Oil price plunge worsens Alaska’s meager budget options

JUNEAU — Alaska legislators watched with concern Monday as plunging oil prices and a developing price war threatened to gouge hundreds of millions of dollars from the state’s revenue forecast.

The state’s dwindling savings accounts contain enough money to cover a short-term decline. But a long-term plunge would create a deficit so large that the state’s Constitutional Budget Reserve would run out of money next year.

Legislators and the governor would then be forced to irrevocably cut the Permanent Fund dividend, significantly cut services, impose new taxes or spend unsustainably from the Alaska Permanent Fund.

As of the end of the day Friday, a barrel of North Slope crude was $44.73 per barrel, down $4.75 from the previous day, and prices kept falling through the weekend.

Gov. Mike Dunleavy said Monday that the downturn is “a momentary glitch” and not a cause for panic.

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The state budget is based upon average oil prices over an entire year.

“If the oil prices turn around here in a few weeks or a month or two, it’s all going to be averaged out,” he said.

Hours later, the governor’s chief of staff issued a memo freezing all state hiring.

“With the recent volatility in the global oil markets and the impacts on our state’s financial resources, prudent management actions must be taken to control spending,” Chief of Staff Ben Stevens said in the memo.

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Marianne Kah, a former chief economist for ConocoPhillips who now works as an adjunct senior research scholar at Columbia University, said there are more signs in favor of a long-term decline than a short-term one.

Late last week, Russia and OPEC failed to agree on production cuts needed to keep oil prices stable amid dwindling demand due to the novel coronavirus. The next day, Saudi Arabia — OPEC’s biggest-producing member — slashed prices, signaling that it will increase production and kick off a price war with Russia.

Asked about the governor’s statement about a short-term decline, Kah said, “the implicit assumption behind that statement is that Russia and Saudi Arabia come back to the table. Logically, economically, they should, but — politics."

When a similar dispute happened in 2014, it took two years for international oil markets to recover. This time, even if the political dispute is resolved, coronavirus concerns remain.

“The basic problem is we don’t know when the demand shock is going to end, said Kah.

At current prices, every time the average annual price of North Slope crude drops $1, the state loses about $30 million in tax revenue.

“I think we have to plan for a long-term impact. It’d be irresponsible if we didn’t,” said Rep. Jennifer Johnston, R-Anchorage.

More spending than revenue

The state’s fiscal year begins July 1, and early estimates indicate a combined state capital and operating budget of about $4.7 billion. The House passed a $4.5 billion operating budget last week, and the Senate is still drafting the capital budget.

That doesn’t include the Permanent Fund dividend, which remains a major point of disagreement in the Legislature. A $1,600 dividend, as paid in 2019, would cost another $1 billion. The dividend supported by the governor would cost about $2 billion.

Even before the recent coronavirus-driven oil price drop, that was going to result in more spending than revenue. The state projected that it will collect only $5 billion next fiscal year.

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The crash in oil prices could “easily” slash $200 million from that figure, said Sen. Bert Stedman, R-Sitka and co-chair of the Senate Finance Committee.

“It’s going to be a budgetary challenge to work through,” he said.

Unless oil prices skyrocket, legislators will balance Alaska’s budget with state’s Constitutional Budget Reserve, which is expected to contain between $1.7 billion and $1.8 billion on June 30.

That isn’t enough to pay for next year’s services and the $3,200 dividend envisioned by Dunleavy.

“In my opinion, there is little to no chance of a $3,000 dividend,” Stedman said.

Even a $1,600 dividend, the amount paid in 2019, may be too large, he suggested, because the state should keep sufficient money in the reserve to shield against additional declines.

“We are going to be taking a fiscally conservative approach,” said Sen. Natasha von Imhof, R-Anchorage, the other co-chair of the Senate Finance Committee.

Watching for impacts to the Permanent Fund

As Wall Street saw its worst day since the 2008 financial crisis on Monday, some Alaska lawmakers also were paying attention to how a long-term decline in the stock market could affect the Alaska Permanent Fund.

While the Permanent Fund transfers money to the state treasury for dividends and services each year, market downturns don’t have an immediate effect.

The transfer is based on a five-year average of the fund’s value, but those five years don’t include the most recent year, so the latest declines won’t be included.

But if the decline lasts longer than a year, Johnston said the impact on oil revenue and investment revenue will have an impact so large that Alaska will have no choice but to cut spending and impose taxes.

In the process, Alaska would lose the distinction of being the only state without an income tax or sales tax.

“We’re at the point where we’re going to be like other state governments,” she said.