Permanent Fund, oil income stung by financial quagmire

STATE NOT PANICKING: Global meltdown has cost Alaska billions, but we're in relatively sound shape.

October 12, 2008 

When world oil prices plummeted again on Friday, they crossed a symbolic threshold for the state of Alaska.

The value of North Slope crude sank $8.89 to $74.65. That's the first time this year it's gone below $83.04, which was the oil price forecast used by the Legislature last spring to draw up this year's state budget.

The world financial crisis is hitting Alaska with a one-two punch, as the Permanent Fund has shriveled in value by one-quarter -- falling $10 billion in all -- and oil prices plunge amid fears of a global recession.

But state officials aren't particularly nervous. Legislators say the price of oil is still comfortably above the state's break-even point. And Permanent Fund managers say they plan to ride out the market swing without changing course on their investments.

This year's state budget has plenty of flex built into it. The $83-a-barrel budget anticipated more than $1 billion of surplus to be socked away into savings. Oil prices have been so high this year -- they peaked at $144 in July -- that there's even more surplus built up on top of that.

Alaska remains in an enviable position compared to other states, with $30 billion still in its Permanent Fund, no personal income tax, and $10 billion salted away in rainy-day accounts to help balance future budgets if oil revenue gets too low.

"The state of Alaska is well aware that its budget is built on a commodity price that is very volatile," said John Boucher, an economist with the state Office of Management and Budget. "We have structures in place to try to deal with these issues."

Legislators say the price of oil has to average $65 for a full year to cover the current level of state operations. Anything above that provides extra money for road and other construction projects, energy rebates, and added savings, among other things.

As worries over long-term economic decline settled in last week, a few analysts said oil prices could reach as low as $50 in a global recession. Most saw the price being higher.

Anything below $65 is likely to bring talk in Juneau of spending cuts, dipping into savings accounts, and long-range use of Permanent Fund earnings or new taxes -- the same discussions that were under way just a few years ago, before oil prices soared.

"We've been through this before," said Rep. Mike Hawker, R-Anchorage, chairman of the House Ways and Means Committee.

Hawker said he thinks much of the current turmoil is irrational and panic-driven, but he said it's a good reminder that the state can't expect to sustain itself with $140 oil.

"It forces us to have that conversation now, instead of burying our head in the sand," he said Friday.

Rainy-day accounts include the Constitutional Budget Reserve, which requires a three-quarters vote of the Legislature to tap, and a $1 billion fund setting aside education money for next year. Altogether, the savings were close to $10 billion, though some of the money was invested in the stock market, Boucher said.

"In terms of savings, we've positioned ourselves relatively well," Boucher said.


The state's coffers filled faster during the oil price upswing because of the new taxes adopted last year by the Legislature. That tax had a windfall escalator clause that raised rates more steeply when prices got above $55 a barrel, said Rep. Les Gara, D-Anchorage. Below $55, he cautioned, state revenue would fall off.

"People need to remember, oil was $18 a barrel for 20 years," Gara said.

In the future, a natural gas pipeline can bring a vital new source of revenue, he said.

"There's probably going to be a gap in there where we're going to have some deficits," Gara said.

Any oil price drop will be exacerbated by declining production in Alaska's oil fields, Hawker said.

"The production decline has been completely masked by the high windfall price," he said.

Next year's legislative session will be too soon to gauge whether the state's new tax regime has helped or hurt production, Hawker said. But watching that relationship remains an important legislative task as oil prices decline, he said -- "looking for the sweet spot in the tax system."


Meanwhile, the value of the Permanent Fund is getting battered in the stock market.

In the last four months, the oil-wealth savings account has seen its steepest loss of dollar-value ever, from $39.4 billion at the start of June to $29.6 billion through Thursday.

The 7.3 percent decline in the third quarter of 2008 was the steepest one-quarter percentage loss in the past decade, the only period for which records are easily accessible, said fund spokeswoman Laura Achee.

In the first seven business days since the end of that quarter, the fund's value lost another 11 percent.

The Permanent Fund's investments -- mostly stocks and bonds -- are now worth less than the fund paid for them. A year ago, at the market's peak, the fund showed an unrealized gain on its books of $7 billion. That number slipped into negative territory at the end of last month, and the fund now shows a loss on paper of nearly $5 billion.

The last time the fund showed a negative valuation like that was in 2002, during the post 9/11 market slump.

None of this has triggered any panic or sell-off of stocks for the Permanent Fund, said fund executive director Michael Burns. In fact, the board's directors met just two weeks ago and confirmed that their mix of stocks, bonds and real estate investments was the right choice for the long term, he said.

If anything, the fund will be buying up stocks in the future to rebalance its portfolio, Burns said.

"It's a challenging discipline," he said. "You're taking money out of asset classes that are working, and putting it into classes that aren't particularly working."

The fund aims to keep 53 percent in stocks, 22 percent in bonds, 10 percent in real estate and 15 percent in other types of investments.


Burns calls this a patient, long-term approach. The fund invests with a longer horizon than other big funds, such as pension funds, which need to keep more cash on hand for monthly obligations, he said.

"Very few institutions around the country have the horizon we have," Burns said.

The stock market decline could stunt Permanent Fund dividends in the coming years, but it's far too early to predict how much, Burns said.

Actual gains and losses from selling stocks and bonds are joined to other income, such as stock dividends, bond interest and real estate rents, to figure how much money the fund made each year. Dividends are based on a five-year average of the fund's profits.

The fund gets hit in another way by the current financial turmoil. One-quarter of the state's oil royalties goes into the fund as new income -- that's where most of the original money came from. As the price of oil goes down, so does the value of the state's 12.5 percent royalty share.

Find Tom Kizzia online at or call him at 1-907-235-4244.

State still has wiggle room

The state this year has a general-fund budget of some $5.9 billion, according to the Office of Management and Budget. That included $669 million spent on capital projects and some $800 million that went to the one-time energy rebates of $1,200 per resident.

Sustained spending of around $4.5 billion -- without the extras like a big capital budget -- would be possible with oil at $65 a barrel, state officials say.

Revenue for this year, almost entirely from oil, was expected to be around $7.5 billion. That's at a forecast average per-barrel price of $83.04.

In the first months of the fiscal year, which started July 1, oil has averaged $114.73, according to the state Department of Revenue. It would have to average just $60.40 the rest of the year to average out at the $83 forecast.

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