Where the money runs out: The price of oil, Medicaid expansion and Alaska social policy …

Fiscal CliffTwo seemingly unrelated events came together this past week to bring the emerging condition of Alaska social policy into stark relief.

The first event occurred Monday, with the release by the federal Energy Information Agency (EIA) of its most recent Short Term Energy Outlook (STEO).  Published monthly, the STEO is a look at the year ahead based on the then-best information.    In my experience, the STEO essentially functions as a monthly update of the EIA’s Annual Energy Outlook, which usually is published in abbreviated, early release form each December and in longer, more detailed form each spring.

While I regularly scan the STEO at some point during the month, the reason this month’s edition caught my eye more quickly than usual was as a result of an article earlier this week on the Houston Chronicle’s Fuel Fix page — one of the best sources for keeping up with current events in the industry.  (Lead articles from the page are listed as part of the “Daily News of Interest” segment of this website (down the right hand column), and frequently are hi-lited in The Alaska Oil & Gas Dailya separate publication of Keithley Consulting, LLC.)

The Fuel Fix noted that in this month’s STEO,

“… the agency forecasts that the crude oil prices will decline [in 2014 over 2013]. West Texas Intermediate crude, the U.S. benchmark, will drop from an average of $97.74 per barrel this year to $95 per barrel in 201[4], the EIA projects. Brent crude, the international benchmark, is projected to fall from $108.01 to $103.”

The reason that caught my eye is because of its implications for Alaska.

To break even (before being supplemented by savings), this year’s (FY 2014) Alaska budget requires an average ANS oil price of $118/barrel based on average annual production of roughly 525,000 barrels/day (bpd).  Earlier this year, the Department of Revenue predicted an average oil price of $109.61/bbl, resulting in an estimated deficit of nearly $1 billion in state spending before being supplemented by savings.

Applying the EIA’s newest price forecast makes this year’s budget outlook even more gloomy.  Historically, the price for ANS generally has tracked the price for Brent, the international benchmark.   With the predicted fall in the price of Brent, the revised EIA forecast implies a lower FY 2014 outlook also for the price of ANS, somewhere in the range roughly of $100/bbl.   Adding some validity to the prediction, the price of ANS has been below $109.61/bbl since the middle of September and has been in the range of $100/bbl since the beginning of this month.  If the price for the year averages out at that level, the potential size of the coming one-year deficit in the Alaska budget will grow to nearly $2 billion.

But even that may not tell the entire story.  Recently some have speculated that the price of ANS is disconnecting from Brent and beginning more closely to track the price of WTI.

There is some basis for that.  Brent generally trades at a premium to WTI.  ANS started the year at roughly a $3.50/bbl discount to Brent, and with a $16.50/bbl premium over WTI.  Making a spot check Friday, however, reveals that ANS is now trading at a nearly $8/bbl discount to Brent, and at only a $6.50/bbl premium to WTI.

Assuming ANS averages over the fiscal year at a level closer to WTI than Brent potentially adds another $250 million to the deficit.   And there may be even more weakness than that.  As noted above, the state’s FY 2014 budget is based on ANS production of roughly 525,000 bpd.  The STEO, on the other hand, now predicts ANS production levels will average less than 500,000 bpd for the calendar year and thus far through October, actual production for the current fiscal year has averaged only 498,000 bpd.

Anyway you cut it, the important indicators are forecasting an increasingly rocky financial road ahead for the state.

How rocky?  Most reading these pages are familiar with the report on Alaska’s current fiscal situation issued earlier this year by the University of Alaska-Anchorage’s Institute of Social and Economic Research.  That report concluded “[r]easonable 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.”

The frightening thing about the most recent news for those of us that worry about the Alaska economy?  The ISER report was based on forecasts made last December which assumed that the state would run a roughly $500 million budget surplus for FY 2014, preserving and even adding slightly to the various state savings accounts.  Now, there is an increasingly real potential that the state may end FY 2014 with a $2+ billion deficit, draining in one fell swoop nearly 12% of the state’s current cash reserves.

To use an analogy from another time and place, that moves Alaska’s fiscal doomsday clock several ticks closer to midnight — and moving at a much faster pace — than it was at the time the ISER study was published.

How does this relate to Medicaid expansion?  The answer is — directly.

The simple truth is Alaska has outstripped its financial capacity to add any more new spending to its mix.  Just as each of us face in our own lives, Alaska only has so much earning power and the fact is we are now spending well past our current income.

When each of us face that point in our own lives — when we spend past current income — we institute limits.  We don’t buy a new truck, take the next vacation, buy a new cabin or even add HBO/Showtime to our cable line-up.

Of necessity, the same steps are beginning to occur now that we have crossed the line at the state level.  Fiscally speaking, at current spending levels Alaska is running on fumes.  The state’s fiscal structure can’t tolerate layering on more programs; instead, it is time to start facing up to the fact that even the current programs are going to need to be rolled back.    Medicaid expansion may be the first, but it won’t be the last of the social programs that are a casualty of Alaska’s coming budget challenges.

Certainly, I appreciate that some argue that Medicaid expansion wouldn’t cost the state much.  The Alaska Native Tribal Health Consortium, for example, argues that the net cost of expansion to the state over the next seven years will only total $23.4 million.

But in all fairness, that number is much like the “sign up” rate for HBO/Showtime:  “sign up now and it will only cost you $5/month for the next three months.”  But then the fine print reads, “after that the price will go to $25/month.”  More importantly, unlike with HBO the state won’t be able practically to terminate the service once it realizes the real cost.  We need to be honest with ourselves; it is unrealistic to think that this or any other state is going to terminate Medicaid benefits to any class of persons once extending them.

It didn’t have to be this way.  With a few exceptions, prior to three years ago Alaska state government largely lived within its fiscal capacity.  While budgets were increasing, they largely tracked the increased price of oil and stayed within sustainable limits.

Then three years ago, state government went badly, badly off track.  From 2002 – 06, state spending averaged around $2.5 billion/year.  From 2007 – 11, spending averaged around $5.35 billion/year.

For the last three years, however, state spending has been $7.0 billion (FY 2012), $7.8 billion (FY 2013) and $7.1 billion (FY 2014).   If state spending had been restrained for those three years within sustainable levels Alaska would have put an additional $5.4 billion into savings and be in a position today to tolerate some additional costs in its social programs.

But it didn’t, and now, the chickens are starting to come home to roost.

Going forward, proponents of new social programs — indeed, all proposed state spending — are going to need to confront a new reality.

The reality is that, going forward, Alaska is going to need to reduce spending significantly.  Rather than suggesting the implementation of new programs, the priority is going to be on identifying what programs should be reduced less than others.

The reason that social programs are going to face the cutting edge of this development is not because they are lower valued than others.  The reason is simply because they are in the forefront of the spending train.

Earlier this fall, David Teal, the Director of the Legislative Finance Division, explained that, based on their current trajectory, “by the time you get to 2022” the “Big 3” of state spending — education, Medicaid and retirement assistance — will account for 105% of the available revenue.  In his typical dry wit, David then followed up by saying, “well. you can’t spend 105% of revenue.”

The fact is those three categories of spending are going to need to be reduced, significantly, if there is going to be any room remaining for any of the other functions of government.  And those other functions are going to need to be reduced also, to fit within a smaller remaining space.

At one point following a meeting in Dallas in the early 1990’s I was looking out the window of one of the downtown skyscrapers onto the footings of another building across the street.   The footings were intended to support a similarly-sized (50+ story) building, but the construction cranes and other equipment had long since been removed and only the underground parking, ground floor and supporting superstructure for the elevator shaft and workings remained.

I asked a friend what had happened.  He said simply, “that was where the money ran out,” referring to the oil crash that had engulfed Texas and the  remainder of the oil patch in the preceding years.  Looking around he then pointed out other buildings which, although they had been completed, sat all or mostly empty.  He explained at one time most of them had been full, before reductions in spending gradually depleted them.

Looking back in the years ahead, that is how Alaskans are likely to remember Medicaid expansion.  That is where the money ran out.  Hopefully, we won’t need to add to that a large number of additional, hollowed out programs, but there will be some.

Rather than expansion, what Alaska faces in the coming years within state government is “competition.”  Programs will have to compete with each other to identify which are the most important.  It is not going to be pretty, but it is going to be necessary.  As the earlier ISER analysis indicates, the sooner we get at it, and turn spending into savings, the softer the landing — and the brighter the future.

Refusing Medicaid expansion is the first step in that effort.  The Governor made the right call in deciding that expanding the program is a bridge too far.  Now, hopefully he realizes we also need to start quickly marching down the other side of that hill.

One response to “Where the money runs out: The price of oil, Medicaid expansion and Alaska social policy …

  1. Brad,

    Just a few points from the empirical or forecasting side of things. Neither of which detracts from your key points of needing to reduce spending at the State level to be more inline with these price expectations.

    Regarding benchmark or “benchmark” pricing and EIA’s forecasts:

    1. The STEO often takes liberties with their month on month fx. This is great due to exogenous factors (logistical/supply bottlenecks, delays or early upstream production, etc…) that are not built into their annual time series forecasts. How much better are these than their annual forecasts? Hopefully better, but these assumptions or inclusions of shocks and shifts to the forecast undermine the validity of a projection and make the forecast all the more likely to be spurious (not wrong per se, but more likely to have an element or component – a unit root for you statisticians out there – that can cause problems in statistical inference or forecasts). The EIA guys are top shelf statisticians and policy boffins, but even they can’t stop the decreases in certainty that come along with model corrections.

    2. Speaking about spurious relationships, I would be pretty leery of extrapolating too much out of the ANS/Brent relationship. You may or may not know this but the Brent pricing system is a little more convoluted than the WTI or Dubai or (pick almost any other benchmark inc. ANS). In short, the fields and weights assigned to the oil coming out of various N. Sea fields. In fact the Brent pricing system has seen a large number of field consolidations over the last 10-15 years (most recently in 2008) due to declining production at the fields that compose the Brent blend. This is all of course to minimize market manipulation and to ensure that the benchmark doesn’t suffer from a liquidity premium (some academics in Norway and elsewhere argue that it does). Again, this is a exogenous factor, aimed at keeping prices stable, but would (for me) undermine any ability to make the kind of inferences that consultants get paid to make.

    I am well aware that other benchmarks suffer from these same kind of shocks, but the fact that they have more to due with logistical constraints rather than liquidity or how the benchmark is defined, makes them easier to account for.


    P.S. I did have one question with regards to Alaska’s budgeting process. I am guessing that the ANS pricing to balance the budget is an annual average? Also, do you know how the state comes up with its own pricing forecasts or what kind of factor they use in determining what price balances the budget? (ie: a risk averse state budget would balance a budget by a factor of less than 1 relative to the spot price for ANS).