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State budget deficit swells as oil prices swoon, challenging the oil oracles

  • Author: Dermot Cole
    | Opinion
  • Updated: September 28, 2016
  • Published October 3, 2014

On the first Tuesday in October, analysts from the oil industry, state government and academia undertake the impossible task of accurately predicting Alaska oil prices.

The annual exercise takes place next week in Anchorage amid a growing sense of urgency about the financial future of Alaska. The Department of Revenue has denied a request by Alaska Dispatch News to attend, saying it is a "closed session."

Oil prices have dipped toward $90 a barrel, the lowest levels since early 2011. While a decade ago the state predicted $25-a-barrel oil for this year, Alaska has long grown accustomed to triple digit prices, while oil production rates have continued the relentless decline that began a quarter-century ago.

Supporters of the oil tax decrease, ratified by Alaska voters in August, believe oil production will increase in the years ahead because of lower taxes, but they also say that at current prices, the new oil tax system amounts to a tax increase on the oil industry.

"Right now, as we have oil prices in the mid $90s -- $95 per barrel -- we're making more under this SB 21 More Alaska Production Act than under the previous act," Gov. Sean Parnell told a Juneau audience Monday in a debate with independent gubernatorial candidate Bill Walker.

Whether the production decline will continue, level off or lead to an increase in daily oil flow remains uncertain, a reality that complicates the state's financial situation.

Over the past two years, state surpluses have given way to deficits that may devour the key state savings accounts -- excluding the Permanent Fund -- in as little as six or seven years.

If prices for this fiscal year average $100, the deficit under the spending plan approved last spring by the Legislature and governor would be about $1.7 billion, according to the Legislative Finance Division.

If the annual average slides to $95, the deficit would reach $2.1 billion, almost $240,000 an hour for the year. World oil prices and Alaska oil prices moved toward the $90 mark this week, down 20 percent since June.

The average so far in the first three months of the fiscal year remains above $100, but the continued downward trend in oil prices will give the participants in the state oil forecasting session reason for concern.

At least 40 people are expected to attend the day-long session at which experts will share their views on the market situation. Revenue Commissioner Angela Rodell said that rather than have the commissioner pick a number for an oil price, the department established a system years ago to create a more solid analysis.

The department describes this annual event, which has taken place for many years but attracted little public attention, as a modified version of the "Delphi Method."

The Delphi Method, a Rand Corp. consensus-building technique created during the Cold War, has been used by industries and governments in many contexts. The name refers to the oracle at Delphi in classical Greece, who was consulted on difficult questions.

In Alaska, a 1983 effort by economist George Rogers used the Delphi Method to predict what 2000 would bring. The California Energy Commission used the technique to forecast oil prices in the 1980s and 1990s, though it now follows the price forecasts issued by the federal Energy Information Association.

"The Delphi Method is based on the principle that a forecast from a structured group setting is much more valid than one from an unstructured group and this has been supported by academic research. Group members must be allowed to freely advance their thought process, opinions and basis for a forecast. Actual forecasts are collected a number of times as the range of answers shrink and converge upon a collective, consensus forecast," Rodell said.

"In order to preserve this methodology, we do not invite any members of the media and this is considered a closed session. Having members of the public and media observe the price forecast will, by its very nature, inhibit and bias members of the group, thereby destroying the methodology. Members are free to discuss their individual views with the public and media outside of the price forecasting session."

The Department of Revenue held what it called "price scenario meetings" for many years. In 2007, it first referred to the Delphi Method in its annual fall revenue book. It said the presentations that year covered worldwide economic growth, oil demand, oil supply, geopolitics, refining, other oil forecasts and a summary of pre-meeting predictions by the participants.

"At the end of the meeting, the participants completed the post-meeting price solicitation form and the Department of Revenue compiled and reviewed all results," the department said in 2007. That year the participants said that oil prices in 2014 would be in the $60 range, dropping back into the $40 range by 2015.

In 2007, the department said its protocol on predicting prices was such that "long-run crude oil price projections can only be changed every two years if Delphi forecasting participants agree to a change over the prior two consecutive fall forecasting sessions."

In an account of the Delphi meeting a year ago, the 2013 Revenue Sources Book said the process provides a way to tap the combined talents of a varied group. Thirty-nine people from private industry, government and the academic world took part.

"Each participant submitted their own price forecasts after a day of presentations by experts on oil price markets and market structure. These individual price forecasts were combined to derive the price forecasts of the session."

"The median price for each time period from the post-session results was used for the department's fall 2013 forecast," the revenue report said.

The thinking last year was that while supplies around the world are increasing because of new technology, many of these projects require prices of about $100 a barrel to be profitable enough to be pursued.

"OPEC countries also need high prices to sustain social programs and have publicly stated that if prices fall in a sustained fashion below $100, OPEC is likely to cut production," the fall 2013 report said. The consensus a year ago was that oil prices would average $105 per barrel in this fiscal year, which is the figure plugged into the state budget models.

But the practice by legislators and governors has long been that it is OK for annual spending to exceed annual income as long as there is money in savings to balance the budget.

At $105 for an annual average oil price, the state would have to spend about $1.3 billion from savings. To achieve a balanced budget, oil prices would have to average $117, a level that appears unlikely unless the world oil market is disrupted. With production declining, the price required each year to balance the budget has climbed.

Early this summer oil prices peaked over fears that Islamist militants might cause a disruption. That hasn't happened yet and world prices have dropped by about 20 percent since June.

As prices fell by a few dollars this week, there were reports that Saudi Arabia had cut its price in Asia to compete for market share. Oil production in Saudi Arabia is about 9.6 million barrels a day, nearly 20 times higher than in Alaska, and the country has the power to influence the world market.

The Reuters news agency quoted a Goldman Sachs advisory to clients saying $90 per barrel oil was a likely floor in the medium term.

"There is a price war within OPEC," Amy Myers Jaffe, executive director of energy and sustainability at the Graduate School of Management at the University of California, Davis, told the Wall Street Journal. "It is the most fractured I have ever seen OPEC."

A year ago the Alaska oil price session settled on a consensus that $100 to $110 was likely for fiscal year 2014, which ended June 30, $105 this fiscal year and $108 in fiscal year 2016.

Some participants said prices could go up, but if that happened, more people would switch to alternative energy. If prices dropped, expensive oil would stay in the ground. The future is uncertain.

The same quandary exists for those predicting the future course of oil prices today.

Oracles are in short supply.

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