Alaska Oil Policy| “If we don’t fix fiscal policy at the same time, doing oil tax reform will be like rearranging the deck chairs on the Titanic …”

Yesterday I testified before the House and Senate Resources Committees on SB 21/HB 72, the Governor’s proposed oil tax reform bill.  A copy of my presentation is available here.  

The webcast archive of the House Resources Committee testimony is available here (beginning at 78:22).  The webcast of the Senate Resources Committee testimony is available here (beginning at 127:15).  Both are about 30 minutes.

The presentation analyzed the Governor’s proposed bill based on the five criteria I outlined in an earlier piece on these pages, “Five things to look for in oil tax reform …“ (Nov. 23, 2012).    As I said during the testimony before both Committees, the area that causes me the most concern about the Governor’s proposed bill is its lack of durability.  Some of that has to do with the bill itself — it doesn’t contain any of the durability provisions sometimes found in other international fiscal regimes.

More important, however, is the state fiscal environment into which the bill is being enacted.  As I testified, Alaska needs to attract substantial, ongoing, large scale investments if the current production decline is to be modified significantly.    One graphic from 2006 included in my presentation estimated that the level of investments need to approach $3 billion annually in order to achieve that result.  DNR Commissioner Dan Sullivan more recently has estimated the number is in the range of $4 billion annually.

Ongoing investments of that magnitude are for projects which generally anticipate payouts over 15 – 25 years.  In evaluating those type of investments, investors understandably place significant weight on the durability of the applicable fiscal regime over the period.  All other things being equal, fiscal regimes that are unstable and likely to change during the life cycle of the investment are fundamentally more risky and unlikely to successfully attract capital from other projects which offer more durable terms.

As I have written elsewhere, based on current trends Alaska’s fiscal future is highly unstable.  As the University of Alaska Anchorage’s Institute of Social and Economic Research concluded last month:

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.

If these trends continue, it doesn’t take much creativity to imagine when, or before, reaching the breaking point the state will be strongly tempted to change the fiscal regime again to increase the level of its take from the oil revenue stream.  The consequence to investors is that, as in 2007, they will find their revenue stream impaired mid-investment cycle, with the returns they anticipated when making the investments undermined.  Understanding the potential for that prospect, investors instead will be much more likely to invest elsewhere.

If Alaska is to be able to attract the levels of long-term investment it requires in order significantly to change the current decline curve, not only must it reform oil taxes to competitive levels, the state needs to adopt a fiscal plan that provides investors with comfort that the state’s fiscal terms won’t change back to a higher level once the investments are made.  The state must find a solution to the “fiscal crunch” ISER foresees and implement it now, while investors are being asked to make long term investments that will span the same period.

Otherwise, as I said during my testimony, doing oil tax reform may end up like rearranging the deck chairs on the Titanic.  The ship will look more neat as it goes down, but it will go down nonetheless.

That and my other thoughts are explained further in the slidedeck and presentations before the House and Senate committees.  I welcome any thoughts readers may have.