Alaska's Fiscal Crisis: The Challenge, the Solution and How to Achieve It (1.7.2015)

Alaska’s Fiscal Crisis:The Challenge, the Solution

and How to Achieve itA PRESENTATION TOTHE ALASKA REPUBLICAN ASSEMBLYJANUARY 7, 2015

BRAD KEITHLEYKEITHLEY CONSULTING, LLC

The Challenge

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Problem has been building

2013 …“Right now, the state is on a path it can’t sustain. … we do not have enough cash in reserves to avoid a severe fiscal crunch soon after 2023, and with that fiscal crisis will come an economic crash.” --ISER Web Note 14 (2013)

2014… “The implications of the figures are severe … Failure to reduce the projected deficits will result in a very hard landing -- Legislative Finance Division (2014)

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And then this happened …

2014 ANS PriceJan $105Mar $111May $105

FY 2015 Budget Breakeven: $117

Jul 1 $111Aug 1 $103Sep 1 $ 97Oct 1 $ 91Nov 1 $ 82Dec 1 $ 70Jan 1 $ 55Jan 6 $ 50

????

The future (2023) is now …

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What does it mean …$105 $70 oil• The revenue equivalent of a

54% production decline to ~230,000 b/d

At current spending rates:• Draining ~$10+ million per day

from savings• ~$3.8 billion (60+%) deficit

(~$5,250 per Alaska man, woman and child; $21,000 per family of 4)

• Less than 3 years of unrestricted savings (SBR & CBR) remaining as of June 30, 2015

Statutory and Constitutional Budget Reserves

$- $1 $2 $3 $4 $5 $6 $7 $8 $9

$10

2016 2017 2018 2019 2020 2021 2022 2023 2024

Billi

on$

Start of Fiscal Year

CASH RESERVE LIFEAT DIFFERENT OIL PRICES

$100

$90

$80

$70

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Mid case scenario …

Assumptions …

$90 oil3% production decline

Viscous oil: 2020NPRA: 2020New Conv Oil: 2020

Gas (moderateprice scenario) 2024No near future OCS or ANWR

$0

$5

$10

$15

2016 2020 2024 2028 2032 2036 2040

UNRESTRICTED GENERAL FUND(BILLION $)

? PF CORPUS DRAW

? PF INFLATION PROOFING

? PF EARNINGS

? DIVERT PFD TO GF

? INCOME/SALES TAXES

? NATURAL GAS

? NEW OIL

CASH RESERVE

CURRENT OIL REVENUES

NON OIL REVENUES

$0$2$4$6$8

$10$12

2016 2020 2024 2028 2032 2036 2040SBR & CBR

CASH RESERVE (Billion $)Start of Fiscal Year

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Where does that lead …

“… reducing expenditures… institution of a broad-based tax, and use of a portion of the earnings of the Permanent Fund ….”

Northern Economics and ISER, Potential National-Level Benefits of Alaska OCS

Development (2011)

Draining the CBR/SBR to maintain current spending shifts all of the consequences to future generations and creates an uncertain and unstable climate for future investors

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The Solution

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What is a “sustainable” budget …

A calculated revenue and spending level which, if adopted now, can be maintained consistently long into the future, adjusted for inflation and population growth

Based on both current and projected revenue streams and asset levels

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What is the current sustainable level …

Nest eggNest egg draw $ 5.4 BPFD payment (1.4)Net oil revenues $ 4.0 B

UGF non-petroleum revenues $ 0.5 B

UGF Sustainable Revenues $ 4.5 B

Sustainable RevenueFinancial Assets $66.2 BNPV of Future Oil/Gas 68.9*TOTAL NEST EGG $135.1BReal rate of return (5%)minus population growth (1%) 4%

Nest egg draw ($135.1 x 4%) $ 5.4 B

* Based on oil prices projected in DOR Fall Revenue Sources Book, plus production assumptions beyond RSB forecast reflected in “middle case” (p. 9).

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Sustainable budget …Results …

Treats all generations equitably

Encourages investment and growth by providing a stable, long term fiscal structure

Smooths the revenue curve even during turbulent times

Encourages and facilitates state support for resource development

Requires … Fiscal discipline to limit

current spending to sustainable level (or enact supplement revenues)

Treating all current savings and reserves as long term investments (“nest egg”)

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The costs of delay …Spending above sustainable levels offsets the short

term economic impact of current spending reductions but reduces the nest egg and as a

result, future sustainable revenue levels

Costs of delayMSY

FY 2012: $6.2 BFY 2013: $6.4 BFY 2014: $5.5 BFY 2015: $5.0 BFY 2016: $4.5 B

$7.0

$7.8

$7.2

$6.2 $5.9

$6.2 $6.4

$5.5 $5.0

$4.5

2012 2013 2014 2015 2016

$ Bi

llion

Fiscal year

Actual v. Sustainable Spending Levels(FY 2012 - 2016 (est.))

Actual Spending Sustainable Spending Level

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Going forward options & costs …

Future Sustainable Budget Levels @ Overspend Above $4.5 BTransition Period $500 M $1 B $1.5 B1 year $4.47 B $4.45 B $4.43 B2 years $4.45 B $4.41 B $4.36 B3 years $4.43 B $4.36 B $4.29 B4 years $4.40 B $4.31 B $4.22 B

A four year transition reduces the sustainable spending level between 5 and 10% (e.g., overspending $4.5 B by $1.5 B/yrfor four years reduces the sustainable level to $4.22 B)

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The FY2016 Budget…

Operating Budget:Formula: $2.1 BNon-Formula: $2.3Statewide: $ .8Add’l O&G Credits $ .2PERS/TRS $ .3Total (rounding) $5.8 B

Capital budget: $ .1Total $5.9 B

FY 2016 Work in Progress (WIP) Unrestricted General Fund (UGF) Budget

FY 2016 WIP ($5.9 B) – Sustainable Budget ($4.5 B) = $1.4 B overspend

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The needed reductions …WIP

BudgetFinal

SpendDiff % Re-

ductionCapitalBudg

Op BudgetFormula Non-Form

$5.9 B $.1 B $2.1 B $3.70 B$5.9 $5.50 B $0.40 B 7% $.1 $2.1 $3.30 (11%)$5.9 $5.25 $0.65 11% $.1 $2.1 $3.05 (18%)$5.9 $5.00 $0.90 17% $.1 $2.1 $2.80 (24%)$5.9 $4.75 $1.15 19% $.1 $2.1 $2.55 (31%)$5.9 $4.50 $1.40 24% $.1 $2.1 $2.30 (38%)

Some transition period may be appropriate, but should involve significant annual reductions and be

relatively quick to avoid additional material reductions to the long-term sustainable number.

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How to Achieve It

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Focus on the 1+60 who count … The Governor (the 1) proposes the

budget and has the power of line item veto at the end

The legislature (the 60) enacts the budget by majority vote in each body The Governor has no authority to increase

the amount enacted

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Expectations, results and response … Establish and communicate expectations

Establish the expectation that the 1+60 will achieve sustainable revenue levels in three years, reducing the budget by one third (~$500 million) of the difference between the starting point (the WIP) and the goal (the final sustainable number, after transition) each year

Measure results Identify the amount by which the operating budget

(and each component) needs to be reduced and monitor progress in HFIN subcommittee process

Identify the amount to which the capital budget needs to be held and monitor progress in SFIN

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Expectations, results and response …

Prepare to respond Support those of the 1+60 who meet expectations But any who do not see the current situation as a

fiscal crisis requiring a response never will – they will always look for ways to kick the can down the road

Be prepared to respond by encouraging and supporting a year long primary challenge to any of the 1+60 who fail to support even a first step by Voting yes in subcommittee/committee for agency

budgets above the transition level Voting yes for a final budget above the transition

level

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Morning in Alaska …

In 1984, Ronald Reagan ran a commercial that captured his vision in three words. The title? “Morning in America”

Achieving a sustainable budget can produce a Morning in Alaska but it will take a Reaganesque level of vision and commitment

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