Oil price decline trims $500 million from Alaska government's previous economic forecast

FAIRBANKS -- Projections about how much Alaska state government can afford to spend, while at the same time preserving a sizable chunk of its oil wealth for the future, continue to slide along with the price of petroleum.

The Institute of Social and Economic Research at the University of Alaska Anchorage plans to publish an update of its "maximum sustainable yield" calculation this week, trimming the recommended spending target by $500 million to $4.5 billion.

That is about $1.5 billion less than the state budget for unrestricted general funds approved by the Legislature and former Gov. Sean Parnell for this fiscal year. The downward revision comes as the investment banking firm Goldman Sachs cut its 2015 oil price forecast to $40 a barrel and prices dropped below $50 on world markets Monday.

The "maximum sustainable yield" is a theory that Alaska's oil resources should be looked at as a long-term endowment that belongs as much to future generations as to the present. The endowment takes the form of resources in the ground as well as financial assets, chiefly the Alaska Permanent Fund, that have been built up with oil revenues, said Scott Goldsmith, a professor emeritus of economics at the University of Alaska Anchorage.

A year ago, the ISER report put a total value of $139 billion on the state assets, with $65 billion in financial accounts and $74 billion in future oil revenues. Goldsmith said the 2015 update, based on lower oil prices and other economic factors, puts the nest egg value at $135 billion.

The drop would have been greater, but the Permanent Fund earnings were strong in 2014, he said.

While many in Alaska politics see the budget as a cash flow problem, Goldsmith's model makes the case that it is a structural problem, one that will not go away even if oil prices spike back up to triple digits or if a gas pipeline eventually gets built. With an economy based on a resource that is nonrenewable, Alaska still has the opportunity to save enough to create financial assets that will be renewable income producers, according to the ISER research.


The ISER model estimates that $4.5 billion is the maximum that can be spent in a year and still retain significant earnings potential for the future. In essence, the exercise is an attempt to set a framework for long-range financial planning based on the transformation of nonrenewable assets into a continual source of cash from investments. It has met with limited interest by many political leaders in Alaska, but that may be changing as the state grapples with the question of how best to respond to the collapse in oil prices.

Reinvestment of financial assets is necessary to generate growth that could sustain government operations as oil resources dwindle. The challenge is how to manage the demands for current spending with future planning.

"Properly managed, the nest egg would, like any asset, generate an annual return which could be drawn off for current spending," Goldsmith has written about the sustainable yield concept.

"By limiting this annual draw to the maximum sustainable yield, the nest egg would be sustainable and future generations would share equitably with the current generation in the petroleum wealth of the state."

The value of oil in the ground would decline as it is pumped out and shipped down the trans-Alaska pipeline, but that could be more than offset by the growth in financial reserves, Goldsmith has written. But the longer the state waits to reduce spending and build up its financial assets, the more difficult that becomes.

He began making that argument when oil prices were more than double what they are today. In his 2014 report, Goldsmith said that if the state holds the budget at a steady level and does not increase it annually, the decline would be equivalent to about $200 million a year.

"The economy might be able to absorb $200 million in cuts and continue to grow if those cuts created an economic drag of no more than 1,000 to 2,000 jobs lost each year," he wrote.

Dermot Cole

Former ADN columnist Dermot Cole is a longtime reporter, editor and author.