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Gambling on future oil prices is no way to set Alaska's budget

  • Author: Dermot Cole
    | Opinion
  • Updated: September 30, 2016
  • Published February 4, 2016

Alaska's budget problem will improve if oil prices rise high enough in the future and oil production doesn't fall so fast. It will get worse if oil production slides more and prices remain close to where they are now — overall state oil income could drop to zero.

Every prediction combines gambling and guesswork, with no guarantees, though the professional prognosticators agree oil prices won't remain below $40 forever. They are probably right, as commodity prices are subject to wild gyrations. Exactly when prices will rise and by how much is impossible to say.

There was much of value in the presentation to legislators Thursday by veteran economist Scott Goldsmith about various plans to transform the Alaska Permanent Fund into an endowment. The Permanent Fund earnings are the largest source of state revenue and the most powerful tool we have to keep the state from going broke and avoid, or at least moderate, a devastating recession.

Using the fund as an endowment with a predictable withdrawal is really the only option the state has to prepare for a new era in Alaska, one in which, like it or not, we have a reduced dependence on the world oil market because of production and price declines. The endowment options differ in technical detail, but the overall approach is the same.

Goldsmith, a professor emeritus at the Institute of Social and Economic Research at the University of Alaska Anchorage, said he thinks oil production will not decline as much as the state predicts and that new revenue from a gas line will flow in a decade. The state predicts a 6 percent decline rate in oil production in 2020 and an 8 percent decline rate starting in 2021.

Goldsmith says the annual withdrawal the state can make each year from the Permanent Fund and oil revenue on a sustained basis — with his higher production estimate — is $4.5 billion, including money for dividends.

It would help Alaskans who are trying to grapple with the state financial situation if Goldsmith changed his terminology. For clarity, it's time to retire the "sustainable budget" label that many reporters and politicians have applied to Goldsmith's "maximum sustainable yield" calculations. This is not his fault as much as that of people like me.

We should call this a "sustainable yield from our oil revenues and financial assets." That's not the same as a budget target, which has to be balanced with the demand for services.

His vision of a sustainable yield, which changes with rising or falling oil forecasts, contains a $2 billion annual budget deficit, that would ultimately have to be filled with budget cuts, reductions in the Permanent Fund dividend, higher taxes and new taxes.

"There would still be a hole of $2 billion plus in the unrestricted general fund," Goldsmith said in response to a question from Anchorage Sen. Lesil McGuire.

"None of these proposals produces money out of a hat," he said. "Different proponents will put forward different assumptions about what future revenues may be."

The clearest sign that ambiguity needs to be dealt with came when Anchorage consultant Brad Keithley followed Goldsmith at the Senate State Affairs Committee meeting. Keithley spoke on behalf of what he calls the "Goldsmith approach" and offered a contradictory interpretation of our fiscal future.

The contradiction is that Goldsmith said PFD cuts and taxes are needed, though not this year. He said he is worried about damaging a fragile economy by taking those steps too soon. Keithley said dividend cuts and taxes are not needed at all.

Goldsmith and Keithley told me they do not believe there is a contradiction, just a difference in inputs. I think the contradiction arises from a difference in inputs.

According to Keithley, the earnings of the Permanent Fund and oil are all we need because future oil income will be higher. He predicts a 3 percent decline rate in oil production and prices rising to $80 by 2020, using a fall prediction from the International Energy Agency. The $80 prediction is a key one because the oil tax law is structured so that there is no big increase in state oil income until you hit that price. The state predicts oil prices will be $71 in 2020 and $84 in 2024.

We are at a low point of commodity prices and the situation will be brighter in a few years, he said. He might be right. He might be wrong.

By using higher prices and production numbers than Goldsmith, Keithley turns a $2 billion perpetual deficit into a $1 billion deficit that can be dealt with through cuts, he says.

The problem is that we don't really know what the future holds, no matter what it says on the PowerPoint slides.

If you guess that oil prices and production will be higher, the state will appear to be able to make more money. If you guess that oil prices and production will be lower, the state will appear to be making less money. In the former case, the oil income and other investments in the Permanent Fund today and the money to be deposited in the future would be used to justify a higher annual withdrawal than in the latter case.

Everyone is free to guess about the future of oil prices. They could return to $100 and above. Or they may stay low for a longer period. We won't know until it happens and the governments in Saudi Arabia, Russia and Iran could have more to say about the future of state oil revenues than anyone in Alaska.

My biggest reservation stems from the economic theory my Irish grandmother drilled into me about counting chickens when they still occupied eggs.

If we put excessive faith in the hope that things will be better tomorrow, we will be less prepared to handle reality if that is not the case. I think it is better to take reasonable steps now and drop the fantasy that no one has to give up anything. As it is, plugging numbers into this formula looks a lot like trying to pull billions out of a hat.

Dermot Cole is a Alaska Dispatch News columnist based in Fairbanks who has written about Alaska government and history for 40 years. His daughter is a deputy press secretary for Gov. Bill Walker. The views expressed here are the author's and are not necessarily endorsed by Alaska Dispatch News, which welcomes a broad range of viewpoints. To submit a piece for consideration, email commentary(at)alaskadispatch.com.

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