A day after the Senate Finance Committee took its first look at Gov. Bill Walker’s proposed budget for Fiscal Year 2018, members of the Department of Revenue (DOR) walked the committee through the department’s revenue projections.
In December, DOR released its Fall 2016 Revenue Sources Book.
Total FY 2018 unrestricted revenue in Alaska is forecast to be $1.6 billion, $1.1 billion of which comes from petroleum.
DOR forecasts the per-barrel price of oil to be $54. That’s a ten dollar increase from the Spring forecast, largely due to Saudi Arabia considering a limit to oil production.
Despite a small Alaska oil production increase in 2016 — the first increase in 14 years — DOR expects production to decline this year and continue to decline by four percent over the next ten years.
“The fields are still in decline. If we don’t bring in new fields, new developments, we will go back into a decline very quickly,” DOR Commissioner Randall Hoffbeck told Senate Finance during a hearing Thursday.
This is the first time DOR has relied on production forecasting by the Department of Natural Resources (DNR). DNR has data to which a contractor would not have access, Hoffbeck said, and keeping the production forecast in-house will save $100,000 per year.
“That being said, I think there’s been a lot of discussion around the fact that right now our forecast appears to be running low,” Hoffbeck said. “The forecast for Fiscal Year  was 490,000 barrels a day. We’re currently running about 510,000 barrels a day for the annual average, and our daily throughput right now is about 550,000 barrels a day.”
“I think we were all surprised that it dropped as much as it did,” Hoffbeck said of the production forecast, “but we were also aware of the fact that if we had to go back historically, we would say that we had tended to over-forecast in the past.”
Rep. Steve Thompson (R-Fairbanks) expressed concern that the Fall forecast is too conservative, thereby inflating the approximately $3 billion deficit.
“How can we really have confidence in the future… if we look at what’s currently there?” asked an incredulous Rep. Lance Pruitt (R-Anchorage).
Pruitt noted that the Spring production forecast for FY 2017 was right in line with the six-month average for the current fiscal year. Now it’s 17,000 barrels per day less.
“You just estimated this back in December. How did that shift so dramatically?” he asked.
DNR Petroleum Geologist Paul Decker responded that Winter is peak production season because the temperature aids compression. Decker said he expects to see production drop off in Summer as maintenance replaces production.
Even if the new forecast is 50,000 barrels per day below actual production, it will not close the fiscal gap. 50,000 barrels of additional oil per day would only add $100 million in revenue, Hoffbeck said, while every dollar increase in the price of oil yields only $30 million in revenue.
Senate Finance Questions, Then Applauds, Conservative Forecast
Initially, Senate Finance members seemed frustrated DOR’s production forecast did not include potential boosts, like ConocoPhillips’ recent Willow discovery in the National Petroleum Reserve-Alaska (NPR-A), or the coastal plain of the Arctic National Wildlife Refuge (ANWR), drilling on which would require congressional action.
“If there was a significant uptick in drilling activity by the operators and field activity and some significant new finds that started to come into production, then that would be what would cause the production forecast to have a lower decline rate or maybe even flat production,” Stickel told Sen. Peter Micciche (R-Soldotna).
Price was also a point of contention in the hearing.
“Can you help me understand why it appears that our forecasts are running somewhat counter to what it appears to be international forecasts are: optimistic on price per barrel?” asked Sen. Mike Dunleavy (R-Wasilla).
Hoffbeck said that the Fall forecast was finalized before the OPEC agreement with Saudi Arabia. If that agreement does lift price, he said, a lot of production will come back online and create oversupply like last year, generating a price ceiling around $60.
“It is true that consumption growth going forward is expected to be, while still growing, growing at a little bit lower rate than may have been the case in the past. That combined with a lot of potential new supply kind of helps set a little bit of a ceiling on oil price potential,” Stickel added.
Hoffbeck and Stickel explained that members of various State departments got together for two days in October to come to a consensus on the price forecast. That forecast often mirrors others around the world.
When Dunleavy asked why DOR can’t simply push a button and come up with an average of the international forecasts, Stickel replied that the price forecast meeting is past practice, and the State has not had a strong reason to change it.
Each forecast tends to have a bias, Hoffbeck said. Goldman Sachs tends to have the lowest price forecast.
“We think there’s actually some benefit in having a larger number of people all hearing the same information and then making a determination on what they think the proper forecast is,” he continued, defending the meeting. “You tend to take some of the bias out by having more individuals involved in the process. Is it absolutely necessary? No, but it’s a process that’s worked in the past, and it’s relatively inexpensive.”
Dunleavy said doing the same thing for years just to come up with the same numbers as Outside organizations “sounds like an Alaska thing.” Such practices will draw scrutiny as the State comes closer to enacting new taxes.
“Those decades-old processes will probably be questioned as to why we’re doing this,” Dunleavy said. “Is the forecast being lowballed so it makes a case for more revenue? These are questions that are coming now.”
However, unlike House Finance, Senate Finance members ultimately praised DOR for the lower forecast.
“I appreciate the cautious approach to forecasting,” Senate Finance Vice-chair Click Bishop (R-Fairbanks) said. “I think that helps us with our job, too, to keep pressure on the budget… but it also, if we get a swing, helps us build our reserves back, as well.”
“We can celebrate if your conservatism results in a higher number when the fiscal year is over,” agreed Micciche.
DOR Forecasts Reduced Industry Investment Due to Unpaid Tax Credits
According to DOR’s presentation, after the State has paid its oil and gas tax credit obligations for FY 2018, it will roughly break even on production tax revenue. Credits will cut other petroleum revenue to about $1 billion.
That is only if the legislature agrees with Walker’s proposal to pay the statutory minimum in cash credits for the second year in a row. This year, that figure, based on a formula, is $74 million.
If future governors continue to pay the minimum to the oil companies, the liability for cash credits will build to $1.6 billion by FY 2026.
“Ultimately, at some point in time, those credits are going to hit the books either as a purchase or as a credit taken against tax liability,” Hoffbeck told House Finance. “One of the statements that has been made in the past is that we’re in arrears as far as paying the credits. That is not true. We have paid all the credits that we are required to pay. But that liability does exist out there that will eventually impact revenues to the State.”
Stickel told Senate Finance Thursday that if the State continues to pay the minimum, companies will be forced to change their behavior.
“Does the administration have a goal to change behavior by only paying out the statutory minimum, and then what behavior are you trying to change?” Senate Finance Co-chair Anna MacKinnon (R-Eagle River) asked. “You’re trying to use a stick or a carrot, and I’d like to know what you’re trying to achieve and change.”
“We’re not trying to change behavior, but we recognize the fact that paying only the minimum could change behavior, that some companies that are relying on the cash repurchase of those credits to make further investments would not be able to make those investments and would have to pull back,” Hoffbeck responded.
Reflecting what Hoffbeck called “pretty dramatic impacts on the companies,” the Fall forecast anticipates reduced capital and operating expenditures by oil companies over the next two years.
MacKinnon noted that another consequence could be less production.
If there is no production, the question of price is moot, Bishop added.
“Every lever we pull on this is going to have some effect,” Hoffbeck agreed.
The current tax regime and its predecessor, Alaska’s Clear and Equitable Share (ACES), were designed to incentivize smaller producers, said MacKinnon. Without the cash payments from the State, she said, smaller companies will be forced to sell their credits to ExxonMobil, ConocoPhillips, and BP, consolidating the Alaska oil industry.
“The lever that you’re pulling based on our fiscal situation… ‘decimating’ comes to mind. It’s probably an overstatement… but we are significantly reducing other players in Alaska to develop those resources,” MacKinnon told Hoffbeck.
“You’ve hit the nail on the head,” he responded. “We don’t have the cash to pay the credits, but yet the companies most harmed by not being able to cash the credits are the very companies that we were trying to incentivize to come up here. That’s the dilemma that we’re working with.”
“I just don’t want us… to forget about the tertiary and secondary employers and employees that are waiting on a paycheck that might be going underwater,” Bishop warned.
Another Tax Credit Battle Looms Without Fiscal Plan
The Walker Administration introduced a package of bills last year constituting a long-term fiscal plan. Had those passed, Hoffbeck said, the State could have paid off its tax credit liability.
If the State does not adopt a fiscal plan this year, uncertainty for the oil companies will remain.
With a fiscal plan that includes restructuring of the Permanent Fund, Hoffbeck said the State can consider using savings to pay tax credits. Until then, the State can’t even invest its savings aggressively for higher returns.
Last year, the legislature fought for months before agreeing on an oil and gas tax bill that changed the tax regime in Cook Inlet, but left the North Slope largely untouched.
Hoffbeck’s comments to Senate Finance Thursday suggest a repeat of that fight will be in store if a fiscal plan is not adopted.
“The administration has a bill in its pocket that can deal with oil and gas tax credit issues in a fashion that we think is fair and balanced, but we are not putting it on the table now,” he said. “It will be introduced if it’s necessary to get us to the finish line.”
“I’m comfortable with where we are on oil tax policy,” House Minority Leader Charisse Millett (R-Anchorage) said during a press conference Thursday, adding that her caucus would defend the current tax regime.
Senate President Pete Kelly (R-Fairbanks) said Tuesday that the Senate will not consider a fiscal plan, upon which credit payments would depend, until a government spending limit is put in place and the budget is reduced.
The Senate and House Finance Committees will hear a presentation Friday on the FY 2018 budget from Legislative Finance Director David Teal.