Sometimes the buzz created by election campaigns tends to mask what is going on in the “real world.” The most recent Alaska election cycle is a good example. While the Walker and Parnell campaigns debated through the fall about whether the state budget should be cut in the next year by 5 percent, 16 percent or something in between, in the real world state revenues have been plummeting to levels that make those numbers seem like artifacts of ancient history.
Revenues from oil finance up to 90 percent of Alaska state government spending, and those revenues largely are determined by two factors — production levels and oil price. During the recent debate over SB 21, Alaskans heard a lot about the importance of production.
Starting about the time that debate culminated in the August vote on Ballot Measure 1, however, price began to change in ways that not many understood at the time but in the short time since have become clear — and overwhelming. On July 1, the beginning of the current fiscal year, Alaska North Slope crude sold for about $111 per barrel. On Aug. 1, it sold for about $103. On Aug. 19, the day of the vote on SB 21, it sold for about $100.
By Sept. 1, however, the price was down to $97; by Oct. 1, $91; by Nov. 1, $80; and as of the close of the oil markets last week, $75 per barrel. That represents a price drop of more than 30 percent in just a bit over four months. From a revenue standpoint, it is the equivalent of losing 40 percent of North Slope production over the same period.
Some — particularly those with a vested interest in maintaining current state spending levels — are saying that these changes are a temporary blip, that prices will rebound quickly and thus, while some adjustment may be appropriate, continued spending near current levels is appropriate.
But those comments are based on wishful thinking, without any foundation in economic analysis. After having time to analyze the market forces at work, last week both the U.S. Energy Information Administration (EIA) and the International Energy Agency (IEA) revised their previous forecasts of where prices are headed.
The EIA made one of the largest one-month adjustments I recall seeing in my three-plus decades of following the industry, lowering their projected 2015 price for international crude by $18, to $83 per barrel. The IEA followed suit two days later, concluding that “it is increasingly clear that we have begun a new chapter in the history of the oil markets.”
Some private economists are even more pessimistic. For example, London’s respected Capital Economics group last week predicted $75 per barrel by the end of 2015 and $70 by the end of 2016, and added that “given the current negative sentiment in the market, it is clearly possible that $70 could be hit much sooner.” They concluded that “lower oil prices are here to stay.”
The impact on Alaska state government of these lower prices is staggering. The state contemplates spending about $6 billion during the current fiscal year. Assuming oil averages at $85 over the year, however, the state will only have about $3 billion in revenues, a 50 percent shortfall. This year’s deficit can be covered by draws from the amounts remaining in the state’s two unrestricted savings accounts, but due to heavy withdrawals the past two years, those accounts are not in great shape and at current spending levels will only last three more years if oil prices stabilize at $85 and less if oil prices end up settling at a lower level.
During the campaign, incoming Gov. Bill Walker said, “I will make the hard choices necessary for a sounder fiscal future, including putting in place a sustainable budget.”
As he faces those hard choices in the days ahead he likely will look back wistfully when they would have required only a 16 percent drop in spending. Now that the election is over, he, the Legislature and Alaskans as a whole need to realize the future is going to be much tougher than that and start focusing on the substantially larger reductions in spending levels that will be necessary to secure Alaska’s fiscal future.
