In Oil-Rich Alaska, Will the Good Times Last?

By: - January 31, 2012 12:00 am

Governor Sean Parnell with oil executives
AP Photo/Alaska Governor’s Office
Alaska Governor Sean Parnell (third from left), met this month with the CEOs of British Petroleum, ConocoPhillips and Exxon Mobil to talk about building a natural gas pipeline.

As oil prices go, so goes the fate of Alaska. With prices averaging over a barrel, Alaska is experiencing a revenue boom unlike any other state, allowing it to recover from the recession as “a rock of stability,” as Governor Sean Parnell puts it. 

Alaska’s budget surplus and reserves are nearing billion, enough to cover any emergency for 10 years. The state has such a fat nest egg that it prepays its future education bills, a practice other states can only dream about. Residents share directly in the oil riches; in October, the state deposited ,174 into each resident’s bank account out of a billion oil wealth fund . Alaskans pay no income or sales taxes. 

Standard & Poor’s, the giant credit rating agency that recently has been getting attention for lowering its ratings of U.S. and European debt, rewarded Alaska on January 5 by raising the state’s credit rating to the treasured triple-A mark. Only 13 states hold S&P’s highest debt rating, which cuts borrowing costs when states sell bonds. S&P’s seal of approval followed a similar upgrade by Moody’s. 

Beyond showing how energy-rich states are leading the nation’s economic recovery, Alaska’s good fortune spotlights how a state so dependent on a single, volatile revenue source skillfully manages its finances. But even the best budget practices cannot disguise another truth confronting the state: Oil production is falling. Unless the trend is reversed, any significant drop in oil prices would spoil the gains Alaska has made since 2005 and halt economic growth. 

“Alaska does face a significant fiscal challenge looking forward,” says Scott Goldsmith, an economics professor at the University of Alaska Anchorage. He notes that of every in revenue comes from oil and that production is declining about 6 percent a year. 

At its peak in 1988, two million barrels of oil a day gushed through the Alaska pipeline system. Today, the flow has fallen below 600,000 barrels a day. Although that still represents roughly 10 percent of the U.S. supply, it is a significant decline. The falloff poses no immediate threat to revenues or economic growth because it is more than offset by high oil prices and increases in proceeds from industry taxes on production. 

But state officials hardly are sanguine, having gone through a similar boom between 1980 and 1986 before oil prices plummeted to as low as a barrel, plunging the state into a prolonged recession. “We promised that if another boom ever came around, we’d do a better job of managing our oil resources,” Goldsmith says. “Now we have that unexpected second chance.” 

Triple-A States

Incentives to expand

Parnell is staking the state’s future on boosting oil production to 1 million barrels a day over the next decade. He also wants to build a natural gas pipeline to tap an estimated 200 trillion cubic feet of natural gas reserves — roughly ten times the amount of gas the United States consumes in a year. The key to increasing oil production, he says, is cutting the industry’s taxes so oil companies have an incentive to expand their investment in Alaska. “Significant new investment in oil production would be a game changer for our state,” Parnell said in his January 18 state of the state address. 

The 2012 legislative session could be dominated by the debate over Parnell’s tax cut, which is endorsed by oil industry leaders. It cleared the Republican-led House a year ago but stalled in the Senate, where party control is split. 

Senate president Gary Stevens, a Republican, says the governor and industry officials have not convinced him that the companies would invest more money in exploration if their taxes were reduced by about billion a year. Democrats, including House minority leader Beth Kerttula, point out that the industry already is receiving generous tax credits — more than billion in the past four years, she says. She calls Parnell’s plan a potential giveaway of Alaska’s oil wealth. “Our state was founded to make sure Alaskans could stand up to these outside interests and get our fair share of the wealth outsiders were taking from our state,” Kerttula said in the Democrats’ response to the state of the state. 

Parnell counters that oil companies have pledged to spend at least billion on new exploration efforts if lawmakers approve his plan. Otherwise, he says, the companies will invest elsewhere around the world, threatening the gains Alaska has made. “If our policy is to grab all the tax dollars we can from declining oil production today, our children and grandchildren will have to fend for themselves,” he says. “Alaska’s oil production decline will become Alaska’s decline.” 

Cautious budgeting

The unpredictability of oil prices forces Alaska to plan its budget a little differently than other states. For example, Alaska officials deliberately set low annual revenue estimates hoping to exceed their projections and finish the year with a surplus. 

Parnell has proposed a spending plan for the coming fiscal year that would add about billion to the state’s savings accounts. The proposed budget would also cut state spending by million, another cautious tactic. The planned .8 billion capital budget — the money the state spends on road, airport, school and harbor improvements — relies mostly on federal and state general funds, only borrowing million. Issuing bonds is cheaper than drawing from reserves, which earn a higher interest rate. 

These practices were noted by Standard & Poor’s when the agency announced its rating upgrade. “Recognizing the volatility inherent in an oil-based economy,” said S&P analyst Gabriel Petek, “the state’s financial management has adjusted by using methods to…significantly mitigate the downside effects of oil price declines.” 

The one mystery to Alaska’s fiscal fitness is its public pension system. Other states seeking to cut their public pension costs often praise Alaska and Michigan for scrapping their “defined benefit” plans, which guarantee retirees a fixed monthly check for life, and replacing them with a 401(k)-style “defined contribution” plan, out of which retirees draw from the retirement savings they have invested. Even with its abundant oil revenue, however, Alaska’s public pension system is one of the worst funded in the country. 

The problem is with the defined benefit plan which Alaska closed to new employees in 2006. The nearly 59,000 members in the old plan far outnumber the nearly 12,000 in the new plan. More of them are retiring each year, and they’re living longer, increasing payouts. That, coupled with investment losses suffered during the recession, has increased the gap between what Alaska has promised in defined benefits to employees and what the state has set aside to pay for those pensions. 

Although the state generally has kept up with its required contributions into the old plan, Alaska has only funded 61 percent of its public pension liabilities, one of the lowest percentages nationally. Most analysts say pension systems should aim for an 80 percent funding ratio. 

The legislature is planning to take up the question of whether to pump additional money into the public pension system. Becky Hultberg, commissioner of the state Department of Administration, which oversees the pension system, acknowledges that financing pensions is “a huge challenge.” The policy choice for state officials, she says, is whether to set aside a portion of Alaska’s extra cash towards public pensions or save more of it for a time when oil prices dip. “Do we dedicate additional money to pension costs or education,” Hultberg says, “or do we preserve those funds in some other way?”  

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Stephen Fehr

Stephen Fehr is a senior officer with Pew’s government performance portfolio. He is a lead writer on many of the products generated by the portfolio, specializing in state and local fiscal health.