The Fuse

With $4 Billion Deficit, Alaska Ponders an Economy Beyond Oil

by Nick Cunningham | March 28, 2016

Alaska’s oil production has been in steady decline since peaking in the 1980s, as the mature fields in the state’s North Slope fade in importance. The state’s production has fallen dramatically from a peak of 2 million barrels per day (mbd) to just 0.5 mbd today.

Alaska is now sitting at a crossroads. Not only is the state’s oil production falling, but the collapse of oil prices by more than 70 percent since mid-2014 has blown a hole in the budget.

The depleting oil fields pushed the state government and Alaska’s congressional delegation in recent years to aggressively promote offshore oil potential in the Chukchi and Beaufort Seas. That campaign died in 2015 when Royal Dutch Shell decided to abandon its Arctic drilling program. Alaska is now sitting at a crossroads. Not only is the state’s oil production falling, but the collapse of oil prices by more than 70 percent since mid-2014 has blown a hole in the budget. Unable to control global oil prices, the Alaskan government has had to severely cut spending, but revenues are still falling far short.

alaska crude oil prodcution

Alaska’s oil reserves losing competitiveness

The completion of the Trans-Alaska Pipeline in the 1970s opened up a transit route for the massive Prudhoe Bay oil field, the largest oil field in the United States. At its peak in 1987, BP’s Prudhoe Bay produced 1.6 mbd, making Alaska one of the largest oil producers in the United States.

But with plenty of shale plays in the Lower 48 and with oil prices down to multiyear lows, Alaska no longer tops the list for exploration companies looking to drill new wells. Shell scrapped its Chukchi Sea drilling campaign in September 2015, failing to make the numbers work in an oil-abundant world.

From there, Alaska received a steady string of bad news as the months wore on. BP announced in January 2016 that it would eliminate about 13 percent of its workforce in Alaska, which amounts to the loss of about 270 jobs. They followed that up in March with a decision to cut its payroll by another 4 percent. Also, the company plans on reducing its rig count in Prudhoe Bay from five to two, likely leading to more layoffs from BP’s contractors. The British oil giant’s Alaska unit lost $194 million last year and its investment decisions could affect production at Prudhoe Bay.

ConocoPhillips appears to be the one company that is forging ahead with investment in the North Slope.

Other companies are narrowing their ambitions or deferring projects. Despite making a “significant” North Slope oil discovery in June 2015, Spanish oil company Repsol and its partner Armstrong Oil and Gas said in October that they would put off drilling for now. The project could ultimately yield 120,000 bpd if developed. Italian oil company Eni also delayed a North Slope project. A smaller company, Brooks Range Petroleum Corp., delayed the startup of its Mustang prospect, pushing back first oil from late 2016 to late 2017.

On the state’s southern coast, Houston-based Apache Corp. announced its withdrawal from the state altogether. Apache had been steadily cutting its presence in the Cook Inlet over the past year, where it is the largest lease holder, but decided in early March that it would pull out from Alaska entirely.

ConocoPhillips appears to be the one company that is forging ahead with investment in the North Slope. The company was the first producer in the National Petroleum Reserve-Alaska (NPRA) in October 2015, a large swathe of land that was set aside as an oil reserve for the U.S. Navy back in the 1920s. A month later in November 2015, ConocoPhillips greenlighted its next NPRA project, the $900 million Mooses Tooth, which could produce 30,000 bpd by 2018. The company has plans to move deeper into the NPRA over time.

Looking beyond oil

ConocoPhillips’ NPRA projects could bring new barrels online, but it would merely slow the bleeding of Alaska’s falling oil production.

The situation has Alaska facing a fiscal calamity. Alaska’s Governor Bill Walker revealed on March 21 that the state budget deficit is worse than expected due to persistently low oil prices. In a preliminary budget forecast for fiscal year 2016, the Alaskan government estimated that it would take in about $300 million less in revenues than it previously thought, or about 20 percent lower than the projected figure published in a 2015 budget forecast.

The revenue shortfall is largely the result of an overly optimistic assumption that oil would trade at $50 per barrel through FY2016. Crude prices plunged below $30 per barrel in early 2016 and have only recently rebounded into the high $30/low $40 range.

Oil accounts for 55 to 60 percent of Alaska’s “unrestricted” revenue, a category of revenue that can be used for any purpose, but covers the bulk of state operations. Most of the “restricted” revenues come from the federal government and are dedicated to programs such as Medicaid, Medicare and transportation spending. Before oil prices collapsed, Alaska sourced 88 percent of its unrestricted revenue from oil.

The fiscal problems facing Alaska are vast. Alaska’s current revenue only covers about 25 percent of the budget, leaving a massive $4.1 billion deficit. Alaska’s revenues could fall by another $100 million next year if oil prices remain between $30 and $40 per barrel.

The Governor says a dramatic change is needed to right the ship. “We have reached a point in our state’s history that we need to be looking beyond oil a bit,” Gov. Walker said on March 21, as he presented a proposed financial overhaul to the budget. “We have that opportunity now. And you’re not going to do it by sitting back with a Ouija board hoping the price of oil’s going to go to $110, $147. It just isn’t going to work.”

The Governor has proposed changes to how the state collects revenue, a recognition that the state’s best oil days are likely in the past. The proposal calls for tapping the enormous Alaska Permanent Fund, an endowment setup in the 1970s to save the state’s oil revenues for a rainy day. The Fund currently holds $52 billion and delivers annual dividend checks to Alaskan residents.

By living off of the interest, plus topping off the fund with oil revenues, proponents of the proposal argue that the change will allow Alaska to put an end to the days in which its budget is held hostage by the boom-bust cycle of the oil markets.

Instead of using oil revenues for state’s budget, the proposed changes would direct oil revenues into the Permanent Fund. State expenditures, in turn, would be funded by the Permanent Fund itself. Governor Walker believes the state can withdraw $3.3 billion per year from the Fund without cutting into the principle. By living off of the interest, plus topping off the fund with oil revenues, proponents of the proposal argue that the change will allow Alaska to put an end to the days in which its budget is held hostage by the boom-bust cycle of the oil markets. The revenue stream for the budget would be stable and consistent.

A sensible idea, but the proposed changes would simply reform the revenue mechanism for the state, not revive the economy. The much harder task will be to formulate a path or a vision that transitions the Alaskan economy to something beyond oil. That problem might have to wait for another day.

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