Alaskanomics

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.

Legislative Budget Update

By Tim Bradner

As the Legislature grapples with huge shortfalls in state revenues – the deficit for this fiscal year is estimated at $2.5 billion – there’s talk of new state taxes, which is causing discomfort among many. Never mind that citizens pay virtually no state taxes in Alaska and even get an annual check from the state.

Angst over this has caused extended sessions of the Legislature for two years now. Lines of disagreement are pretty clear and, just like in Washington, D.C., pretty partisan.

Democrats, who control the state House, are arguing that we’ve cut state spending enough, that levels of public services are now at bare bones, and that it’s time to raise revenues. They are pushing for reimposition of a state personal income tax (Alaska had one years ago) and for higher taxes on oil producers.

Republicans, who control the state Senate, say there’s more room to cut spending and we shouldn’t impose new taxes when the state’s economy is down.

Senators agree that taxes on citizens may be eventually needed but now is not the time. Meanwhile, hitting the oil industry with new taxes, with oil prices at half what they were two years ago, seems unwise, Senate leaders say.

The feelings are intense over these disagreements in the state capitol and we’re unlikely to solve the problem this year, to get a long-term fiscal solution in place. That punts the issue to next year and 2018 is an election year, so it seems unlikely much will happen that soon.

Paralysis in the state capital? Politicians unable to negotiate tough decisions? That looks pretty familiar, actually, considering that Illinois went without a budget for three years and New Jersey actually had a state government shutdown, although it was brief.

But our state isn’t really running out of money with $60 billion in the Permanent Fund, and since we’re still sending out Permanent Fund Dividend checks claims of a fiscal crisis look pretty silly when viewed from the Lower 48.

Still, we have drawn down on savings to fund several years of multi-billion-dollar deficits. In fact, we’ve taken $11.3 billion from two ready asset savings funds over the last four years, the Constitutional Budget Reserve and the Statutory Budget Reserve.

At the end of this state budget year next June 30 the Constitutional Budget Reserve could be down to about $2.2 billion (the Statutory Budget Reserve is essentially depleted. Without a change to the state fiscal system, that’s not enough to fund the following year’s budget, FY 2019.

We have to change the system because it’s obvious oil can’t pull this train any longer. In fact, oil prices have dropped again.

But while we haven’t made much progress toward a final solution it’s worth reflecting that, in fact, things are moving in the right direction.

We’ve cut spending, hugely. Our annual spend of state undesignated general fund dollars, the most common way of looking at the budget, is about half of what it was four years ago, in Fiscal Year 2013.

We’ve also largely agreed that we should use some of the Permanent Fund’s annual income, about $3 billion in a typical year, to help fund the state budget. We created the Permanent Fund in 1976, many believe, to help pay for public services when oil revenue winds down. That time has come, after 41 years.

We’ve also agreed, in principle, that the Permanent Fund dividend should be limited through a new formula, so that some of that money could be used for public services. There’s still some disagreement on this – Democrats argue it should be coupled with an oil tax increase – but the fact that most legislators sign off on lowering the dividend is a huge accomplishment.

All this is still a work in progress, however. The structural changes, mainly a framework for using the Permanent Fund income (changing its management so it functions more like an endowment) and the trimming of the dividend, has passed both the state House and Senate in different forms, but they have not yet been finally agreed on. The oil tax question, which is still part of the debate, is not resolved, either.

But even if legislators left these things hanging until 2018 (more likely 2019) we are moving toward a solution. Political bodies move slowly in making major decisions and sometimes it takes three years or more for people to really get their arms around a problem and do something.

I recall that it took three years for the state to make a major change in its state oil and gas tax structure (work started in 2010, it was finally done in 2013) after a huge amount of debate, and even then the question had to be ratified by voters through defeat of a citizen initiative to overturn the Legislature’s action.

An initiative may happen again, with at least the Permanent Fund Dividend part of the proposed fiscal change. Plans are already being laid for a ballot initiative to overturn a trimming of the dividend, if it happens.

Even if these structural changes are made we still have a budget problem, although it is not as serious. These changes would bring about $1.8 billion in new revenues to the state general fund for the budget (they would, separately, fund about $750 million for a trimmed-down citizen dividend). If we assume about $1.5 billion in typical state revenues, from oil and other sources, total revenue would be about $3.3 billion.

That’s still $800 million short of funding a $4.1 billion budget (undesignated general funds), which is where the debate on new taxes comes in. The House Democrats’ proposed income tax would bring in about $700 million a year and an increase in state fuel taxes proposed by Gov. Bill Walker would bring in about $70 million a year.

That solves the math part of the problem. However, Republicans in the Senate and House still say we can wait on the income tax part, meanwhile enacting other parts of the plan, and draw a bit more from savings. The draw would be substantially less because there are new revenues for the budget from Permanent Fund earnings. If those continue to grow, which is likely, the remaining gap may be taken care of in a few years, senators argue.

Democrats’ response to this is that the Senate plan assumes flat funding of the operating budget and no real money for state-funded construction in the capital budget, or for addressing a $1.8 billion backlog of deferred maintenance on university and other state buildings.

Democrats say we should get with this and do new taxes now if we’ll need them eventually. Republicans say not yet, that we can wait longer. And so it goes. 

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

Oil Tax Credits Must Be Targeted, Affordable

As seen in the Alaska Dispatch News on May 9, 2017

Written by Tim Bradner

Legislators in Juneau are closing out at least one chapter in a very creative, but also expensive, incentive program to stimulate new oil and gas development.

The state's oil and gas tax credit program has existed for years. I will argue that it has achieved its goals of getting more companies exploring, more wells drilled and more oil and gas discovered. But it also grew, piecemeal, into something so top-heavy and complex it just couldn't be sustained, particularly after state revenues imploded in late 2015.

A sore point for legislators was the state's purchase of tax credits for cash from small independent companies who are explorers and developers.

Most of the heavy-lift in winding this down was done last year by the Legislature in a phase out of most tax credits, with most gone in 2019.

This year lawmakers are working to finish things left undone last year, but they're also trying to preserve some of the incentives in ways that don't, like the cash purchases, directly hit the state budget.

Of course, the oil tax bill now before legislators does more than phase out tax credits. It also increases taxes. Whether we want to really do that when our industry and services companies are struggling is another conversation.

Back to the tax credits: Critics have called these subsidies but I think they should be considered investments with the state helping share risks in return for more oil and more revenue, though there are no guarantees.

There's nothing new about this. The state has done it for decades, beginning soon after statehood with a generous royalty break for new discoveries which stayed on the books for many years.

Over the decades we've had many forms of tax and royalty incentives, most to help small, economically-challenged new fields but also incentives for companies who were just exploring.

Governments do this all this time. Across the nation tax breaks are offered to woo new investment. In Alaska the Kenai Peninsula Borough did it in the late 1960s to help get a liquefied natural gas plant and ammonia plants built near Kenai. Anchorage did it in the late 1980s to get the air cargo hubs built at Ted Stevens International Airport.

Incentives can be abused, of course. They have to be thought out and administered carefully. The trick is to design them to really accomplish what's intended and for the sponsoring community to get something back, ideally in results that are measurable and transparent.

I believe our oil and gas incentives have had mixed but mostly good results, using these yardsticks. Just a few years ago there were only a handful of large oil and gas companies operating in Alaska and very little exploration with the exception of ConocoPhillips on the North Slope. The incentives helped bring in a number of aggressive new companies, mostly experienced independents.

Thanks to them fears of a gas shortage in Southcentral are in the past. On the Slope, the list of recent new discoveries could, potentially, increase the amount of oil moving through the Trans-Alaska Pipeline System to a million barrels a day, twice what it is now. Clearly, we're doing something right.

However, it has been at a substantial cost to the state treasury. While we note the successes it's important for legislators to do due diligence and ask questions. One is whether these developments might have happened without the incentives. Some might have. The companies are quick to acknowledge that what really brings them to Alaska is geologic prospectivity, or good rocks, although the tax credits help and result in getting more work done more quickly.

A core dilemma in all incentives is whether investment would have occurred anyway, but in most cases this is unknowable. Government officials in charge of these programs, and elected officials approving the framework, just have to make the judgment call.

However, what is always a good idea is for incentives to be targeted to achieve certain goals, for example enticing exploration in large, unexplored Interior Alaska sedimentary basins, or exploring for new gas in Cook Inlet to meet local utilities' needs, or deep oil in the Inlet or technically-challenged oil deposits on the North Slope.

The unexplored Interior basins offer an example where incentives are clearly helping get exploration done, in this case by Alaska Native corporations like Doyon Ltd. and Ahtna Corp., which are investing their own money in exploring, interestingly, state-owned lands. These are areas where few oil and gas companies have been willing to spend money.

There are a lot of ways incentives can be structured, too. We do have options, even tools that are unused, as we wind down our current program.

Arguably, incentives work best if they are automatic if certain criteria are met. There's no subjective judgment by a state bureaucrat, in other words. An explorer can then have confidence that the incentive will come, as long as criteria are met, and on that basis financial planning can be done.

Another way to offer incentives, however, is through negotiation, which does involve judgment. This is a procedure that may be cumbersome as a part of tax policy but more workable, and in fact required, as a part of modification of state royalty. This approach can provide for assured outcomes, such as certainty that development will occur. This works best after a discovery is made and we do it now through modifications of royalty for discoveries that appear to be economically marginal.

Another form of this, designed for explorers, is our state exploration licensing program. This allows a company to negotiate an exploration contract for a block of state lands without having to tie up money in up-front bidding, instead spending the money on exploration. If a discovery is made this is converted to conventional state leases. The key is that a commitment to invest, and to drill, is achieved.

The state can assist in other ways. Low-cost loans and even equity participation can be done. Equity investment is another option. The Alaska Industrial Development and Export Authority, the state development corporation, has already participated in at least three oil and gas projects, two through equity and one in a loan.

The prime example of participation was our state's partnership with North Slope producers in pursuing a large natural gas pipeline project.

Ironically, we're already a partner with industry through our royalty interest in state oil and gas leases. We own one-eighth to one-sixth of the oil and gas through the royalty share.

No matter how we may feel about joint-venturing with Big Oil, we're already doing it.

Are there creative blends of these ideas that could preserve some incentives without breaking the bank? I believe there are, but surprisingly I haven't seen much discussion of alternatives despite all the angst over tax credits. I believe it's time for that to happen.

Tim Bradner is co-publisher of the Alaska Legislative Digest. He is also a consultant and columnist who writes for the Alaska Journal of Commerce.

Yes, Oil is Down, For Now...But Hold On!

By Tim Bradner

It’s easy to feel uneasy about our state’s petroleum industry right now. Let me cite some reasons:

• Crude oil prices are still down. They are slowly rising but conventional wisdom is that $60 per barrel may be a kind of price ceiling, the threshold where those prolific shale oil drillers flip the switch and bring more supplies, sending prices down again.
• The newspapers are full of articles about layoffs in the oil industry that are now rippling out through the economy, affecting even retail.
• Legislators in Juneau are again talking about increasing taxes on oil producers even though many are still operating in the red. Question: Shall we shoot ourselves in the foot?
• The big gas pipeline/LNG project, which is thought to be our long-term economic savior, now seems more distant than ever.

All the above is true and it is enough to make one feel blue.

But here’s a secret: Whatever we think about our situation now will turn out to be wrong. That’s because we’re always wrong when we think the future will be like the present. It won’t be.

Here are some big positives. Yes, we do need to diversify the economy along with our state revenue sources, which are too dependent on oil. But our petroleum industry has a lot of life left in it, and we now know there’s still a lot of oil on the North Slope. Recent discoveries by ConocoPhillips, Armstrong Oil and Gas and its partner Repsol, and by Caelus Energy confirm that.

This is actually a new paradigm. Until recently, in fact until those discoveries were made, most geologists, particularly government geologists, believed the big heyday of the North Slope was past and that from here on out only small or medium-sized fields will be found.

While there’s a lot we don’t know about the new discoveries – there are still uncertainties about them – but what we do know shows how wrong the past assumptions have been.

For example, it’s a good thing that ConocoPhillips didn’t believe the U.S. Geological Survey when it predicted the National Petroleum Reserve–Alaska would hold mostly natural gas and very little oil. ConocoPhillips is finding a lot of oil, and is now pretty busy with three discoveries there. 

The lesson that ConocoPhillips, Armstrong/Repsol and Caelus is teaching us is that you never know until you drill. (On the other side of the coin, the same must be said about the Arctic National Wildlife Refuge, where there’s a lot of high expectations by Alaskans. Until we can drill, we’ll never really know.)

But this gets me to another point: Those oil incentive tax credits. A lot of legislators call them subsidies. I prefer to call them investments. It’s true that we can no longer afford them and Gov. Bill Walker and legislators are correct that the program, in its present form, needs to wind down.

But the basic idea behind the incentives was to bring more companies to Alaska and get more exploration wells drilled – because that’s the only way more discoveries can be made. The fact is that the incentive program has performed brilliantly. It resulted in new companies coming to Alaska. More natural gas was discovered in Cook Inlet, ending fears of electrical brownouts because of fuel shortages for power generation. More exploration wells were drilled on the slope, with those recent discoveries made.

We can never say that the newcomers, firms like Hilcorp Energy and BlueCrest Energy, Armstrong, Repsol and Caelus, came to Alaska because of the tax credits. They came because we have good rocks. But the tax credit program was what caught their attention. No other place in the world has anything like it. It caused them to come here and take a look and once here they really liked what they saw, in the rocks. Financially, the tax credits allowed them to do more work and at a quicker pace, which speeded the discoveries.

They also allowed companies to tackle new ideas, like the work that Great Bear Petroleum, an Alaska-based company, Burgundy Xploration of Texas and 88 Energy of Australia are going to test the potential for producing oil from the large North Slope shale formations.

That’s out in the future, but let’s put some numbers around what’s been discovered so far.

• ConocoPhillips says its newest NPR-A discovery, Willow, could produce up to 100,000 barrels a day by 2023. Two other ConocoPhillips projects in the petroleum reserve, GMT-1 and GMT-2, are in construction (GMT-1) or in permitting (GMT-2). Together they could add 55,000 barrels a day by between 2019 and 2021.
• Armstrong and Repsol are planning production facilities for their discovery that will be capable of producing 120,000 barrels per day.
• Brooks Range Petroleum, a small independent, has a small project, Mustang, in development that could produce 12,000 barrels per day.
• Caelus has a small project, Nuna, which is in advanced planning that could produce 20,000 to 25,000 barrels per day. Caelus’ big project, further out, is the Smith Bay discovery, which still needs tests but which the company hopes could produce 200,000 barrels per day.

All that adds up to about 400,000 barrels per day of new oil. Let’s not forget that there’s still a lot of undeveloped oil, several billion barrels, left in the big producing fields, like Prudhoe Bay and Kuparuk River. This gives us a lot of reasons to be optimistic.

We are going through some tough times in our state’s “oil patch” but let’s not forget that we’re also coming off several years of boom when oil prices were $100 or more. Our industry is now back to where it was in 2012, and that wasn’t so bad.

Given the uncertainties in future prices we may not see $100 oil, and boom times, again. That could be wrong, of course (and probably will be) but we should plan for what we know, and that includes the knowledge that there’s a lot of oil on the slope.

We can take comfort in that. Meanwhile, let’s not shoot ourselves in the foot. That’s a message to our legislators.

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

Risk and Reward: The Permanent Fund as a Source of Income for the State of Alaska

By Tim Bradner

It seems inevitable that state of Alaska finances will soon be closely linked to performance of the state’s Permanent Fund. That has caused many Alaskans to look closely at how this change could affect the Fund’s management, and at the institutional protections for the Fund built into state law. Some consider those protections weak.

Gov. Bill Walker has proposed legislation that would make earnings of the Fund available to help support the state budget, and also put limits, indirectly, on the popular Permanent Fund Dividend.

The governor’s plan, in Senate Bill 128, passed the state Senate but not the state House, mainly over concerns about limiting the dividend in an election year. The governor is still pushing for passage of the bill either in a possible special session later this year or the regular 2017 session that begins in January, and with the 2016 elections over it’s quite likely the bill will pass.

Basically, Walker’s idea, which was modified in the state Senate, provides for an annual payment of the Fund’s earnings equal to 5.25 percent of the market value of the Fund, a “percent of market value”, or POMV, that is used by many large endowments in one form or another.

Based on this, the Fund could contribute between $2 billion to $2.5 billion yearly in support of the state general fund budget and still leave enough income retained in the Fund to offset inflation, and to allow the Fund to continue growing.

Of course, this would still leave a large deficit in state finances which would have to be filled with other revenues, most likely taxes in some form.

Here’s the math: If the state general fund budget is $4.5 billion, approximately its current level, and oil revenues contribute $1.2 billion, again about the current amount (and assuming, conservatively, that oil prices will remain in current range for an extended period), and that non-oil taxes contribute $300 million, this leaves a deficit of about $3 billion.

This is close to the state’s actual deficits for the past two fiscal years, which are being paid for by drawdowns from the Constitutional Budget Reserve, another state savings account (this fund will be exhausted in two years).

If the Permanent Fund can provide $2 billion to $2.5 billion each year, that still leaves a gap of $500 million to $1 billion to fill. The governor’s solution to this is a mixture of tax increases on various industries like fisheries and mining as well as a hike in the state’s motor fuel tax, which is the lowest in the nation, and a broad-based tax like a personal income tax.

However, given that some kind of change to the Permanent Fund’s relation to the state budget is coming, what questions does this raise?

First off, there are many who are concerned that a 5.25 percent annual draw is too high, that it could erode the Fund over time. Given the long-term uncertainties for financial markets, which are driven by expectations of long-term lower growth in the world economy, many pension funds and endowments are lowering their percentages of annual draws to four percent or 4.5 percent.

If the state of Alaska decides to be more prudent, that would lower the amount the Fund would make available to help the budget, requiring an increase in revenue from other sources or additional spending cuts.

The Permanent Fund’s managers say there are ways a larger draw can be accomplished, however, because the Fund is actively managed and that changes in asset allocations can result in more income. However, more aggressive management of the Fund will also assume more risk, an important consideration.

There are other issues affecting management, for example how the requirement to meet a required large annual cash payout would affect the Fund managers’ decisions over a mix of short-term, more liquid (and less income-producing) investments compared with that are long-term and less liquid (and more income-producing). These are issues but they are similar to those faced by other large endowments and can be dealt with. To some extent the Fund faces this problem now on a smaller scale, in ensuring that $1.5 billion or so is available in the fall to finance the annual PFD payout and an annual “inflation-proofing” payment of earnings back into the Fund to further offset inflation, although this has been low in recent years.

If the state does begin to use Permanent Fund earnings to help support the state budget, the governor and the Legislature will have to balance different goals. One, most important, is preserving and growing the Fund over the long term. A second, if the Legislature approves the governor’s plan, will be to have the Fund become a reliable source of revenue.

A concern many Alaskans have is that these two goals could conflict with each other.

Keep Alaska Competitive Editorial

As seen in various Alaska publications.

 

 

 

 

 

 

We thought the fight was over when voters rejected Ballot Measure 1, which sought to repeal SB 21, the More Alaska Production Act. But here we are, less than two years later, facing another battle over oil taxes.

Gov. Bill Walker has introduced legislation that dramatically changes the tax system by raising the minimum production tax by 25 percent for some — and imposing a new tax for others — and repealing anchor tax credits.

This latest tax hike comes at a time when oil prices are hovering at prices not seen since the crash in the 1980s. It comes at a time when it costs more to produce a barrel of North Slope oil than it’s worth, which has led to negative cash flows.

We are asking you to continue our fight for Alaska’s future. We need you to contact your legislators and tell them that our resource industries are the last place we should look for funding as they are all swimming in an ocean of red ink.

We have updated the KEEP website, added new background information and posted a new fact sheet that explains the situation. You will also find additional information on our Facebook page and the E-blasts we will be sending on a regular basis.

Our state is facing a massive fiscal crisis unseen in more than 30 years. We applaud the Governor and legislators who are willing to put Alaska’s long-term economic future ahead of short-term politics. There is nothing more important for our state than to solve our budget deficit and build a sustainable economic future for our state, but we can’t do it on the backs of an ailing industry that already pays most of Alaska’s bills.

Fortunately, we have the financial resources to not only survive — but prosper. What we need now is the courage to responsibly continue to drive down the cost of state government and utilize the permanent fund as intended, to fund state services. We may eventually need to pay taxes ourselves; however, the last place we should look for new revenue is to unfairly tax the very industries that drive our economic future. If we push them away, our economic future will be hopeless.

This is a time for Alaskans to support responsible fiscal policy.

Sincerely,
Marc Langland & Jim Jansen
Co-Chairs, KEEP Alaska Competitive

The Legislature Must Act on Fiscal Change this Session

By Joe Beedle

Most everyone agrees that now is the time for action by the Legislature to help bridge the fiscal crisis that our state government faces. What started as a politically difficult conversation is quickly becoming an outright battle to ensure fiscal certainty for basic public services while retaining an investment climate for core business in Alaska.

There are voices coming from many sides of the debate; “don’t institute or increase my taxes”, “don’t touch my dividend”, “don’t take away services” and “cut spending to fix the gap”. In the past, the Legislature followed these conflicting voices, expecting that they may not be re-elected if they did not follow the unconstrained wishes of their constituents. Such lack of discipline has resulted in no corrective strategy implementation.  While it may be important for our elected officials to patiently listen to the self-serving wishes of their constituents, it is now critical to realize that the job of leaders is to do what is systemically best for the State and re-set to a more disciplined and logical fiscal plan now to achieve a brighter future for Alaskans for the long term.

The voices arguing against use of the Permanent Fund earnings and increased revenue sources do not understand that if these items are not part of the equation to balance the budget that in a few short years, there will be no savings or future investment to help us out of the hole. There will be no money to pay dividends or provide for essential government services such as roads, education, and public safety.

Unpopular decisions must be made by the Legislature to ensure that state government can operate without continuing a $4B+ deficit annually until we are broke. We urge the Legislature to move forward to enact a sustainable budget and believe that this includes all of the following options:

• Use of the Permanent Fund earnings
• Thoughtful decreases to the cost of State government and implementation of efficiency measures
• Additional revenue sources that include taxes on individual Alaskans

Emotions run high when discussions involve the Dividend and/or taxes, but Alaskans need to have a stake in the state’s budget and the days of oil paying for the majority of state expenses are over. Alaskans carry the smallest tax burden of any state in the nation and receive dividends, while Alaska has the highest per capita cost of state government. We are currently the only state without a state sales tax and state income tax. All other states have one or both.

Our reserves are running low, as is our patience with the State Government. The time to enact or begin enacting a sustainable budget is now and we have the tools to make it happen, but only if all of the tools are utilized to fix the fiscal crisis, including use of Permanent Fund earnings to provide for substantial and immediate relief.

Alaska Economic Update Part 2

By Mark Edwards

As a continuation of the Economic Update, today we look at Alaska’s State Government.

State government will have to make prudent spending cuts and raise new revenues - The most impacted sector from 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.

Major volatility occurs in State revenues due to two factors outside the government’s control: fluctuations in oil prices and changes in market conditions for our investment portfolios. In fiscal year 2015, 75% of the state’s unrestricted spending came from oil taxes and royalties. The State budget estimates for the price of oil have been set too high and fail to account for the extreme volatility in oil prices that occur regularly. As the price of oil has dropped the current deficits have become even larger than expected.

Earnings from the State’s investment accounts are the only other major source of revenue sufficient to offset the loss of oil revenue. However, they have traditionally been off limits for the government to spend, other than for dividends from the State of Alaska Permanent Fund (Permanent Fund) to residents. Instead, politicians have preferred spending from savings accounts like the Constitutional Budget Reserve Fund (CBRF) to bridge periods of low revenues to cover budget gaps until they are bailed out by oil prices rebounding.

This practice has worked now for decades and it appears many legislators have become complacent. Unfortunately, the paradigm has shifted for two primary reasons. First, the savings accounts are being depleted at a faster rate than ever with deficits of over $3 billion a year. Secondly, oil production has fallen from a peak of 2 million barrels a day in the 1980’s to now approximately 500,000 barrels a day. That means we are more sensitive than ever to low oil prices because we are further straining a diminishing pool of assets, while the size of government keeps growing.

Recent windfalls in oil revenue were a result of not only oil prices hovering over $100 for an extended period, but also from progressive oil tax rates that dramatically increased the State’s share during periods of high prices. These forces masked the continued decline in oil production levels. Lower prices sharply reversed the progressive production tax that the State had become accustomed to spend and made the decline on the downside even more painful.

The State’s Revenue Source book published recently helps quantify this volatility. Total State revenue is derived from four primary sources: petroleum, non-petroleum, investment accounts, and Federal contributions. The Federal take has been a steady $2 billion to $2.5 billion for the last decade. Non-petroleum has been between $0.9 and $1.2 billion since 2006 from sources such as fisheries, tourism, mining, alcohol, tobacco and fuel taxes.

As expected, investment accounts have fluctuated wildly. They have twice returned over $8 billion in the last 10 years, but also lost -$1.3 billion and -$6.6 billion in 2008 and 2009 when the national recession began. Petroleum revenues reached a high of $11.3 billion in 2008 and were a low of $2.4 billion in FY15. When these two categories move in concert the revenue shock can be dramatic. In 2008, total State revenues from all sources totaled $13.1 billion then fell to a low of $2.5 billion in 2009. In 2009, petroleum revenue declined by $5.2 billion from the prior year and investment accounts lost $6.6 billion. In FY14 the State earned a total of $17.2 billion, only to see a 51% drop in total revenues to $8.5 billion in FY15.

Faced with this dire budget situation, the Governor has announced his new “Sustainable Alaska Plan”. The primary goals are to take action now by making cuts to government while protecting essential services. He consents to using Permanent Fund earnings as long as we protect the fund’s corpus and preserve a modified dividend program for residents. The spending cuts he suggests include $600 million in reductions through 2019 and 600 fewer employees compared to last year. This is a bit over 2% of the State government labor force, though most would be from elimination of unfilled positions and attrition. Other changes would come in formula funding programs with increases funded in the short run by higher Federal contributions. The energy tax credit program would be reduced and a new $200 million loan fund would be added to support oil exploration. More of the capital budget would be supported through GO bonds.     

The largest change would come from an increased use of the Earnings Reserve portion of the Permanent Fund. New contributions to the fund would come from a one-time transfer of all money in the CBRF, continued transfer of Permanent Fund earnings, and an increase from 25% to 50% of all natural resource revenues. The other 50% would go to pay the dividends, which will reduce the size of dividends.

The last major component of the plan will likely not be addressed for two years. The Governor proposes new taxes for both businesses and individuals. The Governor’s suggestion is to tax 6% of a person’s federal tax liability, which is expected to average about 1% of income for a typical family. There would also be taxes for out-of-state workers, S-corporations and partnerships.

Governor Walker's Fiscal Year 2017 Budget Plan

The Governor is required to present his budget to legislators by December 15 each year. This year had plenty of build-up to the release of the Governor’s plan. Groups of lawmakers, businessmen, and concerned citizens have been meeting for months in anticipation of how we will begin to solve the fiscal crisis occurring in Alaska. In a press release dated December 9, 2015, the Governor introduced “The New Sustainable Alaska Plan” as a way to power the state economy through a mix of spending cuts, wealth management, new revenue, and investments. The state is currently spending over $9 million a day in savings, or $4,900 per Alaskan this year. This is not a problem that will be solved with one measure.

From the Governor’s press release:

The New Sustainable Alaska Plan also calls for continued cuts and ongoing spending restraint. The Walker-Mallott administration worked with the Legislature to cut about $1 billion from state spending since taking office on Dec. 1, 2014, and eliminated 600 state jobs. Governor Walker’s fiscal year 2017 budget calls for $100 million in additional cuts from the operating budget and $425 million in cuts from oil exploration credits.

The plan will change the oil and gas tax credit system into a low-interest loan program, wherein the rates will be determined by the number of Alaskans the companies hire. To honor existing commitments for credits, the FY17 budget allocates $1.2 billion for a transition fund and loan program. The minimum tax on the oil industry will increase by $100 million. The mining, fishing and tourism industries will also be taxed for projected revenue of about $47 million. The plan also calls for an income tax of 6 percent of federal tax liability, which is about 1.5 percent of income for the average Alaskan family, for projected revenue of about $200 million. Taxes will also be levied on alcohol, tobacco and motor fuel for projected revenue of $112 million.

The Governor’s plan is a multi-year approach that helps ease the sting of the cuts to state budget and introduction of new revenue. It is vital that we continue to move forward on this issue because Alaska cannot afford to wait any longer. Inaction will result in the depletion of the state’s savings by fiscal year 2018 if we continue to spend the way we are today. Once the savings is gone, the legislature will have to begin spending the earnings reserve of the Permanent Fund, which will be depleted in fiscal year 2022. A reduction in spending, broad based taxes and priority investments are the way that we will rise out of the ashes and return to a long term balanced and sustainable budget.

Alaskans must work with lawmakers so that the correct balance is found to have an Alaska that is spending within its means as well as serving the people.

For more information about the Governor’s plan, visit https://www.omb.alaska.gov/html/budget-report/fy2017-budget/proposed.html