Resource Development Council - Alliance Financial Speech
11-20-98
By: Senate President Elect, Senator Drue Pearce
I want to thank both RDC and Alliance for giving me this opportunity to be here this morning. It’s an important opportunity because it allows me to frame the message that you’re going to be hearing from me and my colleagues in the House and Senate over the next two years. This speech gives me an opening to set the stage for the Twenty-first Legislature.
Most people don’t realize that the Senate President’s time in the first two weeks of session is often spent introducing the governor. It will be my pleasure to introduce the Governor for both the State of the State speech and the State of the Budget speech. So even though he is not here this morning, I hope his colleagues who are present will carry back my congratulations to Governor Knowles on his reelection.
For those of you who have congratulated me for being named Senate President for the next two years, I want to publicly thank you for those congratulations. But I want to tell you that the very best part about being named Senate President is that I don’t have the job of Senators Parnell and Torgerson of writing the State Budget! However, I am here this morning to discuss the fiscal realities facing the State of Alaska, and the challenges that we have to deal with – not just the legislature and not just the governor, but all Alaskans.
My message to you today – using one of those lofty Harvard words – is that we need a new paradigm. We need new rhetoric for discussing the financial situation Alaska faces. I’m going to give you my opinion of how to develop that new paradigm.
Unfortunately, the rhetoric we’ve been hearing lately - and that used during this last election cycle - does not focus on economics. It didn’t focus on the State budget. We heard a lot of the usual catch phrases and 30-second sound bites, but we heard very little tough talk about the state’s financial situation. We didn’t receive a reality check. Perhaps we have been lulled into a false sense of security.
We have new oil and gas fields coming on line. We have low unemployment. We are looking forward to new leasing in the NPRA. We have a congressional delegation that is one of the most powerful in the United States. We are lucky to have a congressional delegation that managed to bring home one of the largest accumulations of wealth in terms of new projects for Alaska. We have a senior senator who is very good at bringing home the bacon. We like this, but I have been thinking. I would like to challenge Senator Stevens to take a walk in our shoes -- to come home and try to balance Alaska’s state budget. This would give him a reality check on what it is like for us to come up with the matching funds for all the federal money he is bringing to us.
Recent headlines point out that reality and set the stage for my speech today. "Oil Crunch Threatens State Funds, BP Plans Layoffs in Alaska." (Slide #1) "Arco Alaska Cuts 80 Jobs." (Slide #2) "Oil Price Slump to Continue." (Slide #3)
The Nineteenth Alaska Legislature put together the first ever "Commitment to Alaska". (Slide #4) I am very proud of that. Together, House Speaker Gail Phillips and I led a united Legislature in putting together our Commitment to Alaska. And in each of the last three years, we have renewed our commitments. Our goal was to give you a list of our priorities early each year, and from that list, Alaskans could measure our performance on successfully accomplishing those goals by the end of the session.
Also, during the Nineteenth Legislature, on February 12 of 1996, we introduced a Five-Year Budget Strategy. This slide (Slide #5) shows the assumptions in terms of pricing and spending that we had at that time. The primary focus of that budget strategy was to make real cuts in general fund spending in the State of Alaska over five years -- $250 million in total cuts.
The plan (Slide #6) cut more and taxed less than other financial plans on the table at the time. It protected both the constitutional budget reserve and the permanent fund. It closed the spending gap. It did not call for imposing an income tax in five years. It did not change the dividend program. It did not deplete the CBR or the permanent fund over those five years.
The next graph shows the Five-year Plan at Work (Slide #7) detailing the reductions made in general fund spending. We have met our goals to date. In the first three years we had planned for real reductions in general fund spending of $180 million. We actually reduced spending by $189.1 million dollars. We are on schedule.
(Slide #8) Because the legislature took a very real look at the state’s financial picture three years ago, we have seen our bond ratings in the State of Alaska rise. Moody’s Investor Service reports, "The long term outlook for the state is stable given the state’s prudent fiscal planning. Recognizing the need to bring the cost of government in line with the declining long-term revenue trend, state officials have aggressively reduced spending on a year-to-year basis." We have, indeed, had results I think we can all be proud of.
So where were we on the Twentieth Legislature’s adjournment day? (Slide #9) On May 12, 1998, adjournment day, the Department of Revenue’s spring forecast for the average FY 98 oil price was $16.30 per barrel and for FY 99 the oil price projection was $15.32 per barrel. At that time, we expected the net general fund draw on the CBR for FY 98 to be around $395.6 million. And in FY 99 we expected the draw to be $685.7 million. Without questioning the Department’s forecast assumptions, the Legislature had that draw amount in mind when we added a clause to the budget that stated the administration cannot take more than $700 million out of the CBR without coming back to the legislature for another super-majority vote.
Let’s talk a little about the assumptions that were inherent in that Spring Revenue Forecast. (Slide #10) That forecast assumed:
Those were the assumptions that the Legislature left town with on May 12.
(Slide # 12) On October 1, the Department of Revenue released an updated revenue forecast. We utilized those numbers to get a picture of where we are today. The oil price projection as of October 1 for FY 98 was $16.03 per barrel, $0.27 lower that projected in the spring. This change increased the CBR draw by about $4.4 million to $400 million. More importantly, the October 1st update for FY 99, dropped the price from $15.32 per barrel to $14.26. That’s a full dollar and six cents below the spring forecast. At that price level, our CBR draw will be $780 million. You can see, in the FY 99 budget, we are bumping up against that $700 million limitation.
The Department of Revenue’s oil price projection is plotted on this graph (Slide #13). The blue line respresents the revenue forecast in the fall of 1995 that was the basis for our original Five-Year Plan. The Department’s Spring forecast for 1998 is in pink and the October update is in gold. You can see how those numbers have been progressively going down. And we don’t have any reasons to believe they will be going up any time soon.
I want to show you where we are at today in terms of our CBR and our Five-Year Plan (Slide #14). The important numbers that I will call to your attention are highlighted here in gold. First of all, we have used the Department of Revenue price assumptions beginning at $14.26 per barrel for FY 99.
As you can see, we continue our plan to reduce general fund spending in the final two years of the Majority’s Five Year Plan. This schedule shows the planned $40 million reduction in the FY 00 spending and another $30 million reduction in FY 01. Thereafter, general fund spending is projected to remain at the FY 01 level. In this scenario we have also used the Department of Revenue’s anticipated average Settlement Income of $120 million per year over the next four years, and investment income for the CBR is projected to come in at an average 6% rate. You can see that the CBR balance declines at a slow but steady rate.
We set out a second scenario (Slide #15) based on the Department of Revenue’s low oil price projection. In this schedule, we have also reduced the Settlement Income amount, just to see what the CBR balances might look like if settlements were delayed into future years or did not come through as expected. In this scenario we have applied the Five Year Plan reductions in FY 00 and 01 as well. As you can see, in four years, the CBR balance drops to about $1.4 billion from the beginning FY 99 balance of $3.5 billion.
But, if we remained optimistic and oil prices manage to average $14.26 per barrel for FY99, as in the high case scenario, then strengthen to the $15.71 level and above as we go into the new millenium, we would end FY 2002 with over $2 billion dollars in the CBR. Some people might think that if we are going to have at least $2 billion left in the budget reserve account, why are we here worrying about this. Let’s just keep spending money out of the CBR and not make any other changes in the way we do business.
However, I don’t think that approach would be wise. Let’s review the actual monthly averages to date in FY 99. Oil prices per barrel for Alaska North Slope Crude in July were $12.92. August averaged $12.49. September averaged $14.13 and October went back down to $13.38. The November average to date is $12.21. And oil closed yesterday (11-19-98) at $10.43.
Ladies and Gentlemen, there is no reason to believe that the high case scenario will hold true. I expect to see some drastically lower numbers when the new revenue forecast comes out.
The U.S. Energy Department announced on Wednesday, November 18, that World Crude Oil Prices are expected to remain low through 2000 (Slide #17). The Bloomberg Energy News report on Wednesday, November 8, stated that in 2000, when prices are expected to bottom out, the agency expects world oil prices to average $13.97 a barrel, more than $5 lower than was expected last year.
Also from Bloomberg, we have this slide (Slide #18): "Crude Oil Falls as OPEC Production Cuts Seem Unlikely. The surplus is ‘just ugly, ugly, ugly,’ said Tom Bentz, senior vice president-energy at Cresvale International LLC in New York."
And another Headline from Bloomberg (Slide #19): "N.Y. Crude Plunges To 5-Month Low As Mexico, Iran Say OPEC Won’t Cut More. Crude oil plunged almost 4 percent to a five-month low after an Iranian oil official said it’s unlikely the Organization of Petroleum Exporting Countries will announce new output cuts next week. "
So unfortunately, ladies and gentlemen, there is really no reason to believe we are going to be saved by world markets in oil.
I want to show you a plot (Slide #20) that gives both general fund unrestricted revenue and ANS Market Oil Price, Real ‘98 dollars so you can see the close correlation we have between our general fund revenues and oil prices. The present forecast, presented in real 1998 dollars over a three year term, shows our revenues continuing to decline at a slightly faster pace than those projections we’ve been seeing in forecasts made by the Department of Revenue.
Last but not least, (Slide #21) our spring production forecast for the North Slope shows production continuing to decline. The unfortunate thing about this particular slide is that the Department of Revenue based the numbers on information pulled together from investment announcements. The production companies made these announcements based on their exploration and continued investment in secondary and tertiary recovery on the North Slope fields.
Since both BP and Arco have already announced layoffs this year, we cannot expect that their investments will continue at the same rate as earlier planned. I am quite sure, in their London and West Coast boardrooms, they are discussing slower investments to deal with the low prices. Unfortunately their responsibilities are not just to Alaskans - these companies have stock prices to be concerned about and responsibilities to their shareholders.
So what should we do about it? I do have some advice. Also, I want to point out some of the challenges state officials face. And finally, I will make a couple of challenges of my own.
First of all, let’s discuss the budget we are in presently, FY99. My unsolicited advice to the administration is to expect no supplemental appropriations for the current FY 99 budget unless expenditure requests are for truly extraordinary situations.
Secondly, since we are only five months into this fiscal year, I call on the Knowles administration to make some very real changes in the spending habits of the departments today. Rather than reaching a level that requires pulling $700 million dollars out of the CBR, spend less now.
One of the greatest challenges to legislators, the governor and the governor’s commissioners is talking about financial solutions when Alaskans don’t believe there is a problem.
I have already mentioned a few of the reasons why we are experiencing complacency: the budget wasn’t an issue during the election cycle. But more important, we’ve had good news. There are modules being built in the Port of Anchorage and in Nikiski. Alaska has a low unemployment rate. In general, the economy is moving right along. So, we need your help, Ladies and Gentlemen. We need you to help get the message out to the public that this situation we face is very real.
Alaskans need to demand accountability from both the governor and the legislators. It’s a challenge to change the rhetoric on the permanent fund. It’s a challenge to change the rhetoric around tax pledges that people have or have not made during their campaigns.
It’s a challenge when I’m dealing with my 15-member majority. I might have seven Senators who have pledged to never raise taxes until we’ve used permanent fund earnings. And I might have another seven senators who have pledged that we are never going to use the earnings until we have a tax. Everybody can just sit back and say "I made a pledge and I’m not changing it." Well, guess what! If that remains the case, we will never get out of this situation.
In order to change the direction we’re going, we need to change the rhetoric we all use. We politicians must change our rhetoric, and so must all Alaskans in your conversations with us.
I would challenge each and every special interest group to review your paradigms as well as the rhetoric used in lobbying the legislature about spending.
Another challenge: Alaskans don’t have a very good yardstick for measuring results we get from our government. Senator Parnell has spent an enormous amount of time putting Results Based Budgeting into effect. We have written missions and measures for about half of the departments and agencies in the state and we will continue with that. We believe it is important to give Alaskans a budget in a form that allows you to demand accountability from government services.
Another challenge comes in the form of state employee contracts due for renewal this year. The last contracts cost us $72 million in additional general fund spending over the previous three years, and we are paying for that increase to the tune of about $36 million a year. The administration is about to enter a new round of contract negotiations. I personally call on the negotiators to attempt to bring to the table a zero increase in terms of dollars because we are all working within an incredibly tough financial environment.
We also face a credibility problem. For several years now, the Legislature has talked about the severity of our financial situation, yet something always happens to make things seem less severe. During the session, we talk a lot about the gap between our revenues and our spending, and each May we squabble over the three-quarters vote needed to take money from the CBR to balance the budget. But eventually, we settle on a spending number, vote to use the CBR to balance the budget and then leave Juneau. And relatively few Alaskans feel a great impact from our spending reductions.
Another challenge we have in solving this financial problem is the partisan politics that step in the way of changing our rhetoric. The legislature and the administration must make a special effort to disallow partisan politics from subverting our goals.
Our governor is quick to criticize the reductions the Legislature is trying to make when we put the budgets on the table. Just as quickly, he takes credit for them when he campaigns during the interim. And we are quick to criticize him. We say he spends too much. And quite frankly, Alaskans ignore all of us. Remember earlier today when Senator Torgerson told Senator Parnell, "I got here first, how come you got introduced first?" That’s what we sound like.
Standing here, I’ll make one pledge to you: I’ll do my best in the next two years to make sure that the Alaska State Senate’s fifteen Majority members and five Minority members keep focused on the issues. We will do our very best to not dwell on personalities. Although we have our philosophical differences, we will work to keep the discussion on the issues - to point out what those issues are, and work together to find solutions. And we will ask Alaskans to help us find those solutions. You are going to have to empower us to accept the solutions that are out there.
I have a challenge to governor Knowles. I hope he puts a budget on the table in the middle of December that has real spending cuts and that uses honest budget numbers. And we should demand accountability of our chief executive and from every state employee as he puts his budget on the table.
(Slide #22) The Five-Year Plan high price scenario is not all bad news. The CBR balance we have left helps. It’s our job to see that we don’t spend that entire budget reserve account without coming up with long term solutions to carry us into the next millenium so that our children will have a future that’s bright and an Alaska that they want to live in.
In closing, I urge each and every one of you to use your own abilities at the grassroots level to help educate and raise awareness about the tough fiscal road ahead. Foster that discussion.
(Slide 23) We cannot control the price of oil – yet it is the commodity that is responsible for nearly 80 percent of our state revenues. We can only control our costs. That’s our job, Ladies and Gentlemen. We have to control those costs.
I hope you’ll help me, the other 59 members of the Legislature and Governor Knowles in building the new paradigm, changing the revenue picture, and finding solutions.
Thank you very much.
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