In August 2006, staring into a potential fiscal abyss created by an unplanned shutdown of the entire Prudhoe Bay field due to leak issues, then Governor Frank Murkowski immediately announced two steps designed to curb state spending and reduce the potential drain on state savings, while additional analysis was being done.
The first step was an immediate freeze on new state hires. The second was to direct the Office of Management and Budget to review the then-current capital budget to prepare a list of capital projects that could be “phased” (i.e., deferred) until the potential fiscal problems created by the shutdown were “better defined.”
The fiscal outlook that caused such steps? The potential loss of roughly 45% of North Slope production, which in turn was estimated to create a $6.4 million per day hole in state revenues.
Today, Alaska’s leaders face a fiscal challenge of even larger magnitude, but to this point have not yet taken any steps designed immediately to mitigate the resulting problems.
From a state revenue perspective the current, ongoing drop in oil prices is the equivalent of a loss of 40% of North Slope production, if oil prices remain at an average price of $85 per barrel for FY 2015, and more if, as appears increasingly likely, oil prices settle at a lower average for the year.
But the real story is the hole that is being dug in the state’s savings. At a budget deficit that will reach $3.3 billion, again if oil prices stay an average of $85 for the year, the state is dipping into savings at the rate of roughly $10 million per day. That is more than 50% higher than the size of the fiscal drain the state was facing at the time Governor Murkowski responded and the annual equivalent of roughly $4,500 per Alaska man, woman and child, or $18,000 per family of four.
Fortunately for Alaska, the situation the state was facing in August 2006 did not last long. Production from Prudhoe Bay was restored much quicker and at levels higher than first feared and oil prices strengthened by over 30% above the levels projected for that budget year. As a result, Governor Murkowski was able to rescind his actions within a short period.
But the point is that when faced with significant uncertainty about the state’s fiscal future, Alaska’s leaders acted decisively to begin to stem the bleeding.
Alaska’s current leaders need to do the same, beginning now. Other petrostate leaders faced currently with similar budget problems are beginning to take the same steps. In Venezuela — where the budget is balanced on an oil price only slightly higher than Alaska’s — the President is proposing to cut government salaries and has formed a commission to recommend public spending cuts.
In Russia, where the budget is balanced at an oil price roughly 15% lower than Alaska — parenthetically, one might think that the fact the Russian government has based its budget on a more fiscally conservative forecast than Alaska’s might be a source of some embarrassment here — the government already is talking about rethinking a budget passed just last week, at a time when many were still hoping that OPEC would act to stabilize price.
Alaska needs to take similar steps immediately by announcing a hiring freeze, suspending spending on all but the most critical capital projects and, in my opinion, cutting operating spending by 10% of the amount remaining to be spent this fiscal year (see “Alaska Fiscal Policy: The Way Forward,” at slide 25).
Some appear to think that those immediate steps are unnecessary because of the state’s fiscal “cushion” — the state’s Constitutional and Statutory Budget Reserves. One Juneau lobbyist, for example, went so far this week to write an op-ed in the Juneau Empire arguing that the state can defer action for the present because those accounts create “breathing room to craft a long-term strategy to address the budget shortfall situation.”
But either intentionally or not the lobbyist’s analysis seriously misstates the condition of those savings, suggesting that they total in the neighborhood of $17 billion. In fact, adjusting for the $3 billion transfer to the dedicated PERS/TRS accounts and the $3+ billion budget deficit the state is on track to suffer this year, those accounts are likely to end the current fiscal year closer to $10 billion — only enough to cover a little over 3 more years of deficits at current spending levels.
Others seem to think that action can be deferred based on the premise that the oil price dip may only be temporary. In a somewhat troubling passage during an extended interview yesterday with Anchorage television station KTUU, for example, incoming Governor Bill Walker appears to suggest that he may believe the current price dip is a “temporary … one-time dip” in prices.
But basing serious public policy on the assumption that oil prices are going to bounce back sufficiently to avoid the current fiscal crisis is betting against the house.
Those who have long experience closely watching these things have concluded that it is “increasingly clear … we have begun a new chapter in the history of the oil markets,” where “lower oil prices are here to stay.” And those analysts who think that oil prices are likely to “bounce back” are talking only of a return to the $80 range (which is the level used to calculate Alaska’s $3 billion deficit) from current lows in the $60’s; no analysts seriously are talking about a return to the $100 range, and certainly not $117/barrel, which is the price on which the current Alaska budget balances.
Similarly, suggesting that the timing of even an initial round of cuts should be delayed while time is taken to “target” those cuts “strategically” doesn’t hold water. Given the size of the budget deficit, all areas of state spending will need to be cut to some degree. The drain on savings is being created by overall spending levels; those need to start coming down now. Making initial cuts across the board at least will reduce the level of the drain while more targeted, additional rounds are planned.
In the new oil price environment, putting off decisive action now to reduce the rate of state spending only makes Alaska’s future worse by draining savings that otherwise are necessary to help support future Alaska generations. If saved now and invested for growth, the $3 billion that Alaska is on track now to deplete from savings this year instead could produce upwards of a $500 million in revenue annually for future generations. That amount could prove crucial in enabling future generations to avoid — or at least minimize — taxes that otherwise might be necessary to pay for even minimal levels of government services.
In my opinion, depleting those savings now instead is a selfish act by this generation to continue to enjoy the “good life” (or in Louisiana, what would be termed “laissez les bon temps rouler”) for awhile longer at the expense of those that come after.
If the analysts are wrong and oil prices return quickly to higher levels, then like Governor Murkowski in 2006, Alaska’s current leaders can rescind any extraordinary steps they take now to stop the bleeding and return to discussing budget issues from a longer term perspective.
But right now that doesn’t look likely and each month of delay in responding to the situation is digging the state’s fiscal hole deeper.
As Hall of Fame pro football coach George Allen once put it when talking about an upcoming season, “the future is now.” So it is for Alaska. It’s time for the state’s leaders to start living up to their responsibilities.