#AKbudget| Round 3 of “The FY 2015 end game (and its not looking good …)

ThelmaLouise4_001PyxurzEarly last week I wrote a column, after the Senate surfaced its proposed FY 2015 Capital Budget, entitled “#AKbudget| The FY 2015 end game (and its not looking good) ….”  The column was not intended to start off a series but after some in Juneau attempted to defend the indefensibly high budget that the legislature is preparing to pass again this year as “fiscally conservative,” I responded with a second piece later in the week (“#AKbudget| A postscript to ‘The FY 2015 end game …“).

That piece also generated a response.  This time the defense is that the budgets approved by this legislature (which are projected to generate a $2 billion deficit in the current fiscal year and, based on current numbers, likely another $2 billion next) are acceptable because, given the likely increase in future revenues resulting from SB 21 and the LNG project, the state’s fiscal picture will balance out in the long run.

My immediate response?  Good lord, do people really believe such things and, if so, what the heck are they doing running this state?

This is why.

The numbers don’t back up the claim

The first problem with the defense, of course, is that the numbers don’t back it up.   They just don’t, folks.

Last year, as it was considering SB 21 at the end of the session, the House Finance Committee asked EconOne, the Administration’s consultant on the bill, to provide estimates of projected future revenues if the bill passed.   The results are captured here (at p. 13 – 19).

While that analysis demonstrates that SB 21 produces better long term revenues to the state than ACES, at “fiscally conservative” price levels it doesn’t come close to producing the revenues necessary to pay for the level of spending in which this legislature is engaged.

While I think lower oil price assumptions are more appropriate when dealing with state budgets (particularly given increasingly pessimistic oil price forecasts), even assuming oil prices over the next 30 years average out at $110 real and SB 21 over the same time results in lowering the decline rate to 3% — half what the state has experienced under ACES — the best case scenario presented by the Administration is still that long term annual oil revenues will average only around $4.4 billion real over the next 30 years.

Assuming that non-oil revenues continue to generate around $500 million per year on average, that still produces long term revenues, at most, in the range of $5 billion per year, well (~25%) below what increasingly appears to be the low end of this year’s likely ($6.5 billion) spending level.

Some then argue that the Alaska LNG project currently under consideration will make up the remainder, pointing to a slide (at p. 3) produced by the Administration’s consultants on the project that purports to show combined oil and gas revenues reaching $8 billion annually once the LNG project starts up in the early 2020’s.

But that slide is massively misleading when used for this purpose.

First, the gas revenues on the slide represent the gross revenues anticipated to be received by the state.  The number is not adjusted to reflect the portions which go to the permanent fund and which are received by local governments in the form of property taxes, in order to show the remainder which actually is available for use in budgeting as unrestricted general funds.  Instead, they just show total funds anticipated to be received by the state, without categorizing where they go.

Second, the revenues assume that the state owns a 25% equity share in the entire project and that the interest is funded entirely without debt, so that all of the revenues are retained by the state as a return on its investment.  But that does not accurately reflect the Administration’s current proposal.   That proposal is to assign a significant portion of the equity share to TransCanada and even if that does not occur, it is unrealistic to think that the state would finance its share entirely with equity.

Finally, the revenues assume that the current high price levels in the Pacific Rim LNG market remain throughout the entirety of the project, in the face of lower (in the case of Lower 48 US supplies,  significantly lower) priced gas supplies available elsewhere in the world and an increasingly interconnected global gas market.  While its always good to be optimistic, for obvious reasons such “best case” assumptions are never used as the basis for budgeting actual spending.

slide deck provided by another of the state’s Outside consultants which adjusts for those factors provides a much more realistic view of the ongoing revenue potential available from the LNG project.

There, the consultants estimate the likely level of unrestricted general fund revenues available under both robust (at p. 10) and “stress test” (at p. 12) pricing levels.

Instead of the $4 billion in gross revenues projected in the earlier presentation, the more analytical presentation estimates, after adjustments, annual revenues are likely to be in the range of $2.3 – 2.5 billion under the “base case” pricing scenario, and in the range of  $144 million to minus $63 million in the “stress case” scenario.  (The minus outcome at the lower end of the stress case is due to the fact that revenues remaining after making the other required adjustments in those circumstances are insufficient to cover the firm transportation payments due to TransCanada.)

While adding the high end of the LNG range to the optimistic end of the SB 21 range produces potential theoretical revenues in the range of $7 billion, using the high end of price ranges seldom, if ever, is viewed as good budgeting practice.  Using the lower (or in my view given global LNG trends, the more realistic) end produces potential annual revenues in the range of $5 – 5.5 billion.

As a test of that view its useful to look at the outcome of the most recent analysis of sustainable budget levels done by the University of Alaska-Anchorage’s Institute of Social and Economic Research.  That analysis also contemplates — and includes a factor for — the monetization of the state’s gas resource.  For purposes of that analysis (at p. 12):

Natural Gas is monetized through a pipeline to tidewater, exporting 2.7 bcf of LNG per day starting in 2023. Because of the high cost of getting the gas to market, the netback value on the North Slope—which is the basis for taxes and royalties—is modest. So the “take” at start-up is $1.50 per mcf. Over the 50 year life of the project, LNG sales of would be 40 tcf generating $132 billion in revenues. The net present value of those revenues would be $16.5 billion.

Interestingly, the net present value included for gas in the ISER study is greater than that calculated by the state’s consultants.   Mostly because ISER analyzes the revenue stream over a longer period, it calculates the net present value to the state from an LNG project to be $16.5 billion, compared with $13 billion calculated by the consultants (at p. 9).

Yet, despite assuming a higher net present value for gas, the analysis arrives at the same conclusion (at p. 1) as above about appropriate spending levels:  “Alaska’s state government can afford to spend about $5 billion from the unrestricted General Fund in fiscal year 2015.”

Clearly, reasonably applied, the numbers simply don’t support a current spending level that is more than 25% higher.

“Betting on the come …”

There also is a second, more fundamental problem with a defense to current budgets levels that relies on the results of the Alaska LNG project.

I grew up in farm country, where listening daily to the midday corn, soybean, wheat, cattle, hogs and other commodity price reports is not only a ritual — it approaches being a religion.  It is in that context that I first learned the phrase, “betting on the come.”

According to the Urban Dictionary, the phrase is derived from a gambling expression, where it means “you don’t have what you want or need, now at the moment; but, you are betting or hoping you will have what you want or need when the time come,” as in “He thought he would win the lottery but he was just betting on the come.”

In farm country as I was growing up the phrase largely carried the same general meaning, but in that context often was used specifically when a farm or house went up for sale.   As I grew older I learned it meant that the selling family had bet on rising commodity prices when purchasing additional land, new implements, building the new home or taking an expensive vacation.   Not only was the phrase an explanation of why acreage or an entire farm went up for sale or auction, but sometimes also why a classmate that seemed to show such promise went directly to work after graduation instead of going on to college.

The phrase came to mind immediately when I heard some defend the state’s current, excessive budget levels based in substantial part on the outcome of the LNG project.

At this early stage, not even the producers are certain about the outcome of the project and, to be honest, Alaska has pursued similar efforts to commercialize its natural gas resources many times before without achieving success. Since 1999 alone, the state has enacted the Stranded Gas Act (1999); through initiative, formed the Alaska Natural Gas Development Authority (ANGDA) (2002); pursued and conditionally executed a Fiscal Contract with the producers (2006); enacted the Alaska Gasline Inducement Act (AGIA) (2007) and most recently, formed the Alaska Gasline Development Corporation (AGDC) (2013).

To this point, none have resulted in a project or a revenue stream.

To assume more at this point about the LNG project — at any revenue level, much less the high revenue levels needed to justify current spending levels — is just “betting on the come,” or as the Urban Dictionary  makes clear, gambling.  And that, certainly, is not what this Governor and legislature should be doing with the state’s financial resources entrusted to them.

There is no defense to the spending levels which this Governor and legislature have approved the last two years.   Instead of trying to concoct more, they should recognize the problem and reverse course back in the direction of the commitment the current Senate Majority made when they first formed:

“Develop sustainable capital and operating budgets for current and future generations.”

Nice words; they should try to live up to them.

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