Alaska’s Economy| What happens at $70/bbl oil?

While catching up on reading over the weekend I came across an article in the Calgary Herald that made my hands go cold.  The headline was “Shell sees oil lows of $70 in 2012 volatility.”

The story reported on Shell’s recent 2012 outlook and quoted Shell Chief Executive Peter Voser as saying, in preparing the outlook, that Shell had used “a $50-$90 range for oil.”

Then, discussing the $50-$90 planning range, “Simon Henry, Shell’s chief financial officer, told analysts: ‘I’m not sure we see it right at the bottom of that one over the next 12 months, but we could certainly see it in the middle of that range.'”

What is the impact on Alaska if Shell’s outlook is correct, and oil ends up “in the middle” of a $50 – $90/barrel price range on the year?  Very, very bad things.

Why?  Simple.  Alaska’s oil production has declined to the point that the state is entirely dependent on high prices to maintain current levels of state spending.  A quick read of the Executive Summary of the State of Alaska Office of Management and Budget FY 2013 10-Year Plan makes the point.

“Scenario 3” (at p. 13-14) of the Executive Summary describes the present and future that forms the baseline for the Governor’s proposed FY 2013 budget.  In that world, oil averages $108.98/bbl in FY2012, $109.47/bbl in FY 2013, $109.08/bbl in FY  2014 and so on up to $120.31 in FY 2022.  Even under that scenario, Alaska begins running a budget deficit — which it covers by starting to draw down the Statutory Budget Reserve — beginning in FY 2016.

What happens if oil falls below those levels?  “Scenario 2” (at p. 11-12) outlines the picture at $90/bbl oil.  It is not a pretty one.  Deficits start with a bang next year — the deficit in FY 2013 alone is $ 650 million — and widen to roughly $4.4 billion by 2022, the end of the forecast period.  Under that scenario, the Statutory and Constitutional Budget Reserves are exhausted by FY 2020.  The only safety net beyond that is the Permanent Fund, which if used in that capacity, will itself be consumed sometime in the 2020’s.

So, what happens if oil falls to the $70/bbl level projected by Shell?  There isn’t a scenario in the OMB plan that covers that prospect, but if one extrapolates by doubling the impact of going from roughly $110/bbl (“Scenario 3”) to $90/bbl (“Scenario 2”), the results are disastrous.   Deficits begin this year instead of next, the SBR and CBR are used up by FY 2017 instead of FY 2020 and the Permanent Fund, if tapped to make up the difference, disappears by the mid- 2020’s.

My guess?  Your hands are going cold as well.