Brad KeithleyKeithley Consulting, LLCbgkeithley.com

Alaska Fiscal Policy:Dealing with $90 $80 oil

BUDGET ADVISORY COMMISSIONANCHORAGE, AK

NOVEMBER 5, 2014

ItsOurFutureAK.com

The “good” old days …

“Right now, the state is on a path it can’t sustain. Growing spending and falling revenues are creating a widening fiscal gap. … Reasonable assumptions about potential new revenue sources suggest we do not have enough cash in reserves to avoid a severe fiscal crunch soon after 2023, and with that fiscal crisis will come an economic crash.”

ISER Web Note 14 (2013)

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The “good” old days - 2 …“The implications of the figures are severe:

1. Simply constraining expenditure growth is insufficient …

2. Failure to reduce the projected deficits will result in a very hard landing …

3. Revival of the standard fiscal policy options [broad based taxes, etc] may not eliminate deficits …”

-- The Fiscal Year 2015 Budget: Legislative Fiscal Analysts Overview of

the Governor’s Budget, Legislative Finance Division

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And then this happened …

2014 ANS Price

Jan $105Mar $111May $105

FY 2015Budget Breakeven

$117Jul $111Aug $103Sep $ 97Oct $ 91Nov $ 82

????

The future (2023) is now …

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What does it mean …

At $85 oil (average for the year) …

… $6.2 billion spending, $2.9 billion revenue = $3.3 billion (53%) deficit (~$4500 per Alaska man, woman and child)

… $9.5 billion remaining in savings, 2.9 years of unrestricted savings remaining at the end of FY 2015 at that deficit level

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How long will it last …What are the causes?

Increasing world supply (US L48 shale, Libya, Iraq)

Slowing world demand (China, Europe)

Saudi Arabia (swing producer) softening price to maintain market share (revenues)

Possibly some political motivation (v. Russia, Iran)

How long will it last? Saudi breakeven budget price is ~$90, but $750 billion in

reserves

If goal is to reduce marginal supply (to restore supply/demand balance at higher price), will take awhile (assuming other factors remain equal, two or more years)

But, oil futures market indicates we may be seeing a long term shift in pricing fundamentals (driven by shale oil potential)

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What is ahead for Alaska …“… reducing expenditures … institution of a broad-based tax, and use of a portion of the earnings of the Permanent Fund ….”

Northern Economics and ISER, Potential National-Level Benefits of

Alaska OCS Development (2011)

Increased oil production? … would need to increase by more than 250,000 b/d

LNG?… not ready until early 2020’s and market effects there also

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Reducing expenditures …

Operating Budget:Formula: $2.2Non-Formula: $2.4Statewide: $ .7PERS/TRS $ .3*

Total $5.6

Capital budget: $ .6

Total $6.2http://www.legfin.state.ak.us/FisSum/FY15-Budget.pdf

FY 2015 Budget

Remember, at $85, revenues are only in the range of $3 billion

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Where will the focus be …

Capital Budget shrinks first (and fast)

Attention turns to the big drivers in the Operating Budget are: K-12 education

Medicaid

University

Personnel count and cost

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Is there an alternative …“What can the state do to avoid a major fiscal and economic crisis? The answer is to save more and restrict the rate of spending growth. All revenues above the sustainable spending level … including Permanent Fund income, except the share that funds the dividend – would be channeled into savings.”

ISER Web Note 14 (2013)

Over time, earnings from the amounts saved are used to supplement other sources to maintain a sustainable level of overall revenues.

Turns a non-renewable resource (oil) into a renewable resource

(financial assets)

But given past draws and NPV reduction, likely only in the range of $3-4 billion currently

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So, what does that mean …State is in for rough –very, very rough – seas ahead

If oil goes to $90 $80, things become challenging disastrous

New price environment requires huge reductions ($billions) in state spending

Emphasis will need to be on spending prioritization (“high grading”)

State assistance to local gov’t and schools will be under severe pressure (shifting the revenue burden)

Some will also advocate other steps Taxes and use of PF earnings to support spending But revenue potential from taxes is limited (remember,

deficit is $4500 per Alaska man, woman and child)

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Some ideas on the way forward …Alaska retains a strong resource base and bright tomorrow, but must revamp spending to live within our means

Immediately (Murkowski, 2006) reduce state capital budget to bare minimum

Immediately reduce operating costs by 10%; create a panel with the direction to identify additional reductions of 25% (will need to include formulas)

View this as an opportunity to secure Alaska’s fiscal future Transition to sustainable budgets to move Alaska beyond the

boom/bust cycle

In the near term, justifies (slightly) higher spending than “cash” basis approach; in the long term, treats all generations fairly

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ItsOurFutureAK.com

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