Alaska’s Economy: A bright future, but…are we prepared?

By Mike Navarre, Commissioner of the Department of Commerce, Community and Economic Development

Commissioner Navarre gave the following Fly-In luncheon presentation on Sunday, March 25, 2018. His remarks have been edited slightly for length. 

View Commissioner Navarre’s presentation slides here >

We’re at a quarter of the production we were at 20 years ago. That’s significant. Oil and gas is still the biggest part of our economy, and in oil and gas we have some good news. We’ve seen modest increases in production and the NPR-A (National Petroleum Reserve in Alaska) is beating their expectations in terms of production. There’ s new prospects on the horizon that have been identified at Smith Bay, Moose’s Tooth and Willow—a lot of large discoveries that will be, at some point, developed.

Maybe even better than good news, for the first time Congress has opened up ANWR. Leasing there could start by 2021 or 2022. The North Slope future is looking brighter. The LNG project is probably as far along as its ever been in terms of the permitting, how far down the path the EIS process is, and the fact that China is interested in our gas. China is, and will continue to be, the largest purchaser of natural gas for the foreseeable future. From a geopolitical sense, China needs to pay attention to the balance of trade deficit. Not that they won’t try to get a good deal, they certainly will. But there are reasons other than just simple economics that will allow us to maybe to get this investment.

But all of those types of opportunities will require billions of dollars in investment. When making investments, you look at both the opportunities that are provided, and also at fiscal stability. You have a fiduciary responsibility to shareholders and owners in order to make sure that they get a good return on their investment.

Additionally in our economy, this is a presentation that was done by ISER that shows that the direct effects of policy uncertainty are costing the state investment on an annual basis somewhere between $200 million and $600 million in private capital spending. The conclusion was that the losses due to uncertainty are important, and similar in magnitude to the ones the economy would experience due to a tax or further government cuts. It’s opportunity that we’re missing, in terms of investment.

So how does Alaska compare?

From an investor’s perspective we have promising investment opportunities and a growing and diversified economy. But, we have an over reliance on oil and gas revenues, about a $2.3 billion annual deficit, and multiple years of drawing down savings. We spent in excess of $16 billion over the last four years, and have had annual political battles over deficit and taxes.

Here’s something that we should all pay attention to, because when we talk about the oil and gas finds in Alaska, Prudhoe Bay was originally looked at as having about 15 billion barrels of oil equivalent in place and about 9 billion barrels recoverable. We now produce more than 16 billion barrels of oil from Prudhoe Bay and there’s still a lot of oil that we’ll get out. What’s caught up to it is more technology, which is also catching up to oil and gas wells in the lower 48 that are in direct competition with Alaska.

Look at the size of some of these wells. The Permian Basin in Texas is now as much about 115 billion barrels of oil equivalent in place. It’s tight oil and shale oil, so it’s a little different type of investment. Those types of wells don’t flow as long and you have to constantly reinvest in them, but they are closer to infrastructure, and are a quicker return on investment. That’s where the investment dollars are going in the oil and gas industry, into these fields in the Lower 48.

Another prospective field is the Marcellus basin in Pennsylvania on the East Coast of the United States, which shows as much as 400 trillion cubic feet of gas. Compare that to what is estimated on the North Slope to be 100 trillion cubic feet of gas.

So you can see there is huge potential in the Lower 48. We used to be the big game in the United States, but we’re not anymore. We have to compete with these other areas for investment. The Permian Basin alone is expected to see more than 40 billion dollars of investment over the next few years. So that’s where competition is coming from.

The Permian is nearly 3 million barrels of production a day. It’s almost tripled in 10 years and that’s due almost directly to investment. It takes investment to get production up. Over time Alaska has trended downward in terms of our production. What it will take to stabilize our production and get an upward incline is increased investment. Increased investment means we have to have a stable oil and gas tax policy.

I get push back from both sides of the political aisle on this presentation because on the one hand, my more liberal friends think that we need to get more money from oil. On the other hand, when I talk about a broad-based tax, my more conservative friends say we don’t need taxes. So I fall squarely in the middle.

Here’s another slide that shows cumulative oil and gas production in the United States. The flat line at the bottom is Alaska. What it will take to change that is investment.

But here’s another impediment to investment. Production costs in Alaska are significantly higher because of our Arctic environment and because additionally there are transportation costs. So the production costs per barrel are higher here. That’s another impediment to investment in Alaska.

I love going back to this slide because what it shows is that in order to get additional oil and gas development in Alaska so that we can get the revenues associated with that. And even if we got zero production tax, and I’m not advocating that at all, but we would still get the royalty share. So, if we can get production and investment in order to get the royalty share – if the price of oil goes up or even stays steady – we will also get production taxes. Additionally, if we can get additional production, economy of scale works so that the more you have, the less the operating costs are spread over more barrels, so the costs go down.

So we have to compete with larger and more accessible plays throughout the country and world. Our fiscal situation is a real and significant disincentive to investment. We should pay attention.

Is economic development alone the solution? I did make up the scenario. The information in this slide comes from all sourced data, but this next hypothetical is purely made up. This is a disclaimer. I gave a presentation to the House Finance Committee and I used Fairbanks as the example because I’m from the Kenai Peninsula. Last time I did it I used Kenai, so I wanted to show it works the same in other places. I got a little pushback because Fairbanks said, you’re just talking about that because F-35s are coming to Fairbanks. We are going to see investment. Are you against the military? I said no. Are you against economic development? I said no, economic development is of vital importance to Alaska and the purpose is just to illustrate what it means.

So the hypothetical is, a company proposes a major investment in the Kenai Peninsula Borough. The evaluation process is that it must be economically viable for both the state and the Kenai Peninsula, and the project must pay its own way. Here’s the scenario: 5000 new jobs, of which about 1000 would be built with local residents. So 4000 new residents, some with families, 25 new children are students in the school district. $1 billion capital investment and 4000 new housing units in order to accommodate the families that are moving in with an average taxable value of about $200,000. Here’s how the math works for the Kenai Peninsula.

We would have about $14 million dollars in additional school costs because of our local contribution. But we would get $2 million a year and local borough sales taxes, $8 million a year in borough area wide property taxes on the new homes, and $10 million a year in borough areas wide property taxes on the billion dollar factory investment. So when you add those all up, it’s about a $6 million net positive to the local government finances. $6 million would be available for other types of things, including additional investments in education. The decision for the borough is that the tax base covers the cost of the services that result from that development.

How about at the state level?

The state would ee $4 million a year in increased costs for troopers, highways, courts, prisons, agency operations etc. Based on the contribution to the foundation formula the state pays about two-thirds of the cost of education in the Kenai Peninsula Borough. $22.5 million dollars in increased school funding in the state budget, by a 25 percent gain in enrollment for the Kenai Borough. So, $26.5 million dollars in additional expenses with zero new revenues. That development returns nothing to the state along with all that economic activity, and yet there are costs.

That’s really what I’m trying to convey to my friends in the legislature in the presentations I give. We all want economic development, in fact, that’s one of the areas that we can all agree on at this stage. We want economic development and we want to take advantage of the economic opportunities that we have. I just want to remind people that there’s costs that go along with it. When people move into the state, when families move into communities, there’s costs that go along with it for the services that are required for those new families. The state budget would increase without any new revenues to support those services. So the Kenai Borough went back to the plus $6 million to their revenues and budget, and to the state its a minus $26.5 million.

Then I looked at other like communities—Juneau, Fairbanks, Anchorage, Mat-Su—to see what the impact would be there. What’s interesting is it doesn’t matter where this type of economic development, where this factory would be sited. In every single community there is a local tax base that allows them to collect back revenues on that activity to pay for the cost of the services, and the revenues that would generate to the local government would be in excess of the costs of delivering those services. So these are nets. In those communities, the net revenues to local governments would be significant. At the state level the net revenues would be all negative. It costs the state more money. If you add that cumulative it would be over $125 million in total cost to the state, with no revenues. So from a local government perspective, we have a tax base that allows some of the costs to be spread and recovered in order to pay for the cost of services at the state level. We do not.

So that was a hypothetical scenario, but diversifying Alaska’s economy is not hypothetical. As we have discussed, we’ve seen a diversification in our economy. What we haven’t seen is the diversification in our revenues to get some of the costs back from that development in order to pay for the associated services. If we try to put additional burden on oil and gas at this point in time, what it does is drives investment out of the state of Alaska in oil and gas to other areas, and that’s something that is not in our best interests. We need to get the investment in Alaska as much as we possibly can.

So the state needs to recognize the cost associated with economic development and determine how we’re going to pay for them. Our economy is developing and diversifying, but our revenues are not.

“Cutting government will save us.”

Can we cut our way of prosperity? The answer to that is, we can cut more expenses, but there will be significant impacts associated with it.

Here are the most recent revenue figures for the state of Alaska. $1.8 billion dollars in unrestricted petroleum revenue, and $536 million in everything else. That’s $2.3 billion of a $4.5 billion estimated budget this year, or almost a $2.3 billion dollar deficit.

Here are the top categories of spending, and I know that you’ve all seen this slide before. The number one expenditure that always rises to the top in Alaska, even though it doesn’t always seem that way, is education. Education spending is the highest category and the biggest expenditure of state government. Right behind it is Health and Social Services. Of the $4.5 billion budget, just these two categories are $2.4 billion of that $4.5 billion deficit. So all of you know this in your communities, but the education foundation formula is not a bunch of bureaucrats sitting around somewhere pushing paper around. It’s teachers in the school that provide for a great education, which is also an incentive to economic development because when people look at investing in communities and in states, they also want to make sure that the kids who come to those communities have the opportunity to get a good education, because it’s a foundation for their future.

Health and Social Services is another one. The Medicaid dollars that are spent we get matched. That’s the state general fund. There’s also a federal match, so we get at least two to one. So for every dollar you take out of Medicaid you’re taking two dollars of the economy. Again this is not bureaucrats that are pushing paper around. This is money that gets invested out in the community to pay for the cost of health care, to pay for providers, to pay for hospitals, to pay for clinics and things like that in our communities. Another important aspect of a strong economy and an incentive to investment is making sure that we can have access to good quality health care.

So this is just an example of the money that came to the Kenai Peninsula Borough from the state in FY17: $103 million that was directly transferred from the state to the local governments in just those categories. Most of that is education and part of it is community assistance. When you add any other communities that I referenced before, out of a $4.5 billion budget almost a billion dollars of it is transferred out just to those five communities.

When you cut the state budget, you’re not cutting just your bureaucrats or bureaucracy. What you’re doing is you’re affecting investments into communities and education and health care and public safety and those types of things which is also why we need to have a fiscal plan.

Cuts have real impacts that must be weighed.

Cutting government means cutting services, cutting local funding, and real economic impact. We can do it but there will be impacts, including passing additional costs down to local governments in PERS/TRS and extending the amortization for PERS/TRS. It makes it look like a reduction in the budget, but all it’s doing is pushing it out further and extending the time frame.

I spent a lot of time talking to economists, legislators, local government officials, businessmen and women, researched data and brainstormed with a multitude of diverse interests to develop the perfect solution. This is what we came up with. There isn’t one.

The reality is that the legislative process is an ongoing and dynamic process. It’s just like you at the local level when you’re determining your budget. People change, budgets change, sometimes priorities change. But the reality is, we’re going to be talking about these issues every year. Talking about whether, and if, and what kind of taxes to increase. What types of spending decisions. Where do we invest in our communities and our residents. Where and how do we invest and promote economic development, and quality of life issues that we all want as part of living in our communities and in this state.

A review of the options shows that none of them are easy. Budget cuts are easier said than done. There’s a lot of rhetoric. There are different priorities and perspectives, and lots of philosophical differences. For taxes, its the same thing. There’s rhetoric, its easier said than done. Even if you implement a tax, it takes time for the revenues associated with that tax to be collected and then dispersed again. And then of course, Permanent Fund earnings. Much easier said than done. Political consequences associated with it, effects to the Permanent Fund itself, effects to the Permanent Fund dividend, and the economic impacts associated with it.

But what’s important is that in each of these cases there will be consequences. Taxes take money out of the economy. Budget cuts take money out of the economy. Permanent Fund earnings take money out of the economy. But at the same time remember: we’ve got a $2.3 billion deficit. So we’re taking money out of the economy on one hand, and we’re reinvesting it on the other hand. It may be that the impact of it is blunted. If we take taxes and reinvest it into our economy, it blunts that impact a little bit. It’s spread a little bit differently, but it does blunt the impact somewhat.

When I gave this presentation internally to my department managers they said, “Wow you’re really negative.” So this is my attempt to wrap up on a positive note.

We do have a lot of economic opportunity in Alaska. We have tremendous resources. We’re still a very young state. We have oil and gas, mining, minerals, tourism, fishing, agriculture, and all kinds of opportunities that we can take advantage of. But in order to do that, we absolutely have to diversify our revenue base. If we don’t spread the burden of that and you try to put more burden on the oil and gas industry, it will even reduce that further.

So, as hard as it is, in my opinion and what the House and the governor have been talking about for the last couple of years, we need a broad-based tax of some kind. We can argue about what that broad-based tax is, but we cannot just simply keep kicking the can down the road because we’re just about out of road.

The revenues that we have now from the Constitutional Budget Reserve are almost depleted. This year for the first time we will use earnings of the Permanent Fund. The reason we’ll use earnings of the Permanent Fund is because we don’t have enough revenues left in the Constitutional Budget Reserve to meet the needs in what the legislature will pass as their budget this year.

So we will use Permanent Fund earnings. There will be economic consequences or some political consequences associated with that. But the reality is that there is no fiscal plan that works in the long term without earnings of the Permanent Fund. The Permanent Fund is our largest single source of revenue. We get more on an annual basis from the Permanent Fund earnings then we do from oil and gas development. That’s significant. It wasn’t always the case, but it is now. If we want to turn that around, we have to have an incentive to investing in Alaska.

So the Permanent Fund will be used this year. It means a smaller dividend. Yes it has impact. But the reality is unless we diversify our revenues this gap will continue, and it hurts our ability to invest in the things that we have and we think are priorities in our communities, such as education, health and social services, and public safety.

If we’re able to work together and come together with a good solution, this is our future. Its a bright future, but we need to work together. Compromise is not a bad word. There are philosophical differences, but we can bridge them if we can focus on what we all agree on, which is: we want a strong economy in Alaska. We want economic opportunities for those of us who are here now, and for future generations. We can agree on that. Then it’s just a question of which types of taxes do we put in place, and what do we build into our foundation to allow for a solid future for Alaskans.

How can school board members help?

I think that its the “multiplier effect.” All of you are are in education and are critically important, so educate people who can also spread the message further. Its got to be spread further and further, because right now what really is happening in the legislature is there are different perspectives and different opinions about things. But there’s also always a little bit of fear about the political consequences of leading. So empower the leaders to lead. Try to encourage them that, there are tough decisions but we’re going to support the tough decisions.

The reality is, look beyond the rhetoric in campaigns, and try to elect good people who don’t think compromise is a bad word and who have the future of Alaska in their hearts and in our best interests. Everyone will say that, but I am here to tell you that I have analyzed this since my time dating back to the legislature. I gave a speech to the Municipal League when I chaired the Finance Committee in 1991, and I talked about then the need for a long-range fiscal plan because our foundation is broken. And back then we still had 2 million barrels a day of oil, but I said, “Look, it is a finite resource.” That’s really what the Permanent Fund was set up for; to take a non-renewable resource and create a renewable resource when oil revenues started to drop. We do now, and we’re going to use it this year. But its not enough. If we want to have additional opportunities and economic development in Alaska, we have to have a better foundation.

What happened when I did that in 1991, I talked about the need for broad-based taxes. I said either a statewide sales tax or a statewide income tax. I talked about the need for continuing responsible budgets, and by responsible I mean look at where the efficiencies can be found and try to achieve them. Find other ways, if you can, to get the outcomes that you want that are more cost effective. I trust that you have done that in your districts and in your communities. And then of course Permanent Fund earnings. I talked about all three of those. Someone from that meeting, who was on the assembly at the time, went right back to Kenai, filed against me, and said I wanted to take away the Permanent Fund dividend and I wanted to pass a state income tax. Fortunately I won that election.

It’s OK to talk about these issues and we need to talk about them. We need to reach consensus. If all we’re going to do is vilify what the other side is offering, we’re not going to get there. That would be sad and it would mean that we’re all complicit in perpetuating a stagnant economy or perhaps worse; perhaps going from a recession to a depression in Alaska. The threat is real. We’re not there yet. We have time to fix it, but we have to pull together. Stop vilifying. You hear about how public employees, school teachers, and rural communities are costing us too much. You know, the cost of education is cheap compared to cost of ignorance.

You are leaders in your communities. If you are willing to stand up and talk about some of these issues, we don’t have to agree on what the tax is going to be, whether it’s an income tax, a sales tax, or a statewide property tax. But, point out that at the local level we do have a diversified tax base, which is what allows us to pay for those services. At the state level we do not.

I really was on my way toward retirement when the governor offered me this job. I thought, I have to make an effort because I really am truly concerned about the long term economic well-being of Alaska. What I want to do is change the message from taxes and Permanent Fund to an economic message about why the economy in Alaska is what we should be talking about. The components of that economy will have differences. We have to be willing to write letters to the editor, to host lunch and learns in our communities, do chamber presentations, talk to the Editorial Boards and on the radio, and say look, the foundation is broken.

If somebody has questions or disagrees with what you have to say, point them in my direction. I’m happy to talk to the people in your communities, whether they’re press people or organizations. I’ll come and make a presentation and talk about these issues.

If we do that together, it broadens the message. You have credibility in your communities, so use it for good. It can be used for good or evil. You’re here because you’re trying to use it for good.

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