Alaskanomics

Permanent Fund's Structural Problem

Alaska’s Permanent Fund has a structural problem. Left untended, it could put the Fund in jeopardy.

The Fund’s trustees have warned about this for two decades. The state’s political leaders haven’t paid attention. Preoccupied with the Permanent Fund Dividend, there has been almost no attention paid to the deeper problem.

Here it is, in a nutshell:

The Fund, now $81 billion in value, is really two funds. One is the constitutionally protected principal. The second an earnings reserve account that holds cash income as it is earned, and which is not protected. It can be spent by the Legislature.

This is an odd construct and no other large investment fund is built like this. There are historical reasons why it happened. When the Fund was created it was organized like a trust fund with money invested in very secure fixed-income assets, mainly bonds. Equities like stocks were considered risky. Many types of equity investments are now made for the Permanent Fund.

The 1976 constitutional amendment that created the Fund established the protected principal as the Fund. Income from investments went to a special account in the Fund, as they still do to hold the earnings. This is known as the Fund’s earnings reserve.

What’s important is that funds can be appropriated from the Earnings Reserve. It is unprotected, unlike the principal.

Many people believe the earnings reserve should be part of the protected principle, and this change is included in a proposal this year by Gov. Mike Dunleavy.

The problem now is that unless this is done the principal of the Fund, the protected part, does not grow from the realized, or cash, earnings of its investments. Those go to the earnings reserve in the General Fund.

In contrast with the principal, the earnings account does grow through realized earnings, which are mostly retained. The benefits do not flow to the principal.

Any transfer from the unprotected earnings reserve to the protected principal must be done by the Legislature through an appropriation. This has been done over the years as an annual “inflation-proofing” payment to the principle and sometimes by direct appropriation.  But in recent years inflation proofing has not been done, at least not on a regular basis.

Protected principal grows more slowly than earnings reserve

The difficulty this creates is that over time, and particularly in recent years, the protected principle has grown at a much slower rate than the unprotected earnings reserve.  

Here’s an illustration: In state Fiscal Year 2016 the principle was valued at $44.2 billion. Over five years, FY 2016 through April 30, FY 2021, the principal value increased to $59.5 billion, a growth of $15.3 billion. Included in this was a transfer of $4 billion from the earnings reserve to the principle by the Legislature in FY 2020. Absent this transfer, the growth of the principal though unrealized gains in market value and ongoing petroleum royalty deposits was $11.3 billion.

In contrast, over the same five years the earnings reserve value increased from $8.6 billion in FY 2016 to $18.3 million in FY 2021, an increase of $9.7 billion.

This doesn’t include $11 billion paid from the earnings for various purposes, mainly the Permanent Fund Dividends and more recently the percent-of-market-value payment to the state General Fund to support the budget.

 If these funds earned but paid out are included, the earnings reserve actually increased by $20.7 billion.

What the figures show that the earnings reserve is growing faster than the principal. Unrealized market value growth is reflected in both the earning reserve and the principal because assets are invested equally. What isn’t shared in the principal is the realized income from the periodic sales of assets (stocks or real estate, for example) or income from bond interest and rentals of real estate.

The realized earnings are substantial and are held in the earnings reserve. For that reason, the growth of two funds is unbalanced.

Unless the problem is solved the principal value will lag over time and the earnings reserve will get much larger, and because it can be spent It will be an inviting target for politicians looking for money.

This year, in fact, the Legislature and Gov. Mike Dunleavy are proposing to take $3 billion from the reserve as part of a broad restructuring of state finances, but in effect it is to cover state budget deficits and to pay a higher PFD.

The solution: Merging the two funds

The solution to the problem, the Fund’s trustees have proposed for the last 20 years, is to end the odd construct of the two funds, the principal and earnings reserve, so that all of the money is protected. It could then operate like a large endowment like those of major universities and charitable funds.

The Permanent Fund’s annual payment to help support the state budget, using a percent-of-market-value, is set by statute at 5 percent of the Fund’s total value averaged over five years. Combining the principal and earnings reserve as the Trustees propose wouldn’t affect this, but by protecting the entire fund and not just part of it the annual payment becomes more secure.

A constitutional amendment is required to combine the two funds, however. Governor Dunleavy has proposed this as a part of his plan to also guarantee the PFD in the constitution.

However, putting a spending program in the constitution along with a payment methodology, which is also part of the governor’s proposal, is controversial because it could be seen as giving priority to the PFD over other requirements in the Constitution, such as support for education and public safety.

However, one attractive feature of this is that including the POMV and its annual payout of 5 percent of the Fund’s value effectively caps any payment from the Permanent Fund, which adds more protection against efforts by politicians for large payments, such as for large dividends.

Complicated ballot propositions are risky

Despite the popularity of the PFD voters often reject ballot propositions that are complicated. This one, with its merging of the earnings reserve and the principle and the guarantee of the dividend and its payment methodology, is very complicated.

It may be difficult to explain to voters in the 2022 general election. Experience has also shown that when ballot propositions are complicated voters often say no.

Despite the risk of rejection by voters, the governor and many legislators feel the only way to resolve the political turmoil that has occurred over the size of the PFD (it has dominated recent elections and legislative sessions, distracting from other matters) is to guarantee it.

The only way to do that is to put it into the Constitution, the governor and many others argue. It would lay the annual fight over the PFD to rest.

Tim Bradner is editor and publisher of the Alaska Legislative Digest and Alaska Economic Report

Alaska Economic Update - May 2021

By Mark Edwards, EVP - Chief Credit Officer & Bank Economist

2020 was a challenging year for the global economy as health policies led to significant disruption in normal business activity. It is counter-intuitive to have a year where payroll jobs declined by 8.5% and gross state product fell 5% in Alaska, yet per capita income rose over 3% and housing prices and sales activity increased substantially.  This was only possible because billions of dollars in federal stimulus money reached Alaska and helped support businesses and individuals through the most challenging times. Record low interest rates and low levels of building activity also contributed to home price increases. 

Oil prices were shocked much lower at the beginning of 2020 at the height of the virus fears and low level of travel activity.  However, as the year progressed, oil prices returned to a more stable level and oil production levels in Alaska also followed a similar path.  The demand for energy increased as the transportation and tourism sectors accelerated.

March 2021 employment data from the Alaska Department of Labor shows a 6.9% reduction in total payroll jobs, a decline of 21,900 jobs compared to March of 2020.  Leisure and hospitality was hit hard from travel restrictions, down 23% year over year, a loss of 7,200 jobs.  Direct Oil and Gas jobs fell 36% or 3,600 jobs. A decline in public education positions led to a 2,000 job decrease in local government. Transportation, Warehousing and Utilities declined 10% or 2,000 jobs since last March. Professional and Business Services has also been negatively impacted, down 9% or 2,500 fewer positions.  According to the Labor Department report, State Government was the only sector to grow year over year.  The 1% or 200 job increase was attributed to hiring people for contact tracing and to process unemployment insurance claims.  The level of unemployment claims in the second week of March was 5 times higher than the same week in 2020.

Alaska’s real gross state product (GSP) was $52 billion in 2020, compared to $55 billion in 2019, according to the Federal Bureau of Economic Analysis (BEA). The U.S. GDP declined 3.5% in 2020.  Alaska’s reduction was 5% and the worst state was Hawaii at 8%.  Both states were more negatively affected by travel restrictions reducing tourism.  Alaska’s GSP declined sharply by 34% due to COVID-19 in the second quarter of 2020, but then grew by 32% in the third quarter.  This is very similar to the nationwide economic swing in production. Alaska’s largest GSP declines in 2020 came from Transportation and Warehousing, followed by Accommodation and Food Services, Oil & Gas and Health Care.  All of these sectors showed positive recovery in the 4^th quarter of 2020 in Alaska, helping place it 9^th fastest growing for the quarter of the 50 U.S. states.

Alaska’s seasonally adjusted personal income for 2020 was $47 billion compared to $46 billion in 2019, according to a report released by the BEA.  Personal income in the U.S. in 2020 increased 6% and Alaska rose 3%.  In a typical year, the majority of personal income is derived from wage earnings.  Additionally, some people receive government transfer payments, such as social security, Medicare and Medicaid. Personal income is further supported by earnings from dividends, interest and rents.  However, in 2020 earnings from wages and investments decreased in Alaska. The U.S. growth was entirely from a net $1.1 trillion increase in government transfer payments.  About half of the transfer payment increase was from unemployment insurance. Direct stimulus payments accounted for a large part of the remainder.

Per capita income in the U.S. was $59,700 compared to $64,800 in Alaska.  This placed Alaska as the 9^th highest income of the 50 U.S. states.  In Alaska, earnings from wages decreased 1.5% or $435 million in 2020 and investment income fell 1% or $65 million.  Government transfer payments however, rose 24% or $1.9 billion over 2019 levels.  By far the largest drop in wage earnings came in Accommodations and Food Services, followed by State and Local Government and Oil & Gas.  There were positive increases in wages in the Professional and Technical Services Industry and Health Care.

The price for Alaska North Slope (ANS) crude oil had monthly averages in 2018 and 2019 ranging from $59 to $80 a barrel. Prices fell quickly at the beginning of 2020, responding to fears that COVID-19 would devastate the global economy and reduce the demand for travel.  The low month was April when ANS averaged $16 a barrel.  However, by June the oil markets stabilized and for the last six months of the year the average monthly price remained between $40 and $50.  In the first three months of 2021, the monthly average has climbed from $56 to $66.

Alaska’s crude oil production averaged 485,000 barrels per day (bpd) in fiscal year (FY) 2020, which ended in June.  This was a decrease of 4.8% compared to the previous FY end.  The State Department of Revenue forecasts production on the North Slope to increase by nearly 1% in FY 2021 to 489,000 bpd.  The average production for the first quarter of 2021 has been higher than the forecast.

Alaska’s home mortgage delinquency and foreclosure levels continue to be better than most of the nation.  According to the Mortgage Bankers Association, the percentage of delinquent mortgage loans at the end of 2020 in Alaska was improving to 6.2%. However, this is still significantly higher than 2.9% at the end of 2019 before the effects of COVID impacted the market.  The comparable delinquency rate for the entire country was higher than Alaska at 7.2% at the end of 2020, compared to 4.1% at the end of 2019.

The Mortgage Banker’s survey reported that Alaska’s foreclosure rate was 0.45% at the end of 2020.  This is an improvement from 0.63% at the end of 2019.  The comparable national average rate was slightly higher than Alaska at 0.56% at the end of 2020, and 0.78% at the end of 2019. This is somewhat misleading because the federal moratorium on foreclosure activity on occupied homes led to declining numbers, even though job loss strained the economy and borrower’s ability to pay.

Many people across the country took advantage of mortgage forbearance plans available from lenders to delay payments or pay interest only on their homes.  Until they catch up on past due payments these loans will appear delinquent because they are still behind according to the original terms of the mortgage.

According to the Alaska Multiple Listing Services (MLS), the average sales price of a single family home in Anchorage rose 5.9% in 2020 to $397,000.  This is following increases of 0.5% and 2.3% in 2019 and 2018, respectively.  Average sales prices in the Matanuska Susitna Borough rose 9.9% in 2020, continuing a decade of consecutive price gains.  These two markets represent where the vast majority of Northrim’s residential building activity occurs. 

The low interest rate environment has been a major factor in rising prices.  According to the Federal Reserve Bank of St. Louis, the average 30 year fixed rate mortgage in the U.S. hit all-time record lows last year.  Rates began 2020 at 3.7% in the first week of January and fell one percent to 2.7% by the end of the year.  Rates began to rise in the first quarter of 2021 and finished March at 3.2%. However, in April they declined slightly to 3%.

The number of units sold in Anchorage was up significantly in 2020 by 19.5%, climbing from 2,719 homes sold in 2019 to 3,249 last year.  The main difference was a record number of sales occurred in the last quarter of the year, when sales activity typically declines in the winter. The Matanuska Susitna Borough also had strong sales activity, up 9.7% in 2020 to 2,135 units sold compared to 1,946 in 2019. The Mat-Su also had stronger than normal sales in the second half of 2020. 

In Alaska, the number of building permits issued for new home construction were 1,680 in 2019.  According to the U.S. Census Bureau this fell 15% to 1,420 housing units in 2020.  This does not include building in unregulated parts of the state.    

Across the country, the prosperous baby boomer population is living longer and often keeping a second cabin or vacation home.  This housing inventory is not turning over at the expected rate, as the even larger population of millennials are finally becoming home owners.  The Federal Home Loan Mortgage Corporation, commonly known as Freddie Mac, determined that the nation was undersupplied by about 2.5 million homes pre-COVID.  Now that has grown to 3.8 million homes in April of 2021.  The high cost of building has constrained construction levels and also made the price of a new home out of the reach of hundreds of thousands of first time homebuyers.

Inflation is generally caused when there is an increase in the money supply that outpaces economic growth. Trillions of dollars in COVID-related deficit spending expanded the money supply and diluted the value of existing money. Spending on a home mortgage or rent is the largest expense for consumers.  The rapid rise in home prices across the nation in 2020 will be a large inflationary force.  The second largest consumer expense is energy for home heating and transportation.  The energy index rose 13% year over year through March of 2021. The increase in oil prices have been good for the Alaska economy, but are a major part of rising inflation figures.  Across the board there are signs of rapidly rising prices of most commodities. 

The Consumer Price Index or CPI rose 2.6% between March of 2020 and March of 2021.  For the first quarter of 2021 the CPI increased 0.9%.  This was the largest first quarter increase in 13 years. The index rose 0.6% this March alone, which was the largest single monthly increase in the last 9 years.  This acceleration in inflation will be one of the most important economic indicators to track in 2021.  Since the 2008 recession, Americans have benefited from a prolonged low inflation environment, averaging only 1.7% a year over the last 12 years.  2% is the Federal Reserve’s long-term target rate for inflation. Many economists feel sustained inflation over 3% will be problematic for the economy unless GDP growth also accelerates concurrently.

Supply chain disruptions have slowed the pace of economic recovery.  Most impactful is the dramatically lower level of workforce productivity due to millions of workers losing their jobs.  Trade with our leading partners Canada and Mexico has been affected by cross boarder restrictions slowing the supply of many goods and raw materials.  Numerous companies did not have sufficient IT infrastructure in place to quickly react to a work-from-home scenario.  Government permitting and regulation approval took longer than normal in many instances. Significant storms, such as the one that hit Texas hurt chemical production and other manufacturing.  Cargo shipping had embarrassing setbacks.  These and other factors resulted in high commodity prices and low product availability throughout the world.

The economic roller coaster of 2020 was not a normal business cycle.  It was created by governments around the world forcing millions of businesses to close or seriously constrain business activity.  The economy was also rescued by massive deficit spending that reached consumers and businesses quickly to stop a serious problem.  Recent news suggests the Biden administration is preparing to increase taxes to help pay for the record deficits.  Typically, this is a drag on the economy and lowers future investment.  Therefore, more than ever, to predict where the economy is going in the coming year will depend on the policies government officials enforce on taxes, health regulations, and monetary policy.

An economic rebound is definitely occurring, it is just slightly disorganized.  Abundant cash should continue to drive consumer spending and force companies to work out kinks in the supply chain to meet a growing demand for goods and services.  Trillions of dollars in federal stimulus money is providing much needed relief to millions of Americans impacted by COVID regulations.  Excess cash is also driving investment into the stock market and leading to a slow recovery of jobs.  However, it has also created inflation by expanding the money supply and diluting the value of existing money. 

This is putting upward pressure on interest rates as investors want to maintain a “real” rate of return after factoring in the effects of inflation.  The yield curve is still flat and near record lows for maturities less than two years.  However, it is getting steeper for medium and long term rates. The five year U.S. Treasury rate has increased a half percent in the last year.  The 10 and 30 year Treasuries have both increased slightly over 1% since April 30, 2020.

Fears of higher taxes to pay back the large deficit spending is also dampening the enthusiasm of investors and led many to question if this short-run economic growth will be sustainable. At least for the near term, it appears the massive liquidity in the financial system should spur on an economic rebound.  Government health regulations, changing tax rates, and monetary policies will be the largest variables impacting inflation, interest rates, and the stock market in 2021.  There will undoubtedly be more unexpected economic challenges to come.  However, companies that are nimble in a changing environment; well-prepared to meet technological and distribution challenges; and have financial resources available can still succeed in these challenging times.

                                                                                                                                                Mark Edwards

                                                                                                                                                May 4, 2021

 

 

References:

https://www.bea.gov/

http://almis.labor.state.ak.us/

http://www.tax.alaska.gov/programs/oil/prevailing/ans.aspx

http://www.tax.state.ak.us/

www.mba.org

https://www.alaskarealestate.com/MLSMember/RealEstateStatistics.aspx

https://fred.stlouisfed.org/series/MORTGAGE30US

Standard Time.

41st annual Alaska Resources Conference

The Alaska Resource Development Council hosted its 41^st annual Alaska Resources Conference on Wednesday, November 18. This year’s event was a single day, hosted online. As in years past, the presentations were from industry experts and provided an insight in to the past year as well as a look forward to the future of Alaska’s resource industry.

Not surprisingly, most presenters noted that they were pleased that Ballot Measure 1 was defeated and that tax policy wasn’t changed yet again. There were also concerns about what the new administration would mean for resource development. As has been the case in the past few years, the concern over a stable fiscal plan for the state weighed heavy on most presenters.

Mining did provide a bright spot for a year that saw many disappointments and most of the industries represented were looking forward to the start of recovery in 2021. The full agenda with presentations can be found at https://www.akrdc.org/conference.

Commonwealth North launches new Alaska budget website

Commonwealth North has launched a new website to assist Alaskans in better understanding the State's fiscal challenge. The site allows Alaskans the opportunity to make revenue and spending choices to address the projected $1.3 billion shortfall in the 2022 budget. 

Designed by the group's Fiscal Policy Study Group, the site was created to help determine the most likely options for balancing the state's budget. 

Visit the Alaska Budget Choices website to see how you would balance the budget for the state. 

 

The 40th Annual Alaska Resources Conference

Last week, the Resource Development Council (RDC) hosted its 40^th Annual Alaska Resources Conference in Anchorage. The event is the chance for leaders from the tourism, fishery, oil and gas, mining, and forestry industries to come together and share highlights and frustrations from the past year and look forward to the coming year.

Overall the presenters and attendees were optimistic about the future of the resources industries in Alaska. There were concerns due to the tariffs being raised on fish, timber, and other goods. The other overwhelming concern came from the possibility of yet another ballot initiative to regulate oil taxes on the North Slope. The group OneALAKSA has been created to protect Alaska’s economy and oppose the Fair Share oil tax measure - an initiative to raise oil taxes that will likely be on the 2020 ballot. OneALASKA is a diverse group that includes organized labor, business and Alaska Native corporations, outdoor recreation, small business, and non-partisan political leaders. The group is working to make sure the ballot initiative does not make it on the 2020 ballot, and if it does, they will fight to oppose it.

Industry representatives painted an optimistic picture for 2020 and moving forward, dependent on the tax structure staying consistent and tariffs on goods. Most were moving forward with plans for expanded development and exploration and new projects.

It was clear that Alaska is moving out of the recession of the past few years, but speakers were hesitant to say that it was officially over. Individual presenters were happy to report milestones in their industry, such as Fort Knox pouring its 8 millionth ounce of gold this past October. BP expressed gratitude to Alaska for the past 60 years of exploration and development and was happy to have Hilcorp bring new life to the legacy fields on the North Slope.

The two days of the Alaska Resources Conference is always a time to celebrate past victories and rally around new challenges. This year was no exception. The room was more optimistic than the recent past, but that optimism had shades of apprehension over forces outside of the industries that could impact landscape of resource development in Alaska.

All presentations, including videos of each session, are located on RDC’s website.

The 39th Annual Alaska Resources Conference

Last week, the Resource Development Council (RDC) hosted its 39^th Annual Resources Conference in Anchorage. The event is the chance for leaders from the tourism, fishery, oil and gas, mining, and forestry industries to come together and share highlights and frustrations from the past year and look forward to the coming year.

There was clear optimism throughout the conference as many in the room had worked hard on the campaign to defeat Ballot Measure 1. Many of the industry leaders expressed their gratitude to volunteers, donors and voters who helped defeat the initiative.

This is the third year where presenters were optimistic about the future of resource development in Alaska. This year’s optimism was even stronger, especially in oil and gas, mining, and tourism. Fishing is still a bit cautious because of the uncertainty around tariffs and imports/exports with China. The timber industry still has a lot of challenges with federal regulations. There are opportunities for timber, but it will take time to sort those out.

Each year, Neal Fried presents his look at the past year and a look forward to the year ahead for the State’s economy. He looks at all aspects of Alaska’s economy and provides a great overview for conference attendees. Alaska is still in a recession, and while this is the longest recession that the state has faced, it is not the worst. Employment continues to fall, but it is moderating and many believe that 2019 will be the end of the recession. Fried’s presentation has a lot of valuable data and is worth watching if you missed the conference.

Dr. Ian Mead, Assistant Administrator for Energy Analysis with the US Energy Information Administration shared global energy trends and where Alaska fits in. His presentation outlined that global energy consumption continues to rise, especially throughout non-OECD Asia. Fossil fuels remain dominant and will supply 77% of the world’s energy consumption in 2040.

Governor-Elect Dunleavy wrapped up the first day with remarks to the crowd regarding his administration’s focus on bringing business to Alaska and his desire to work with the resource development industry to grow Alaska’s economy. He also announced the Corey Feige would be the Commissioner for the Department of Natural Resources. The Governor-Elect made it clear that he wanted to work with industry as a partner not as an adversary.

Keith Meyer highlighted the work that was being done to move the Alaska Gasline forward. He noted that the project has momentum and Alaska should get ready for the mega-project to kick into high gear. The focus for 2019 is accelerate. His slides show the progress that has been made to date and how Alaska has a competitive advantage over global competition when it comes to the natural gas market. Meyer noted that the gasline would be beneficial for not only the oil and gas industry, but other resource development sectors throughout Alaska. Gas will power Alaska’s growth.

This year’s conference was much more optimistic than the recent past and industry leaders are working hard to make sure that all resources are safely and responsibly utilized throughout Alaska. There was a lot to celebrate a week after the election and presenters and attendees seemed to be reenergized to move forward with projects that have been on hold or slowed because of the recession and uncertainty around Ballot Measure 1. There will always be areas of concern for the resource development industries, but you could feel a sense of relief moving into 2019.

All presentations, including videos of each session, are located on RDC’s website.

AEDC 3-Year Outlook Luncheon

AEDC’s annual 3-Year Outlook Luncheon was held Wednesday and featured a recap of the 2017 employment numbers and a look forward to the next three years. This year’s luncheon was the first one in a few years that included some optimism about the future of Anchorage’s economy. AEDC is predicting that we will be out of the recession by the end of this year or in early 2019.

Job losses have slowed and things are starting to look up in a number of sectors. In the first half of 2018, Anchorage has lost 1,600 jobs, which is a decrease of just over 1 percent. This is expected to be the worst part of the year for job loss. It is expected to even out for the remainder of the year. Health care continues to be a strong sector but transportation has also begun to add jobs in Anchorage. During the first half of the year, it has added 400 jobs. In relation to GDP, logistics is the largest portion of the local economy, contributing $3.4 billion to Anchorage’s economy. Transportation is a large part of this sector.

The number of sectors that have remained flat in 2018 is larger than those who were flat in 2017 and the sectors to lose jobs is shrinking. There are sectors that are still losing jobs, but they are losing fewer than in recent years. Retail is the exception, with a loss of 600 jobs. The main loses have come from national chains closing their stores, which was due to national business decisions and not about the local economy. The loss of Sam’s Club, Sears and Toys R Us accounts for about two-thirds of the retail job loss in Anchorage.

The Anchorage Consumer Optimism Index for Q2 2018 continues to climb and is over the mark of 55 which is the point where you can say that the public is optimistic about the future. The overall index is at 57.2, which is the highest it has been since Q1 2015. Local economy confidence is 52.3, personal financial confidence jumped to 68.1, and future expectations is at 54.2. All of the indicators have shown significant growth, especially since 2016.

The 3-Year Outlook Report is consistent with the 2017 report. Anchorage is starting to see a turnaround in the economy. This turnaround will slowly continue through 2019 and 2020, and build slightly in 2021. Most indicators in the report follow this prediction. The past few years have been difficult in Anchorage, but we are starting to show a light at the end of the tunnel of the recession. There are positive aspects of the local economy, which includes tourism, an increase in personal disposable income, and residential real estate, which has not taken a huge hit during the lean years. It is not all blue skies as tariffs loom on the horizon as a potential drag on the economy. Even with this potential problem, AEDC believes that the next few years will be better than the last few. 

For the full reports, visit AEDC online.

State Budget Update

By Tim Bradner

It will take a while for its significance to sink in, but the Legislature’s adoption of a plan to use certain Permanent Fund earnings to help support the state budget is a historic milestone. For the first time since North Slope oil revenues began pouring into the state budget in the late 1970s we have diversified the state’s revenue base.

There’s more to be done, of course. There’s still a deficit, but it’d smaller and more manageable, maybe $500 million for next year compared with – ugh! - $3.7 billion in 2015.

Accomplishing this has taken three years and it’s not unusual for a major change in state policy to take several years. It just takes a while for the Legislature, and indirectly to public, to get their arm around a complex problem. This was, because it affects the Permanent Fund, was particularly sensitive.

There are still problems, too, such as built-in pressures in the budget that will push costs higher, such as health care costs for public employees and teachers, and retirees. Getting a handle on those costs is now a major objective of the state administration.

But we’ve come a long way. State budget director Pat Pitney ticked off some of the accomplishments in a July 13 talk with members of Commonwealth North, a business-focused public policy group based in Anchorage.

Here are some highlights from Pitney’s presentation:

• In 2015 we had a $6.1 billion state budget (general funds, undesignated) but only $2.3 billion in revenues after oil prices crashed.
• Today the budget is $4.7 billion – a 30 percent reduction – and the deficit would shrink to $700 million assuming oil prices at $63 per barrel, the official state forecast. Oil prices are already averaging above that and the deficit is likely to shrink to $500 million. If prices average $73 per barrel over the next year there will be no deficit.
• The spending cuts have not been easy. Today there are 2,900 fewer workers on the state payroll than in 2015. About 1,500 of these are from state executive branch agencies and 1,400 are from the University of Alaska. The savings from these reductions amounts to about $25 million a year in wage and salary outlay.

What if nothing had been done? If the Legislature had not authorized the Permanent Fund earnings draw in Senate Bill 26 and if spending had not been cut the state would face a $3.1 billion deficit in FY 2019. “We have covered 80 percent of this with spending cuts and the Permanent Fund earnings,” Pitney told Commonwealth North. About $1.4 billion of this can be attributed to the cumulative reductions in expenditures and $1.7 billion to money taken from the Permanent Fund earnings reserve this year.

Pitney cited one example of expenditure reductions, in travel. “We’re spending 40 percent less in travel this year than in 2015.”

There are several “shared services” initiatives including facility maintenance, where a pilot program being done in Juneau is being expanded statewide.

Efforts to streamline services in agencies that serve the public directly, like the Division of Motor Vehicles and the business licensing group in the Department of Commerce are getting satisfactory reviews from the public. Much of this is being accomplished through wider use of on-line service.

This hasn’t been easy for some state employees used to the old ways, Pitney said, but the administrative services staff in the different agencies, who tend to the budgets, “are on board with it.”

Discomfort from disruption is understandable. “People want to know, ‘who’s my boss?’ We think it will take about five years before people think this is normal,” Pitney said.

To date, however, reductions have been the “low-hanging,” or at least the “mid-hanging” fruit. Deeper reductions, if they are made, will require major reorganizations. It’s not certain that the Legislature, or the public, will agree to this, either.

In the 2018 legislative session, for example, the Legislature actually ordered increases for certain programs above what was recommended the Governor. One example, while small, was telling: The administration had recommended elimination of $100,000 in grants to community libraries and museums. Legislators added it back.

In another case lawmakers authorized new money as “innovation grants,” for schools to research for new, improved curriculums for certain academic studies.

In health care, where there are major concerns over rising costs, the Department of Health and Social Services is beginning to implement experimental demonstration programs in delivery of health services to Medicaid patients.

The belief is that improved service will make for healthier people and lower costs in the long term.

Legislators also gave the governor his requested increases for public protection and crime prevention, although there was intense public pressure to do more to combat rising crime.

A point Pitney made is that the Legislature, and the public, may have reached the point where they sense enough cuts have been made, and that more reductions will cut into services people really care about.

“Right-sizing” government will always be an imperfect process. Legislators can never know precisely what the right level is. In the end it’s a judgement call. But when push back starts, when legislators back away from cuts and start adding back, it’s a signal.

Tim Bradner is copublisher of Alaska Legislative Digest and is the 2018 Atwood Visiting Professor of Journalism at the University of Alaska Anchorage

Is the sun shining a little brighter in Alaska’s oil patch?

By Tim Bradner

There is a little spring warmth, it seems, after a long winter. Several winters, in fact, of low oil prices and workforce cuts.

The job numbers have not yet ticked up and in fact they’re still slipping, though modestly now, after big cuts made in 2016 and 2017 as producing companies adjusted to the world of lower prices.

But prices are ticking up again. Even during the slump a number of new projects were being worked on and the brighter price outlook should cause some companies to push the green button on their projects.

It’s possible there could be enough new oil that the Trans-Alaska Pipeline System, now running at one quarter of its design capacity, could see an increase in oil throughput. But given that some projects could be delayed, not happen at all or meet expectations, it’s a safe bet there will be enough to maintain the current production for a decade or more.

This is significant because it wasn’t long ago that forecasters were predicting continued declines, to the point that the pipeline might be no longer economic in 10 years.

There’s other reasons for cautious optimism. One not widely recognized is that for the first time in years the Alaska Legislature wasn’t convulsed in acrimony over oil taxes. Some lawmakers did raise the tax issue, mainly to look at things not done in a big tax overhaul last year.

Despite that there was little appetite in most of the Democrat-led state House to revisit this issue, at least this year. The Republican-led Senate opposed this from the beginning.

But what’s also important is the Legislature’s action to use some Permanent Fund earnings to help finance the budget, and not turn to the oil companies once again, is a big shift.

This is a signal to new resource industry investors, whether in oil, minerals or fisheries, that if they’re lucky enough to develop profitable businesses after investing they won’t be heavily taxed the next time the state needs money.

Another underappreciated accomplishment of the Legislature this spring was in developing a solution, finally, to the festering sore of a billion dollars in unpaid oil tax credits to oil explorers, mostly small independents, who had been promised payment by the state.

One can argue whether the state’s oil tax credit investment program was a good idea. It involved state funds used to help fund exploration, but it did achieve its objectives in bringing new companies to Alaska and getting more wells drilled, and new discoveries made.

However, it was hugely expensive. In the end we just couldn’t afford it. But welching on commitments, even in our dire financial circumstances, became a black stain on Alaska’s reputation.

This spring the Legislature dealt with it with a plan proposed by Gov. Bill Walker to pay off the tax credit liabilities with bonds. Companies participating would accept a 10 percent discount in what they are paid, which is enough to cover the state’s costs of borrowing. State revenue commissioner Sheldon Fisher said this is a good deal for the companies because they get money right away rather than having to wait 10 years or so.

A feature of this is companies can get a lower discount, down to 5 percent, if they put the money to work in their Alaska projects within 24 months. Sheldon Fisher estimates this could result in over $700 million in new capital being deployed to restart projects stalled when the tax credits couldn’t be paid.

The companies can also get the lower discount by agreeing to a higher royalty on their state oil and gas leases, but state officials believe most will opt to put their money back to work in Alaska. If this plan works – there is a court challenge from an individual that must be dealt with – the stain on our financial reputation will be removed.

Added up, this paints a nice picture. We’re getting our financial house in order, and oil prices are up.

But things are still fragile. What’s causing the oil price rise is the agreement between OPEC and Russia to restrain production as well as continued Middle East tension. This could change quickly. Also, those prolific U.S shale oil producers will respond to higher prices, putting new oil on the market.

We haven’t closed the state fiscal gap, the difference between revenues and spending, although it is narrower. Even with this year’s financial restructuring a $700 million deficit remains for the next fiscal year, which begins July 1.

There are also upward pressures on the state budget that seem uncontrollable. Rising health costs, a problem almost intractable, along with rising costs in prisons and higher pension expenses combine to push the budget up. If the oil price rise sticks and oil production remains stable we could have more revenue, which would help this. But one should never try to predict oil prices.

The plan to use part of the Permanent Fund earnings has risks, too. A few bad years in financial markets could bring the wolf back to the door. The Legislature may be tempted to draw more than is prudent from Permanent Fund earnings.

We can’t even count on all those new oil projects. Most of these haven’t been sanctioned, or formally approved, by their developers. Some of the discoveries that seem very promising need more wells drilled to confirm the oil is really there, and some of these might not pan out. Even if companies move to develop new discoveries there could be unexpected technical problems in reservoirs that could impede production. It’s happened before on the North Slope and in Cook Inlet, more than once in fact.

Summing up, things are still fragile and there are reasons to be cautious. Still, there’s also lot of progress and a lot to be pleased with.

A little sunshine feels nice.

Tim Bradner is co-publisher of the Alaska Legislative Digest and the 2018 Visiting Atwood Professor of Journalism at University of Alaska Anchorage

Alaska Economic Update- Part 4

By: Mark Edwards – Senior Credit Officer & Bank Economist

We conclude our Alaska Economic Update today with a look at Oil Prices, State Budget Issues and the Federal Government.

Oil Prices - Oil prices have fluctuated between $47 and $71 over the last twelve months and finished February 2018 at a monthly average of $66.20. They are forecasted to average $56 per barrel in FYE 2018, according to the State of Alaska Department of Revenue.

Alaska’s crude oil production averaged 540,600 barrels per day in FY 2017. This was an increase of 9,300 barrels per day over the previous year and the second year of production growth. The State Department of Revenue forecasts production to rise again in FY 2018 to 550,100 before settling back to 547,900 barrels per day in FY 2019.

The low price environment experienced between 2015 and 2017 caused companies to cut back on spending as certain projects were no longer economically viable. This led to a reduction in State revenues and a loss of thousands of high paying oil and gas related jobs.

State Budget Issues – Low oil prices over the last three years have left the state government with a multi-billion dollar budget deficit due to the heavy reliance on oil taxes to fund government. A short-term drag on the economy has been occurring as the legislature made the difficult decisions to move towards a sustainable balanced budget by cutting government spending and limiting dividends. That impact has been reduced slightly from higher than expected returns on the State’s sizable investment portfolio and improvement in oil production and prices.

The FY 2018 approved budget includes some reductions to government spending and limiting the size of the Permanent Fund dividend to about $1,200 per resident. Total State appropriations, including the dividend, are budgeted for $10.2 billion in FY 2018, down from $10.75 billion in the prior fiscal year. As a comparison, the FY 2015 budget was $12.1 billion. Over the last three years the state government budget has declined by $1.9 billion or 15.4%. The aggregate dividend payout is $582 million lower, the capital budget has been reduced by $529 million, and the operating budget has been reduced by $774 million, according to the Alaska Governor’s Office of Management and Budget.

Revenues have been increasing primarily due to above average investment returns. The Alaska Permanent Fund returned over 12% in FY 2017. This accounted for $3.2 billion of the total $3.4 billion the State earned in its investment portfolio. Oil prices have remained well above the State’s budget forecast for the last five months, which would result in several hundred million in increased petroleum revenue for the State if that persists through the end of the fiscal year in June of 2018.

Current and future deficits are expected to be funded out of the Constitutional Budget Reserve Fund (CBR) or the Permanent Fund Earnings Reserve Account (ER). The Alaska Division of Legislative Finance reports the CBR had $4.4 billion and the ER had $12.8 billion at FYE 2017. The CBR is projected to have $2.2 billion remaining at the FYE June 30, 2018 and the ER is projected to grow to $15.7 billion. In total at FYE 2017, the State had $17.6 billion in undesignated reserve accounts and another $1.5 billion in accounts designated for specific purposes, such as the Power Cost Equalization Endowment, the Community Assistance Fund and the Alaska Higher Education Investment Fund. The net sum of these accounts is projected to increase by nearly $600 million at FYE 2018 to $19.6 billion.

In addition, the Permanent Fund principal, excluding the ER, was $47 billion at FYE 2017. That is budgeted to grow to $47.6 billion in FY 2018. A majority of the investment returns are budgeted to be kept in the ER because they are capable of being appropriated by the Legislature for spending.

Another option that has been discussed intensely is dedicating a portion of the earnings of the Permanent Fund, or a percentage of its market value, to partially fund state government. Broad based taxes are also being discussed seriously.

Federal Government - The change in federal administration in 2017 has the potential to positively impact the government regulation of natural resource development in Alaska and is likely to increase the levels of military and domestic infrastructure spending. Alaska’s strategic location will unfortunately benefit from tensions rising in Asia, specifically in North Korea. Fairbanks has been positively impacted by the announced transfer of two F-35 squadrons to the local Eielson base between 2020 and 2022. They expect a large increase of in base population, adding around 3,500 people including families. This is projected to require over $550 million in base construction and significant residential construction both on and off base, according to a presentation by officials at Eielson Air Force Base.

There is renewed optimism in Alaska for future natural resource development as the new federal administration has taken action to achieve domestic energy independence. According to the U.S. Department of Energy, in November of 2017 oil production exceeded 10 million barrels a day (BPD) and broke the U.S. record that has lasted since 1970. That moved the U.S. past Saudi Arabia and we are now second only to Russia in total oil production in the world. Forecasts project over 11 million bpd is possible this year due to continued shale production gains in Texas and North Dakota. The U.S. also set an all-time record for natural gas production in the lower 48 of 87.1 billion cubic feet a day.

The comprehensive change to the U.S. tax code includes a provision opening the coastal plain of the Arctic National Wildlife Refuge for oil and gas exploration and development. The law requires two large lease sales within four and seven years, with half of the royalties going to Alaska. There have also been executive orders reversing the prior administration’s policies regarding climate change and offshore leasing in the Beaufort, Chukchi and Cook Inlet.

Two Alaskans have recently been appointed for important positions in the U.S. Department of the Interior. Joe Balash is now the Assistant Secretary for Land and Mineral Management. Tara Sweeney, an Alaska native leader from Utqiagvik, was nominated for Assistant Secretary of Indian Affairs. Their representation in Washington D.C. should help with numerous Alaska regulatory issues.

Written by Mark Edwards, SVP Senior Credit Officer and Bank Economist with Northrim Bank. He was an adjunct professor of economics at Alaska Pacific University. Market served the State of Alaska as an Economist in the Department of Commerce and the Department of Revenue, and as the Director of the Office of Economic Development. He has a B.A. in Economics from the University of Virginia and a Master’s Degree in International Business from the Thunderbird School of Global Management.