Oil price war could cost Alaska hundreds of millions in revenue

What started as a small dip in oil prices from concerns of a virus-induced global economic slowdown has turned into a free fall from battling authoritarians.

It all adds up to another big hole in the State of Alaska’s budget.

Lawmakers heard from Legislative Finance Division officials on Wednesday that the ongoing drop in oil prices will likely add $300 million to the current year budget deficit and upwards of a $600 million revenue reduction in the 2021 fiscal year that starts July 1.

Oil price forecasts in the $60 per barrel range — that in recent years has been the baseline for the “new normal” in oil markets — now appear overly optimistic.

Legislative Finance Director Pat Pitney told House Finance Committee members that it would be irresponsible to continue to assume the projections made in the Fall 2019 Revenue Sources Book will hold given the disruptions of the past few weeks.

The updated Legislative Finance figures for state oil revenues are based on Brent benchmark futures, or oil market trading today based on what traders believe the price will be weeks and months from now.

Brent is the global standard price for waterborne crude shipments and Alaska North Slope crude has historically traded close to the going Brent price.

“There’s futures trading at $40 per barrel and that’s as good a predictor as anything to say what it’s going to be,” Pitney said.

The Department of Revenue typically provides legislators an update in March to their annual fall state revenue forecast. However, department officials said the sudden volatility of oil and financial markets has caused them to temporarily put that on hold.

Alaska oil prices were largely in the mid-$60s per barrel through most of 2020 fiscal year — in line with Revenue’s forecasted average of $63.54 per barrel. They began falling in early February as traders reacted to lower demand forecasts from China due to the country’s reaction to COVID-19.

That price decline turned into a plunge earlier this month when Saudi and Russian officials could not agree on curbing production rates to stabilize oil markets in the face of less demand due to the virus curtailing economic activity worldwide. That disagreement quickly turned into a price war, with officials from each side refusing to cut production on the premise they can outlast the other in a time of painfully low prices for each oil-dependent government.

Alaska North Slope crude sold for $33.47 per barrel on Thursday, according to the Revenue Department.

If Alaska oil prices average $40 per barrel for the rest of the 2020 fiscal year, the yearly average will be about $55 per barrel, or about 13 percent below the fall forecast price. Revenue officials originally estimated a $59 per barrel average price for Alaska oil in fiscal 2021, meaning prices in the $40 per barrel range would be more than 30 percent less than what lawmakers once presumed they could budget from.

The most recent Legislative Finance projections put Alaska’s final 2020 fiscal year deficit at approximately $930 million. The state would have a deficit of more than $2.1 billion in 2021 based on Gov. Mike Dunleavy’s proposal for ostensibly flat state budgets and full, statutory Permanent Fund dividend payments.

Pitney said the bottom line for Alaska is the Constitutional Budget Reserve, the state’s last remaining savings account, is in serious jeopardy in nearly all budgeting scenarios, especially those that include large PFDs.

The CBR held $2.2 billion at the end of February, but state officials will make additional calls on that money before the June 30 end to this fiscal year. Dunleavy’s 2021 budget proposal originally included a roughly $1.5 billion deficit that has only grown as oil prices have fallen.

“In considering the governor’s amended budget, the CBR would be completely depleted and we wouldn’t get through the fiscal ’21 period,” Pitney said.

Without a PFD, the governor’s budget originally had a roughly $430 million general fund surplus, but that has all but evaporated.

Pitney said it’s hard to project a scenario in which the CBR lasts beyond the 2022 fiscal year at current budget levels of about $4.5 billion in unrestricted general fund spending plus nearly any level of substantive PFD payments.

Lawmakers and Revenue officials have said the CBR needs to hold at least $500 million or so to allow for daily cash management as money is continually added to and drawn from the general fund for state operations.

Legislative Finance analyst Alexei Painter noted that a broad-based tax would take months to set up and start collecting, meaning the revenue couldn’t be used immediately to help remedy the situation. Most income and sales tax proposals have been pegged to generate about $500 million at most.

Painter said the state could likely maintain current levels of services and balance the budget without dividends at the new oil price and revenue projections as long as large annual supplemental budgets can be avoided.

“If you assume no supplementals it would be a balanced budget, so the CBR balance would increase over time because there would be (interest) earnings to it but no draws from it,” he said.

However, the supplemental budget is a near yearly necessity to pay for unexpected costs, such as wildfire expenses, incurred after the budget is set each spring.

The 2020 supplemental passed by the House and under consideration in the Senate has $298 million in unrestricted general fund spending. The largest appropriations are for Alaska’s severe 2019 wildfire season and backfilling Medicaid cuts the Department of Health and Social Services was unable to achieve.

Rep. Adam Wool, D-Fairbanks, noted that the legislative majorities have committed to not overspending from the Permanent Fund, but added that the situation laid out by Legislative Finance leaves the Legislature few other immediate options.

“I haven’t heard too many people say they don’t want a dividend, so it’s really a conundrum,” Wool said.

Anchorage Democrat Rep. Andy Josephson predicted lawmakers will ultimately approve a “significant CBR draw to pay a modest dividend” in October, but how they will deal with a potentially long-term oil price drop is unclear. Most legislators are still trying to fully comprehend the situation.

Finance co-chair Rep. Jennifer Johnston, R-Anchorage, said any idea of full PFDs is “built on fairy dust” and questioned whether Revenue officials could use the Permanent Fund Earnings Reserve Account as a cash management tool instead of the CBR in future years.

“However we look at this we’re taking our CBR away as a cash management fund,” Johnston said.

Elwood Brehmer can be reached at elwood.brehmer@alaskajournal.com.