FAIRBANKS — That Alaska is facing a $2 billion budget hole seems as unlikely as a rainy day in December, but here it is.
The new forecast from the Department of Revenue predicts state income is suddenly expected to slide by billions, creating a deficit of $2 billion this fiscal year. The state will have to use about one-eighth of its easily-available rainy day savings to pay the bills. This comes six months after lawmakers and the governor described the budget as the embodiment of fiscal restraint.
Lots of ideas have surfaced in the past few days to explain Alaska's vanishing dollars -- lower oil prices, oil production declines and the new law that cuts oil taxes.
But the key element is the new prediction that the capital costs of developing oil will be much higher than the numbers used by every consultant and administration witness during the oil tax debates of the past few years. Those higher industry expenditures are deductible against the value of oil before taxes are assessed, which means that high costs lead to lower taxes.
The conventional wisdom that North Slope operating and capital costs would be in the range of $30 per barrel went largely unchallenged by lawmakers over the last two years.
The Parnell administration now says that with more investment, production costs are $41 per barrel this year and will rise to $46 in 2015. Back in 2010 the state put the cost at $19 per barrel, while a year ago the state estimated the cost at $25.
Had these higher costs been part of the legislative discussion, every presentation about future expectations for income under the old Alaska oil tax system would have had to be revised downward by billions.
That legislators did not question the cost numbers was in keeping with the prevailing attitude of the majority: Accept advocacy as analysis.
The state remains handicapped in its understanding of North Slope expenses because of the failure to complete audits of the net profits system going back to the Palin years. Without detailed audits, there isn’t a clear picture of industry expenses, but the companies do provide projections of lease expenditures for up to five years in advance.
"Our forecasts reflect significant increases in spending at legacy fields, including recent announcements of rig additions and investment in new drilling areas," the revenue department says.
In general, higher costs for operating and capital expenditures meant lower tax rates under ACES, while lower costs for operating and capital expenditures meant higher tax rates.
The administration will argue that the projected increases in expenses are due to increased investment triggered by passage of the tax cut bill, but the trend toward higher expenditures began years ago. One significant element already in motion before the tax cut bill was the the long-awaited work by ExxonMobil at Point Thomson.
The cost of operating the North Slope oil fields is about $3 billion a year.
The revenue department says capital expenses this fiscal year are expected to be $3.9 billion on the North Slope, an increase of $1 billion over the fiscal year that ended in July. Half of that increase was already in the forecast before the tax cut bill was approved. An additional $1 billion increase is expected the following year.
Because the costs are deductible for the companies, the investment increase is a major factor in the production tax decline this year of 50 percent, from $4 billion in fiscal year 2013 to $2 billion in fiscal year 2014.
One of the other interesting aspects of the projected increase in capital spending is that at today's oil prices, the old tax law, Alaska's Clear and Equitable Share, would take in about the same amount as the new tax law.
This is the case when oil is priced at near $100 a barrel and when expenses are high. It would not be the case if oil spiked to $130 or $150, even for a brief period.
The state spent a lot of money over the past couple of years for consultants’ reports predicting operating and capital expenses of $30 per barrel and corresponding tax rates. Because the repeal of the law will be on the ballot next August, the state should, at a minimum, run the numbers again at the higher cost figures to help clear up some of the confusion about North Slope spending and tax income.
That we've reached $2 billion deficit territory at a time when the Legislature and governor never saw it coming should be enough to demonstrate that they didn't do their homework before it started raining.