Oil, Gas & Juneau

The appearance before Senate Resources last Thursday was interesting.   The slide deck for my testimony is here.   As I said to the Committee, the “August 9” date on the cover is likely because it was snowing (again) the day I did the slide and my subconscious was wishing for another season.  The actual date, of course, was February 9.

The video of the hearing is here.  My appearance begins at 35:35.  There were several questions and comments by members of the Committee.  The most extensive comments came from Senator Stedman.  Part of my presentation contained a series of slides and discussion around recent forecasts made by the Office of Management of Budget (“OMB”).  The forecasts come from the most recent OMB 10-year plan and  compare the level of state expenditures against revenues over the ten year period beginning with Fiscal Year 2012.

Due to declining oil production, the OMB report clearly shows and my testimony reflects that Alaska government starts running a deficit (expenses exceed revenues) sometime this coming decade under all of the scenarios addressed in the plan.  Under OMB’s most probable scenario, the deficits start in FY 2016 — a little over three years from now — and continue to deepen through the remainder of the decade.   But that scenario assumes the continuation of very robust oil prices, ranging from an average of roughly $109/bbl in FY 2012 to $120/bbl in FY 2022.

If instead oil averages $90/bbl over the same period, the OMB plans shows that the state starts running deficits beginning this coming year (FY 2013).   Even more troubling is what the OMB plans show happens to the state’s financial reserves in the event that scenario comes to pass.   Over time, the state has created two budget reserves that are intended to operate as savings accounts — rainy day funds — to be tapped when oil revenues fall below expenditure levels.  Under OMB’s most probable scenario, one of the reserves (the Statutory Budget Reserve or “SBR”) is completely drained and the other (the Constitutional Budget Reserve or “CBR”) is starting to be tapped by the end of the 10-year period.

In the $90/bbl scenario, the SBR is drained by FY2016 and so is the CBR by FY 2021.  As a result, in the $90/bbl scenario, the OMB numbers show that both of the state’s rainy day funds have been fully depleted by the end of the 10-year period.

The point of including these data in my presentation simply was to demonstrate that the decline in oil investment — and thus, production rate — is a here and now problem.  The purpose was to provide a counterpoint — an “alternate perspective” — to earlier suggestions that Judge Gleason’s recent finding regarding the potential life of TAPS should “ease the mind” of Alaskans and justify “keeping oil taxes where they are.”

Staring at the potential for looming deficits resulting directly from continued declines in production, my point was that Alaskans  and their Legislature should be concerned — now — about the effect of declining level of oil production, and that the Legislature should focus — now — on finding ways to stem that production decline.

Senator Stedman was curiously defensive on the point.  During the course of questioning, Senator Stedman said that the scenarios developed in the OMB report are not “going to happen … we [the Legislature] won’t let that happen.” (Senator Stedman’s comments on this point begin at 71:30 of the vide0.)  In the same vein, at the end of the presentation he added further that “some of the presentation on the finances should be taken with a grain of salt.”  (85:15 of the video).  Along the way, he also threw in a “ridiculous.”

The fact that the Senator dismisses the use of the OMB reports so blithely is troubling.  These aren’t industry or trade group data — these are projections that Alaska’s own state government is providing.  The reports should set off serious alarm bells about Alaska’s future.  To suggest that Alaskans dismiss the warnings simply on faith that the Legislature “won’t let that [future] happen”  places too much faith — and power — in the Legislature.

After all, Alaska has gotten itself into this situation in the first place partly through the acts of the Legislature — most particularly, the passage of ACES in 2007.

More importantly, the remedy Senator Stedman suggested during his questioning that the Legislature is likely to adopt to avoid the future painted in the OMB reports  is similarly troubling.  In the course of discussing why OMB’s forecasts “won’t happen,” the only remedy he suggested was to cut expenditures.

If this is the direction the Legislature chooses to go, the OMB forecasts imply huge cuts.  Under the most likely scenario, the cuts required by FY 2022 would be over a quarter of otherwise projected state expenditures.  Under the $90/bbl scenario, the cuts required would start next year at more than 10% of expenditures and grow to more than half of projected state expenditures by FY 2022.

The purpose of my testimony was to suggest another way — to focus on stabilizing and increasing production levels to help address the situation on the revenue side.  Managing the decline through expenditure cuts — which will need to be dramatic based on the OMB forecasts  — should not be the preferred option.

Frankly, I have come away from the experience concerned about the Legislature’s focus on Alaska’s largest looming problem.  The OMB forecasts are a clear sign that Alaska’s economy faces serious, near term challenges.  The warnings should be taken seriously, not with “a grain of salt.”

It may be true, as Senator Stedman suggests, that the future won’t fulfill the projections.  But that misses the ultimate point — what will happen between now and then to change that future?

Will it be, as Senator Stedman suggests, because the Legislature cut expenditures to keep the budget balanced.  Or will it be because Alaska found ways to increase production rates.  One way or another, the future is upon us.

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Addendum:  My testimony was the subject of an entry on the same day in Dermot Cole’s (Fairbanks Daily News-Miner) blog,   “‘It’s the production rate, stupid’ Anchorage oil attorney argues.”  Additional mentions are in articles on the larger set of Senate Resources hearings by Matt Buxton, “Senate concludes pipeline lawsuit review,” Fairbanks Daily News-Miner, Feb. 9, 2012; Pat Forgey, “Parnell’s view of oil tax policy challenged,” Juneau Empire, Feb. 10, 2012; and Lisa Demer, “Oil tax debate cuts to core of state-industry relationship,” Anchorage Daily News, Feb. 13, 2012.