A presentation on the current state of Alaska state finances and suggested ways forward to respond.

1. Ira Perman
Board Member
Institute of the North
Alaska Fiscal Policy: The Way Forward
ALASKA POLICY FRONTIERS
ANCHORAGE, AK
NOVEMBER 22, 2014
Brad Keithley
President
Keithley Consulting
Dr. Scott Goldsmith
Professor Emeritus
UAA & ISER

2. Overview

Where are we today

What’s ahead for revenues

What are the alternatives

Way forward

What does it take to get there
2

3. Where are we today …

Background

2013

2014

Today
3

4. 2013 …
“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.”
ISER Web Note 14 (2013)
4

5. 2014 …
“The implications of the figures are severe:
1.
Simply constraining expenditure growth is insufficient …
2.
Failure to reduce the projected deficits will result in a very hard landing …
3.
Revival of the standard fiscal policy options [broad based taxes, etc] may not eliminate deficits …”
--The Fiscal Year 2015 Budget: Legislative Fiscal Analysts Overview of the Governor’s Budget, Legislative Finance Division 5

6. And then this happened …
2014 ANS Price
Jan $105
Mar $111
May $105
FY 2015
Budget Breakeven
$117
Jul 1 $111
Aug 1 $103
Sep 1 $ 97
Oct 1 $ 91
Nov 1 $ 82
Nov 18 $ 75
????
The future (2023) is now …
6

7. What does it mean?
If spending stays the same…
At $85 oil (average for the year)
•The revenue equivalent of a production decline to ~300,000 b/d
•$3.3 billion (53%) deficit(~$4,500 per Alaska man, woman and child; $18,000 per family of 4)
•Draining $10 million per day from savings
•3 years of SBR & CBR remaining at the end of FY 2015
Statutory and Constitutional
Budget Reserves
$- $1 $2 $3 $4 $5 $6 $7 $8 $9 $10201620172018201920202021202220232024 Billion$ Start of Fiscal YearCASH RESERVE LIFEAT DIFFERENT OIL PRICES$100$90$80$70
7

8. How long will low prices last
Uncertain early in the cycle, but now increasing consensus:

EIA NovemberShort Term Economic Outlook

“ … Brent crude oil prices will average $83/bblin 2015, $18/bbllower than forecast in last month's STEO.”

IEA November Oil Market Report

“Our supply and demand forecasts indicate that barring any new supply disruption, downward price pressures could build further in the first half of 2015 .... it is increasingly clear that we have begun a new chapter in the history of the oil markets.

Capital Economics (London)

Forecasting $75 per barrel by the end of 2015, $70 by the end of 2016 and “given the current negative sentiment in the market, it is clearly possible that $70 could be hit much sooner ... we believe that lower oil prices are here to stay." 8

9. An important point …

The effect of lower prices on the oil companies is different than on the state

Over time, the state’s “breakeven” oil price –the point at which the state starts “losing money” --has increased substantially

The breakeven price in the FY 2015 budget is roughly $117+/bbl

On the other hand, the companies (and other states and nations) have continued to use lower, much more conservative prices (e.g., Saudi, Texas and BP use ~$80)

As a result, industry and others’ financial condition may remain relatively robust, even when the state’s is not

State should not think continued industry activity is because industry believes prices are returning to previous levels
9

10. What’s ahead for revenues
Future revenue levels depend on …

Key variables we can’t influence

Oil prices

LNG prices

Key variables we can influence, but not control (or better put, the DNR/Congressional “to do” list)

Changes in the production curve

New oil on state lands (conventional & viscous)

LNG

NPRA

OCS (with royalty sharing)

ANWR
10

11. Ifwe hit the trifecta …
Assumptions …
$105 oil
2% production decline
Viscous oil: 2020
NPRA: 2020
New Conv Oil: 2020
Gas (@$3.50) 2024
OCS: 2026
ANWR: 2026
Sustainable Spending
$6.52 B
$0$5$10$152016202020242028203220362040UNRESTRICTED GENERAL FUND(BILLION $) ? PF CORPUS DRAW ? PF INFLATION PROOFING ? PF EARNINGS ? DIVERT PFD TO GF ? INCOME/SALES TAXES ? NATURAL GAS ? NEW OILCASH RESERVECURRENT OIL REVENUESNON OIL REVENUES$0$5$10$15$20$25$302016202020242028203220362040SBR & CBRCASH RESERVE (Billion $) Start of Fiscal Year
11

12. Amiddle case … Assumptions …
$90 oil
3% production decline
Viscous oil: 2020
NPRA: 2020
New Conv Oil: 2020
Gas (@$1.50) 2024
No near future OCS or
ANWR
Sustainable Spending
$4.49 B
$0$5$10$152016202020242028203220362040UNRESTRICTED GENERAL FUND(BILLION $) ? PF CORPUS DRAW ? PF INFLATION PROOFING ? PF EARNINGS ? DIVERT PFD TO GF ? INCOME/SALES TAXES ? NATURAL GAS ? NEW OILCASH RESERVECURRENT OIL REVENUESNON OIL REVENUES$0$2$4$6$8$10$122016202020242028203220362040SBR & CBRCASH RESERVE (Billion $) Start of Fiscal Year
12

13. Alow case … Assumptions …
$80 oil
5% production decline
Viscous oil: 2020
NPRA: 2020
New Conv Oil: 2020
No near future gas, OCS or
ANWR
Sustainable Spending
$2.78 B
$0$5$10$152016202020242028203220362040UNRESTRICTED GENERAL FUND(BILLION $) ? PF CORPUS DRAW ? PF INFLATION PROOFING ? PF EARNINGS ? DIVERT PFD TO GF ? INCOME/SALES TAXES ? NATURAL GAS ? NEW OILCASH RESERVECURRENT OIL REVENUESNON OIL REVENUES$0$2$4$6$8$10$122016202020242028203220362040SBR & CBRCASH RESERVE (Billion $) Start of Fiscal Year
13

14. What are the alternatives …
If we don’t hit the trifecta … all middle and low cases will require one or more of the following:
“… reducing expenditures… institution of a broad-based tax, and use of a portion of the earnings of the Permanent Fund ….”
Northern Economics and ISER, Potential National-Level Benefits of Alaska OCS Development (2011)
14

15. Inaction is not an option

Loss of quality of life

Household income down

Business loss, employment down

Public services consolidation and retrenchment

Population decline (with affect on small business and housing values)

Loss of economic opportunity

Impaired ability (if not inability):

To finance the state’s share of the LNG project

To continue building out and maintain state infrastructure

To pursue co-investment to help drive development

Reduced private investment due to uncertain economic climate
The economic consequences of inaction ...
15

16. Reducing expenditures …
Operating Budget:
Formula:$2.2Non-Formula:$2.4
Statewide:$ .7
PERS/TRS$ .3*
Total$5.6
Capital budget:$ .6
Total$6.2
http://www.legfin.state.ak.us/FisSum/FY15-Budget.pdf
FY 2015 Unrestricted General Fund (UGF) Budget
Remember, at $85, revenues are only in the range of $3 billion
What to do about FY 2015, what to do going forward
16

17. Where will the focus need to be …

Capital Budget shrinks first (and fast)

Attention will need to turn to the big drivers in the Operating Budget (FY2015):

DEED/ K-12 ($1.4 B)

DHSS/Medicaid ($1.1 B)

O&G tax credits ($.45 B)

University ($.37 B)

Personnel count and cost
17

18. Additional facts …

Additional cash reserves

Designated reserves: $2.8 billion (accessible through legislative action, but will reduce endowments)

PF earnings reserve:$6.7 billion (est. July 1, 2015, accessible through legislative action, but will reduce PFD)

Potential revenue generating options

Sales/income tax: $1.3 billion (~$1800 per capita)

Diversion of PFD: $1.4 billion (~$1900 per capita)

Permanent Fund corpus

$47 billion (est. July 1, 2015, but accessible only upon vote of the people)
18

19. A word about other options

“Increase taxes on other industries” (mining, fish, tourism)

ISER studies repeatedly demonstrate limited revenue impact to state and potential harm to investment

“Invest in economic diversification”

To be helpful in meeting budget shortfalls, investment has to produce revenue to the state (i.e., through taxes)

Other than the LNG line (possibly), no realistic options currently on the table

Limited cash to invest, long history of failures

Change Permanent Fund investment mix to increase potential return

Potentialcomes at increased risk
19

20. Way forward …

Goals

Maintain quality of life for both current andfuture generations

Create a stable economic environment where private businesses invest and grow

Implementation

Treat all Alaskans fairly, balance among regions, peoples and groups

Treat all Alaska generations fairly, mitigate risks and put Alaska on a stable, sustainable path

Reform budget process to create transparency so citizens understand state’s fiscal position and help contribute to informed choices
20

21. Put Alaska on a sustainable path …
“What can the state do to avoid a major fiscal and economic crisis? The answer is to save more and restrict the rate of spending growth.All revenues above the sustainable spending level … would be channeled into savings.”
ISER Web Note 14 (2013)
$0$5$10$152016202020242028203220362040MAXIMUM SUSTAINABLE SPENDING(BILLION $) ? PF CORPUS DRAW ? PF INFLATION PROOFING ? PF EARNINGS ? DIVERT PFD TO GF ? INCOME/SALES TAXES ? NATURAL GAS ? NEW OILCASH RESERVECURRENT OIL REVENUESNON OIL REVENUES
Chart showing effect of sustainable spending
at “Middle case” (slide 12)
21

22. Sustainable budgeting …

Each Alaska generation lives within its means (its share of revenues) without putting the future at risk

Same underlying policy as sustainable fishing management

Mitigates risk by smoothing out boom and bust cycles

Over time, earnings from the amounts saved are used to supplement other sources to maintain a sustainable level of overall revenues

Sustainable budgets adjust to changing conditions, but changes in any given year are not dramatic

Requires consistent implementation

Future generations are harmed if any generation spends above sustainable levels and depletes savings
22

23. Reform budgeting process

Create boundaries and transparency in the budget process

Require the sustainable budget number to be provided as part of each budget submission

Require that legislature set overall spending limits early in the budget cycle to ensure individual budgeting decisions fit within the state’s overall means

Require early disclosure of proposed capital spending projects (CAPSIS) so that Alaskans can help set priorities

Provide that spending outside boundaries results in consequences

Impose triggers that limit capital and operating spending outside of sustainable limits without additional votes
23

24. What does it take to get there …

Provide a vision: Alaska retains a strong resource base and bright tomorrow, but must revamp spending to live within our meansin order to achieve bright tomorrow for all Alaskans

Continually educate Alaskans on the situation, the steps needed to respond and progress as it is made

Take both short and intermediate actions

Short term: reduce the current cash bleed

Intermediate: fix the long term problem by prioritizing state spending and developing a plan to implement a sustainable and transparent budgeting process going forward
24

25. Next steps …

Short term:

Immediately: (a) reduce remaining FY 2015 operating budget by 10% overall, and (b) suspend all capital projects not yet initiated, evaluate others for suspension/reduction

2015 Session: (a) reduce overall spending by an additional 10% in FY 2016 budget, and (b) enact budgeting process reform to increase transparency

Intermediate term: create a panel (similar to BRAC, including legislators) with the direction to …

Recommend additional steps necessary to achieve sustainable levels

Recommend additional procedures necessary to achieve a transparent budget process
25

26. Questions, comments …
26