Ira PermanBoard MemberInstitute of the North

Alaska Fiscal Policy:The Way Forward

ALASKA POLICY FRONTIERSANCHORAGE, AK

NOVEMBER 22, 2014

Brad KeithleyPresident

Keithley Consulting

Dr. Scott GoldsmithProfessor Emeritus

UAA & ISER

Overview

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

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Where are we today …

Background 2013 2014

Today

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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

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

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And then this happened …

2014 ANS Price

Jan $105Mar $111May $105

FY 2015Budget Breakeven

$117Jul 1 $111Aug 1 $103Sep 1 $ 97Oct 1 $ 91Nov 1 $ 82Nov 18 $ 75

????

The future (2023) is now …

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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 2015Statutory and Constitutional

Budget Reserves

$- $1 $2 $3 $4 $5 $6 $7 $8 $9

$10

2016 2017 2018 2019 2020 2021 2022 2023 2024

Billi

on$

Start of Fiscal Year

CASH RESERVE LIFEAT DIFFERENT OIL PRICES

$100

$90

$80

$70

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How long will low prices lastUncertain early in the cycle, but now increasing consensus: EIA November Short Term Economic Outlook

“ … Brent crude oil prices will average $83/bbl in 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."

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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

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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

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If we hit the trifecta …

Assumptions …$105 oil2% production decline

Viscous oil: 2020NPRA: 2020New Conv Oil: 2020

Gas (@$3.50) 2024OCS: 2026ANWR: 2026

Sustainable Spending $6.52 B

$0

$5

$10

$15

2016 2020 2024 2028 2032 2036 2040

UNRESTRICTED GENERAL FUND(BILLION $)

? PF CORPUS DRAW

? PF INFLATION PROOFING

? PF EARNINGS

? DIVERT PFD TO GF

? INCOME/SALES TAXES

? NATURAL GAS

? NEW OIL

CASH RESERVE

CURRENT OIL REVENUES

NON OIL REVENUES

$0$5

$10$15$20$25$30

2016 2020 2024 2028 2032 2036 2040SBR & CBR

CASH RESERVE (Billion $)Start of Fiscal Year

11

A middle case …

Assumptions …$90 oil3% production decline

Viscous oil: 2020NPRA: 2020New Conv Oil: 2020

Gas (@$1.50) 2024No near future OCS or ANWR

Sustainable Spending $4.49 B

$0

$5

$10

$15

2016 2020 2024 2028 2032 2036 2040

UNRESTRICTED GENERAL FUND(BILLION $)

? PF CORPUS DRAW

? PF INFLATION PROOFING

? PF EARNINGS

? DIVERT PFD TO GF

? INCOME/SALES TAXES

? NATURAL GAS

? NEW OIL

CASH RESERVE

CURRENT OIL REVENUES

NON OIL REVENUES

$0$2$4$6$8

$10$12

2016 2020 2024 2028 2032 2036 2040SBR & CBR

CASH RESERVE (Billion $)Start of Fiscal Year

12

A low case …

Assumptions …$80 oil5% production decline

Viscous oil: 2020NPRA: 2020New Conv Oil: 2020

No near future gas, OCS or ANWR

Sustainable Spending $2.78 B

$0

$5

$10

$15

2016 2020 2024 2028 2032 2036 2040

UNRESTRICTED GENERAL FUND(BILLION $)

? PF CORPUS DRAW

? PF INFLATION PROOFING

? PF EARNINGS

? DIVERT PFD TO GF

? INCOME/SALES TAXES

? NATURAL GAS

? NEW OIL

CASH RESERVE

CURRENT OIL REVENUES

NON OIL REVENUES

$0$2$4$6$8

$10$12

2016 2020 2024 2028 2032 2036 2040SBR & CBR

CASH RESERVE (Billion $)Start of Fiscal Year

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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)

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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 ...

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Reducing expenditures …

Operating Budget:Formula: $2.2Non-Formula: $2.4Statewide: $ .7PERS/TRS $ .3*

Total $5.6

Capital budget: $ .6

Total $6.2http://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 billionWhat to do about FY 2015, what to do going forward

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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

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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)

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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 Potential comes at increased risk

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Way forward … Goals

Maintain quality of life for both current and future 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

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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

$15

2016 2020 2024 2028 2032 2036 2040

MAXIMUM SUSTAINABLE SPENDING(BILLION $)

? PF CORPUS DRAW

? PF INFLATION PROOFING

? PF EARNINGS

? DIVERT PFD TO GF

? INCOME/SALES TAXES

? NATURAL GAS

? NEW OIL

CASH RESERVE

CURRENT OIL REVENUES

NON OIL REVENUES

Chart showing effect of sustainable spending at “Middle case” (slide 12)

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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

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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

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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 means in 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

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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

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Questions, comments …

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