levels. The Gross State Product in Alaska is $51 billion. A $1 billion reduction in state spending would reduce aggregate demand in our economy by about 2%. A positive way to look at this would be despite government cuts we would still have a $50 billion economy.
Join us tomorrow for our look at the root causes of the recent price decline.
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