By Tim Bradner
Alaska’s economy is struggling. The COVID-19 closures of business and institutional employers last spring had a heavy impact, leaving thousands of Alaskans suddenly unemployed.
Several billion dollars of federal emergency aid were pumped into the economy through enhanced unemployment benefits and business loans and grants, and these helped soften some of the impacts, but those were temporary measures that will expire.
While a gradual reopening of Alaska’s economy is allowing many Alaskans to return to work this is still tenuous, and employment is still far below levels of early 2020.
There is room for optimism if the COVID-19 virus can be kept under control. So far Alaska’s rates of infection, hospitalizations and deaths are far below national averages, adjusted for population, but it still may be 2023 before the economy returns to its pre-COVID 19 levels, economists at the University of Alaska Anchorage’s Institute of Social and Economic Research have estimated.
Several of Alaska’s basic industries have been severely affected. The state’s oil and gas industry was hit hard by the crash in oil prices as the economic slowdown effected major parts of the developed world, causing demand for fuel to plummet.
Alaska’s tourism industry has effectively lost an entire year with the cancellation of cruise ship visits for the summer and concerns for health while travelling among independent tourists who might otherwise have come to Alaska by air or highway.
It is still uncertain how COVID-19 will affect Alaska’s commercial fisheries, also an important industry. Seafood processors and harvesters are working under strict health protocols, but these have increased costs for the industry. Meanwhile, there are concerns for seafood demand with key segments of the market, like “white tablecloth” restaurants still shut down, and uncertainties in transportation and demand in Asia.
On a brighter note, demand for fuel products is picking up and Alaska oil prices gradually rose above $40 per barrel in June from essentially zero a few weeks previously. If the trend continues past the $50 per barrel threshold North Slope producers may put drill rigs back to work and resume preparations for new projects, work that was largely halted in March when the COVID-19 crisis hit.
Other sectors of the economy, like minerals production and personnel and support work at Alaska’s several military installations are either stable or growing. Alaska’s producing mines are operating normally, with heath safeguards in place. While summer exploration is expected to be down work is continuing on certain major prospects, such as the Donlin Gold project on the Kuskokwim River and a significant new gold discovery in the Yentna mining district in the western part of the Matanuska Susitna Borough.
International air cargo flights through Anchorage’s Ted Stevens International Airport are actually up, according to data from the airport system.
Although many of these are “gas and go” stopovers for refueling, many flights are also operated by major freight operators like Federal Express and United Parcel Service, and these companies operate facilities and employ a substantial number of Alaskans.
In broad terms, the overall outlook is for a gradual return to normalcy, with temporary setbacks still possible. However, there may be lasting changes, as yet unknown, on the pattern of work, schooling and life in Alaska as well as elsewhere in the world.
However, one problem remains unresolved and it still adds uncertainty to Alaska’s recovery.
This is the continued structural imbalance in state government finances, the lack of a secure revenue system as government costs, mostly for public services and protection, continue to rise gradually while the state’s ready liquid asset reserves are depleted.
For decades, oil production and revenues funded most of the state budget, allowing for a generous expansion of public services and major infrastructure construction. The Permanent Fund Dividend, or PFD, was established to shares Alaska’s oil wealth with its citizens. It is unique in the world.
Alaska’s annual spending of several billion dollars a year of its oil revenues has been a major foundation of its economy, the PFD itself adding a billion dollars or more in recent years to the economy. This has spurred consumer spending, although many Alaskans save their dividends, and part of it is in any event subject to federal tax.
However, long before the COVID-10 crisis hit the underpinning for this – the economic health of the state’s petroleum industry – has been in increasing jeopardy. North Slope oil production began declining in 1988 and has continued to drop.
The decline was flattened for a period after the state Legislature passed an oil tax reform bill in 2013 but it has now returned and is expected to accelerate in the next three years.
While there are new oil discoveries and possibilities that the decline can again be flattened if work can be resumed on developing these new prospects there is also a ballot initiative pending in the November state general election that would substantially increase state taxes on petroleum. If voters approve Ballot Measure No. 1 it would double state taxes on Alaska’s largest oil fields, hitting the industry hard just as it struggles to regain its footing.
Meanwhile, the outlook for state finances, which can no longer be supported by oil, is highly uncertain. The state had built up hefty cash reserves during a period of high oil prices but a prolonged price slump starting in 2015 required the Legislature to draw down these reserves by several billion dollars a year.
Although state spending was cut by a billion dollars a year, or about 20 percent, over this period, the Legislature also had to wrestle with multi-billion-dollar annual deficits.
There was little real alternative to the deficits because simply cutting spending in to match available revenues over those years would have required huge spending reductions which would have crashed the economy.
In its response the Legislature chose to draw down assets by $18 billion from liquid reserve funds by between 2016 and 2019, and this now leaves an estimated $2 billion in the Constitutional Budget Reserve, or CBR, the state’s main liquid asset fund, as of July 1.
An estimated $1 billion deficit for FY 2020 and an expected, but unknown, deficit for FY 2021 (wildfire costs are always an uncertainty) will draw this down further.
The state’s CBR fund will be essentially exhausted except for a minimum needed to pay recurring expenses, like payroll, during the year.
There is, or course, the earnings reserve of the Permanent Fund, which is still ample, but although it can legally be spent (the principal of the Fund cannot be spent) it is still part of the Permanent Fund and should not be spent because that would the long-term growth of the Fund.
One positive note is that as oil revenues declined the Legislature has opted to diversify the state’s revenue sources by allowing, for the first time, some of the Fund’s earnings to help support the budget. Previously the Fund’s earnings were used only to pay the PFDs and to inject an “inflation adjustment” of earnings into the principal of the Fund. In 2018 the Legislature adopted a percent-of-market-value, or POMV, mechanism to allocate 5 percent of the Permanent Fund’s realized, or cash, earnings to help support the budget.
This has resulted in about $3 billion a year now being available for the budget and reducing the state’s dependence on oil income. While there are risks with depending on financial market performance for public revenues, just as with oil income, a five-year averaging mechanism on the POMV is expected to smooth out any effects of volatility.
Even with that, however, deficits remain. For FY 2021, the budget year that began July, traditional state revenues including from oil are expected to total $1.15 billion. The POMV draw from Permanent Fund earnings will total $3.09 billion. Total state funds available for the budget total $4.24 billion. When the $680 million expenditure for the PFD is added, a deficit of $982.2 million is projected.
While this appears down from the FY 2021 deficit of $1.3 billion, which included costs for the heavy summer, 2020 wildfire season, it is likely that unforeseen events, like more fires, could add to the $982.2 million current year deficit now estimated.
What is interesting about this estimate is that had the $680 million expenditure not been made the deficit would be reduced to $302 million. A modest increase in taxes would have covered that.
While there are still funds in the CBR reserve the current year deficit will not only deplete the fund but require other sources of income to meet ongoing cash costs, legislative finance analysts now say.
This means the state will have to find other ways to meet its ongoing commitments, and some margin of savings are always needed in case there are emergencies, like from an earthquake.
Short-term borrowing in debt markets, through issuing revenue-anticipation notes, is always possible, but this has costs. There are a handful of other reserves than can be tapped or borrowed from, like the Power Cost Equalization fund, which now has about $900 million.
This is now used to pay subsidies to rural utilities to offset high residential power costs in small communities and using this fund as the state’s “checkbook” for its costs, even if the borrowing is repaid, will reduce the PCE’s earnings, jeopardizing the payments to utilities.
The Legislature will be tempted, with the CBR fund nearly depleted, to reach into the Permanent Fund’s earnings reserve. But this will have consequences. For every $1 billion that the state takes from the reserve, money available under the POMV declines by $50 million in future years, financial analysts to the Legislature have concluded.
Bond rating agencies will take a dim view of this. Firms like Moody’s Investor Services, Standard and Poor’s and Fitch Rating Services are aware of Alaska’s circumstances and were heartened two years ago when the Legislature approved the POMV and its 5 percent limit on draws from the Fund’s earnings. The agencies increased the state’s credit rating on its bonds, which also affect ratings on most Alaska municipal bonds.
If the Legislature were to choose to exceed the 5 percent limit while also ignoring the state’s substantial unused tax capacity (there is no state personal income tax or sales tax) and attempting to continue a PFD payment it would only underscore Alaskans’ inability to deal with their finances. Our credit ratings will sink.
At this point it seems inevitable that the Legislature will face difficult choices. It has to enact some form of broad-based tax like an income or sales tax, end the PFD or cut public expenditures, which would inevitably jeopardize education and public safety.
Continued spending reductions are likely in any event, and many of these will take the form of costs passed down to local governments. They, in turn, will have to increase local taxes.
It was long known that Alaskans will have to eventually deal with their finances. COVID-19 has only accelerated this.
Tim Bradner is copublisher of the Alaska Legislative Digest and Alaska Economic Report
