Legislature(2009 - 2010)HOUSE FINANCE 519

01/22/2009 01:30 PM House FINANCE


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01:32:40 PM Start
01:32:45 PM Revenue Forecast - the Department of Revenue
03:29:57 PM Adjourn
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+ Revenue Forecast - Dept. of Revenue TELECONFERENCED
                  HOUSE FINANCE COMMITTEE                                                                                       
                     January 22, 2009                                                                                           
                         1:32 p.m.                                                                                              
                                                                                                                                
CALL TO ORDER                                                                                                                 
                                                                                                                                
Co-Chair Hawker  called the House Finance  Committee meeting                                                                    
to order at 1:32:40 PM.                                                                                                       
                                                                                                                                
MEMBERS PRESENT                                                                                                               
                                                                                                                                
Representative Mike Hawker, Co-Chair                                                                                            
Representative Bill Stoltze, Co-Chair                                                                                           
Representative Bill Thomas Jr., Vice-Chair                                                                                      
Representative Allan Austerman                                                                                                  
Representative Harry Crawford                                                                                                   
Representative Anna Fairclough                                                                                                  
Representative Richard Foster                                                                                                   
Representative Les Gara                                                                                                         
Representative Reggie Joule                                                                                                     
Representative Mike Kelly                                                                                                       
Representative Woodie Salmon                                                                                                    
                                                                                                                                
MEMBERS ABSENT                                                                                                                
                                                                                                                                
None                                                                                                                            
                                                                                                                                
ALSO PRESENT                                                                                                                  
                                                                                                                                
Pat  Galvin,  Commissioner,  Department of  Revenue;  Cherie                                                                    
Nienhuis,  Acting Chief  Economist,  Department of  Revenue;                                                                    
Jerry   Burnett,   Director,  Division   of   Administrative                                                                    
Services,  Department of  Revenue;  Dan Stickel,  Economist,                                                                    
Alaska Department  of Revenue; Donna Keppers,  Audit Master,                                                                    
Department  of  Revenue;  Senator Stedman;  Senator  Menard;                                                                    
Representative     Guttenberg;    Representative     Seaton;                                                                    
Representative Kawasaki; Representative Buch                                                                                    
                                                                                                                                
PRESENT VIA TELECONFERENCE                                                                                                    
                                                                                                                                
Dudley Platt, Consultant, Department of Revenue                                                                                 
                                                                                                                                
SUMMARY                                                                                                                       
                                                                                                                                
^REVENUE FORECAST - THE DEPARTMENT OF REVENUE                                                                                   
                                                                                                                                
1:32:45 PM                                                                                                                    
                                                                                                                                
Co-Chair Hawker  acknowledged legislators and  staff present                                                                    
in the room. He explained  the role of the finance committee                                                                    
as an  appropriation body spending  state funds in  a budget                                                                    
bill  with  guidelines  and   information  provided  by  the                                                                    
revenue department.  He added that  the present  budget will                                                                    
for the fiscal year beginning July 2009 through June 2010.                                                                      
                                                                                                                                
1:35:43 PM                                                                                                                    
                                                                                                                                
Co-Chair Hawker noted the  greatest component in determining                                                                    
much of Alaska's  revenue is the projection of  the price of                                                                    
oil,  within  the two  variables  of  production volume  and                                                                    
market price.  He requested Commissioner Galvin  present the                                                                    
big-picture components of Alaska's revenue.                                                                                     
                                                                                                                                
PAT GALVIN, COMMISSIONER,  DEPARTMENT OF REVENUE, introduced                                                                    
his team  including in the audience  DAN STICKEL, ECONOMIST,                                                                    
ALASKA  DEPARTMENT  OF  REVENUE  and  DONNA  KEPPERS,  AUDIT                                                                    
MASTER, DEPARTMENT OF REVENUE.                                                                                                  
                                                                                                                                
1:38:21 PM                                                                                                                    
                                                                                                                                
Commissioner  Galvin characterized  revenue projection  as a                                                                    
critical   tool   in   building  the   state   budget.   The                                                                    
Commissioner declared  his intention to start  with the fall                                                                    
forecast showing the layers of  information and the building                                                                    
blocks contributing  to the forecast. He  commented that the                                                                    
budget forecast is a process  where the revenue team watched                                                                    
the  markets,  collected   information  from  experts,  then                                                                    
incorporated the  data into the  revenue forecast  to assist                                                                    
the state in the budget making process.                                                                                         
                                                                                                                                
1:39:54 PM                                                                                                                    
                                                                                                                                
Co-Chair  Hawker acknowledged  the  loss  of Brian  Andrews,                                                                    
former Deputy Commissioner of the  Department of Revenue and                                                                    
his outstanding  contribution to  the department and  to the                                                                    
state of Alaska.                                                                                                                
                                                                                                                                
1:41:30 PM                                                                                                                    
                                                                                                                                
Co-Chair  Stoltze also  recognized  the great  contributions                                                                    
and friendships of Mr. Andrews.                                                                                                 
                                                                                                                                
CHERIE  NIENHUIS,  ACTING  CHIEF  ECONOMIST,  DEPARTMENT  OF                                                                    
REVENUE,  provided a  PowerPoint  presentation, Overview  of                                                                    
the Fall 2008  Revenue Forecast (copy on  file). She defined                                                                    
budget   making   and   revenue   forecasts   as   processes                                                                    
incorporating  the  variables   of  production,  price,  and                                                                    
costs/investments (p.  2). She  explained that  the forecast                                                                    
variables  interplay with  each  other starting  at the  top                                                                    
with supply and demand.                                                                                                         
                                                                                                                                
1:44:10 PM                                                                                                                    
                                                                                                                                
Ms.  Nienhuis continued  that supply  and demand  is closely                                                                    
related  to  price  which in  turn  affects  production  and                                                                    
costs/investments (p. 3).   She noted that costs/investments                                                                    
can not be  separated from price since the  price drives the                                                                    
level  of investment  that the  oil industry  is willing  to                                                                    
make in producing more oil.                                                                                                     
                                                                                                                                
1:45:19 PM                                                                                                                    
                                                                                                                                
Ms. Nienhuis began with the  production variable noting that                                                                    
production  was consistent  from  the  spring forecast.  She                                                                    
referred  to the  "mountain" slide  indicating that  maximum                                                                    
production was  reached in the mid  to late 80s (p.  5). The                                                                    
graph refers  to the annual  North Slope production  and the                                                                    
contribution of  various other fields broken  into "history"                                                                    
and "forecasts". She showed the  steep decline from the high                                                                    
of 2  million barrels a day  to the low of  700,000 barrels.                                                                    
Ms.  Nienhuis reviewed  the  forecasted  Arctic North  Slope                                                                    
(ANS) production for FY 09 to  FY 2030. The graph showed oil                                                                    
from currently producing projects  and those scheduled to go                                                                    
online  in  the  future.  She pointed  out  that  the  graph                                                                    
indicated a flatter, less steep, decline (p. 6).                                                                                
                                                                                                                                
Co-Chair Hawker  interjected that  the committee  planned to                                                                    
ask  questions during  the presentation.  He clarified  that                                                                    
the numbers calculated as the  state's forecast revenues are                                                                    
based on  both the current  producing projects, as  well as,                                                                    
future revenue  projections on new  or existing  fields. Ms.                                                                    
Nienhuis agreed  that the  official production  forecast was                                                                    
broken   into   several   categories   including   currently                                                                    
producing,  under evaluation  and under  development fields.                                                                    
Ms.  Nienhuis cautioned  that the  production profile  could                                                                    
change if  variables, such  as price,  remained low  but the                                                                    
figures   represented  the   present   best  scenario.   She                                                                    
indicated  that  this  information  comes  from  interaction                                                                    
within the oil industry.                                                                                                        
                                                                                                                                
1:48:49 PM                                                                                                                    
                                                                                                                                
Co-Chair Hawker questioned the  process in actualizing these                                                                    
revenues and what standards were applied.                                                                                       
                                                                                                                                
1:49:17 PM                                                                                                                    
                                                                                                                                
Ms.  Nienhuis referred  to the  Revenue  Sources Book,  Fall                                                                    
2008,  (p.  53),  showing  the  Currently  Producing,  Under                                                                    
Development, and Under Evaluation categories.                                                                                   
                                                                                                                                
1:49:50 PM                                                                                                                    
                                                                                                                                
DUDLEY PLATT,  CONSULTANT, DEPARTMENT OF  REVENUE, testified                                                                    
via teleconference,  and indicated that he  took a "bottoms-                                                                    
up"  approach  to  each  field.  He  first  requested  field                                                                    
information  from all  the North  Slope operators,  analyzed                                                                    
the information  and then formed his  "best guess." Co-Chair                                                                    
Hawker asked if  Mr. Pratt could provide more  detail on how                                                                    
he  arrived   at  his  "best  guess"   scenario.  Mr.  Platt                                                                    
explained that  the "best  guess" could  be wrong  noting he                                                                    
had missed  the fall  forecast by about  2000 barrels  a day                                                                    
but he reminded  the committee that in  such forecasts, this                                                                    
guess was  considered very close. Co-Chair  Hawker asked for                                                                    
further explanation on the standards  used in making the cut                                                                    
for outlying years. Mr. Platt  indicated that 100 percent of                                                                    
the  barrels shown  in the  graph fall  into the  operator's                                                                    
business  plan but  the  timing is  uncertain.  He gave  Pt.                                                                    
Thompson as an example of  a potential high performing field                                                                    
that will eventually proceed but  the exact date is unknown.                                                                    
He  explained  this  uncertainty   often  results  in  wrong                                                                    
forecasts.  Mr. Platt  revealed that  his standards  are the                                                                    
same  used  by the  oil  industry,  but  he also  applies  a                                                                    
sophisticated software program in  the analysis of long term                                                                    
forecasts.                                                                                                                      
                                                                                                                                
1:52:32 PM                                                                                                                    
                                                                                                                                
Co-Chair Hawker asked for an  explanation how the production                                                                    
points  were   arrived  at  for  Pt.   Thompson.  Mr.  Platt                                                                    
explained  that because  of the  incredible uncertainty  and                                                                    
sensitivity in recovering the 200  to 400 million barrels of                                                                    
liquid  hydrocarbons  from  Pt. Thompson  coupled  with  the                                                                    
determination  if it  is a  gas  cycling or  major gas  sale                                                                    
project, resulted  in a  lot of  uncertainty.   He disclosed                                                                    
that he gives the project ten years to develop.                                                                                 
                                                                                                                                
1:53:46 PM                                                                                                                    
                                                                                                                                
Representative Gara  noted that most  of the present  oil is                                                                    
high tech  with high royalties  on state land  but expressed                                                                    
concerned about  some of the  future projects that  were low                                                                    
revenue,  offshore or  without a  royalty or  production tax                                                                    
associated with them.                                                                                                           
                                                                                                                                
1:54:27 PM                                                                                                                    
                                                                                                                                
Mr.  Platt identified  the Liberty  field scheduled  to come                                                                    
online  in  2011 as  100  percent  federal oil  with  shared                                                                    
royalties at  27.5 percent, making  it an  effective royalty                                                                    
of 4  percent. He  mentioned the  Endicott field  net profit                                                                    
sharing will  provide the  state with  some revenue  and the                                                                    
National  Petroleum Reserve-Alaska  (NPR-A) fields,  west of                                                                    
the Alpine field, will receive  a production tax, but due to                                                                    
the fact it is not state land, the royalties will be less.                                                                      
                                                                                                                                
1:55:35 PM                                                                                                                    
                                                                                                                                
Commissioner Galvin interjected  that the revenue projection                                                                    
is based  upon the amount  of revenue expected from  each of                                                                    
these different  types of fields. The  revenue reflects that                                                                    
there will  be limited revenue  from fields such  as Liberty                                                                    
but the  graph also shows the  production profile throughout                                                                    
the North Slope.                                                                                                                
                                                                                                                                
Representative  Gara queried  if the  revenue projection  is                                                                    
for next year. Commissioner Galvin  replied it is a ten year                                                                    
forecast.  Representative Gara  asked if  there was  an easy                                                                    
way  to  look  at  the non-producing  fields  that  are  not                                                                    
Prudhoe Bay.  Commissioner Galvin  remarked that  each field                                                                    
would be  different with a  different royalty rate  and cost                                                                    
profile.                                                                                                                        
                                                                                                                                
1:57:40 PM                                                                                                                    
                                                                                                                                
Representative Gara  questioned if the royalty  rate applied                                                                    
to federal land but  not offshore. Commissioner Galvin noted                                                                    
that the production  tax applies to the  three mile offshore                                                                    
limit. He  continued that anything  from three to  six miles                                                                    
is "shared" federal royalties but  no royalties are paid out                                                                    
for anything beyond the six  mile boundary. The Commissioner                                                                    
cited  the plan  to  talk with  Congress  about receiving  a                                                                    
similar deal that  the Gulf of Mexico enjoys  where there is                                                                    
more   robust   federal   revenue  sharing   with   offshore                                                                    
production.                                                                                                                     
                                                                                                                                
1:58:37 PM                                                                                                                    
                                                                                                                                
Ms.  Nienhuis added  that these  new  projects will  require                                                                    
some  capital expense  increases,  an immediate  hit to  the                                                                    
production tax revenue,  but this will be  positive since it                                                                    
indicates further production.                                                                                                   
                                                                                                                                
1:59:35 PM                                                                                                                    
                                                                                                                                
Ms. Nienhuis  pointed out that  there was minimal  change in                                                                    
the near term for production from the spring forecast.                                                                          
                                                                                                                                
Ms. Nienhuis moved to the  price variable indicating it is a                                                                    
very  lengthy process  taking in  account efforts  from many                                                                    
different divisions within the  Department of Revenue (DOR),                                                                    
the Office of Management and  Budget (OMB) and the Permanent                                                                    
Fund  Corporation (PFC),  The  Forecasting Timeline-Part  1,                                                                    
(p. 8). She reported that  the "Delphi" session, held on Oct                                                                    
7, 2008, provided the best oil price forecast estimate.                                                                         
                                                                                                                                
Co-Chair Hawker questioned the origin of the word Delphi.                                                                       
                                                                                                                                
Ms. Nienhuis  indicated the term  was developed by  the Rand                                                                    
Corporation  in the  60s  and 70s.  She  clarified that  the                                                                    
revenue department  uses a modified Delphi,  a bit different                                                                    
from the model  used by the Rand  Corporation. She continued                                                                    
that  after the  "Delphi" session,  the department  compiles                                                                    
and reviews  the current year's revenues,  then a production                                                                    
forecast is  finalized by Mr. Platt  after consultation with                                                                    
the oil  industry. This year's price  forecast was finalized                                                                    
on November 6, 2008.                                                                                                            
                                                                                                                                
2:02:40 PM                                                                                                                    
                                                                                                                                
Representative  Fairclough asked  for  clarification on  how                                                                    
the reserve  calculation was  used for  Pt. Thompson  in the                                                                    
formula for  production. Mr. Dudley  indicated that  the Pt.                                                                    
Thompson estimate  evolved over  twenty five  years starting                                                                    
with Exxon but changed from  linking it with major gas sales                                                                    
containing one  production profile to a  gas cycling project                                                                    
with   a  completely   different   projection  profile   and                                                                    
recovery. He  indicated that the proposal  submitted in 2008                                                                    
by Exxon  is not the  scenario used but one  more indicative                                                                    
of not  cycling the gas.  Mr. Dudley signified he  based his                                                                    
estimate   of  275   million   barrels   of  reserve   after                                                                    
discussions with Alaska Oil  and Gas Conservation Commission                                                                    
(AOGCC)  and the  Department of  Revenue.  He revealed  that                                                                    
confidential   information  has   been  garnered   from  the                                                                    
industry over the  past 10 to 20 years.  Mr. Dudley remarked                                                                    
that  based  on all  his  information  that there  were  275                                                                    
million  barrels,  starting  in  FY  2019,  with  production                                                                    
starting at  65,000 barrels, declining  by 7 to  8.5 percent                                                                    
per year.                                                                                                                       
                                                                                                                                
2:05:03 PM                                                                                                                    
                                                                                                                                
Representative Fairclough  questioned if his  calculation of                                                                    
barrels  was  based  on  a balance  sheet  line.  Mr.  Platt                                                                    
indicated  that   it  was  not.   Representative  Fairclough                                                                    
reported  that when  she attended  an Exxon  presentation on                                                                    
the Pt. Thompson  field it was indicated that  the oil could                                                                    
not be  recovered under  the pressure  and wondered  if this                                                                    
information   had  been   given  to   Alaska  Oil   and  Gas                                                                    
Conservation Commission (AOGCC) to make the determination.                                                                      
                                                                                                                                
2:05:48 PM                                                                                                                    
                                                                                                                                
Commissioner  Galvin  remarked that  he  did  not have  that                                                                    
particular information  but the  issue in regard  to whether                                                                    
it would  be a  gas blow-down  or a  gas cycling  project is                                                                    
part of the  current controversy. He was not  aware of AOGCC                                                                    
having a  pending decision.  Co-Chair Hawker  indicated that                                                                    
AGOCC will  be with  the committee in  a future  meeting and                                                                    
this question  could be  directed toward  them. Commissioner                                                                    
Galvin  asserted that  Mr. Platt  makes his  own assessments                                                                    
based on  confidential data on  the nature of the  field and                                                                    
the type  of production  profiles that  he would  see coming                                                                    
out  of that  type  of field.  He  contended that  questions                                                                    
regarding  the  likely  production scenario  would  be  best                                                                    
directed elsewhere.                                                                                                             
                                                                                                                                
2:07:15 PM                                                                                                                    
                                                                                                                                
Ms.  Nienhuis continued  with  her  presentation. She  noted                                                                    
that  after finalizing  the oil  price forecast  the revenue                                                                    
department   finalizes  the   costs  forecasts   (p.8).  She                                                                    
disclosed that  cost information is received  from the North                                                                    
Slope  operators which  is incorporated  into the  forecast,                                                                    
then the  department looks into  the longer  term production                                                                    
forecast to  determine if more production  is brought online                                                                    
how that will  impact the cost structure.  She reported that                                                                    
on November  11, 2008 the unrestricted  revenue forecast was                                                                    
finalized  incorporating the  three  previous variables  and                                                                    
the prior fiscal  years actual revenues. This  model is then                                                                    
given  to the  Treasury  department and  the  OMB for  their                                                                    
input.  Ms.  Nienhuis  indicated  that  the  Permanent  Fund                                                                    
Corporation (PFC)  makes their best estimates  based on what                                                                    
the DOR  believes will be  the royalties. She  reported that                                                                    
on November  14, 2008 the  Department of Revenue  gave their                                                                    
summary to Office of Management and Budget.                                                                                     
                                                                                                                                
2:09:53 PM                                                                                                                    
                                                                                                                                
Ms. Nienhuis  continued that  on November  18, 2008  the DOR                                                                    
prepared  the  narrative  and the  tables  for  the  Revenue                                                                    
Sources Book (p. 9), with  the final forecast on December 9,                                                                    
2008. She  added that  on December  15, 2008  the Governor's                                                                    
office released their budget.                                                                                                   
                                                                                                                                
2:10:33 PM                                                                                                                    
                                                                                                                                
Co-Chair  Hawker  referred  to the  timelines  as  benchmark                                                                    
events  and   questioned  if  the   DOR  ever   returned  to                                                                    
reevaluate  decisions  when   world  situations  change.  He                                                                    
provided an  example that the  price forecast  was finalized                                                                    
on November 6,  2008 and between that date  and the forecast                                                                    
release  date, the  world experienced  a calamitous  change.                                                                    
Co-Chair Hawker  wondered if there  was a process  for going                                                                    
back and revisiting  a benchmark after such an  event or was                                                                    
it on a committed track.                                                                                                        
                                                                                                                                
2:11:35 PM                                                                                                                    
                                                                                                                                
Commissioner Galvin  remarked that it becomes  a question of                                                                    
cost benefit. He  reiterated that the process  is a sequence                                                                    
of events  with information  obtained feeding into  one part                                                                    
of the  process that will then  affect the next part  of the                                                                    
decision making process rather than  something set in stone.                                                                    
The Commissioner  emphasized that there are  firm dates when                                                                    
a  revenue projection  must be  made and  when the  Governor                                                                    
must roll out  the budget. He agreed that  this year changes                                                                    
in the financial world did  affect the process but there was                                                                    
a point  when the  process could  not look  back but  had to                                                                    
move on  in order to  complete the process.  Co-Chair Hawker                                                                    
understood the practical dilemma  of a statutory deadline in                                                                    
the process.                                                                                                                    
                                                                                                                                
2:13:52 PM                                                                                                                    
                                                                                                                                
Commissioner Galvin  indicated the  DOR sought a  balance in                                                                    
the  public   rollout  noting  that  rolling   out  multiple                                                                    
revenues and numbers would confuse  the public regarding the                                                                    
process.                                                                                                                        
                                                                                                                                
2:15:04 PM                                                                                                                    
                                                                                                                                
Ms. Nienhuis  interjected that this was  the most compressed                                                                    
timeline   she   had   worked  with   during   her   tenure.                                                                    
Commissioner  Galvin added  that the  November 6,  2008 date                                                                    
was not the  original date but a  point-of-no-return date to                                                                    
agree on a price.                                                                                                               
                                                                                                                                
2:16:14 PM                                                                                                                    
                                                                                                                                
Ms. Nienhuis  elaborated on the  Delphi session  (p.10). She                                                                    
indicated  that in  this  modified  Delphi technique,  fifty                                                                    
groups were  invited to  participate with  eventually twenty                                                                    
nine participants  providing twenty eight  forecasts. During                                                                    
the Delphi  topics included the  fundamentals of  supply and                                                                    
demand,   geopolitics,   financial  markets,   and   analyst                                                                    
expectations.  Ms. Nienhuis  remarked that  on Oct  7, 2008,                                                                    
the price  of oil averaged  $92.85, still a high  range. Ms.                                                                    
Nienhuis showed  on the graph  price forecasts  available at                                                                    
Delphi  from  the   Energy  Information  Association  (EIA),                                                                    
Merrill  Lynch,   New  York  Mercantile   Exchange  (NYMEX),                                                                    
Goldman Sachs, and the Bloomberg Analysts Average. (p. 11).                                                                     
                                                                                                                                
2:19:55 PM                                                                                                                    
                                                                                                                                
Co-Chair  Hawker   stated  that   there  are   thirty  three                                                                    
participants in the Bloomberg report  and wondered if it was                                                                    
possible  to get  this  information  directly. Ms.  Nienhuis                                                                    
indicated  the information  was provided  by a  subscription                                                                    
service that is available at the Department of Treasury.                                                                        
                                                                                                                                
2:20:45 PM                                                                                                                    
                                                                                                                                
JERRY BURNETT,  DEPUTY COMMISSIONER, DEPARTMENT  OF REVENUE,                                                                    
indicated it could be made available to the committee.                                                                          
                                                                                                                                
2:21:12 PM                                                                                                                    
                                                                                                                                
Ms.  Nienhuis reiterated  that in  the  five months  between                                                                    
July  and December  there  was  an 80  percent  drop in  oil                                                                    
prices (p.  12). She showed  that historically the  two most                                                                    
volatile years in  oil prices proved to be  1991 and 2008(p.                                                                    
13).                                                                                                                            
                                                                                                                                
2:23:14 PM                                                                                                                    
                                                                                                                                
Co-Chair Hawker agreed with the  difficulty in preparing oil                                                                    
price  forecasts  during  this  volatile  time  but  he  was                                                                    
surprised  to  read  in  the   introductory  letter  to  the                                                                    
Governor  that   "This  price  forecast  assumes   that  the                                                                    
financial  crisis  experienced  in the  U.S.  is  relatively                                                                    
short-lived, and the economy returns  to a more stable state                                                                    
within one or two years."  (Revenue Source Book, Fall 2008).                                                                    
Co-Chair  Hawker  did not  believe  this  reflects the  real                                                                    
volatile nature  of this  unprecedented deviation  level and                                                                    
wondered if this was a conscious decision.                                                                                      
                                                                                                                                
2:25:24 PM                                                                                                                    
                                                                                                                                
Commissioner   Galvin   acknowledged   that  there   is   an                                                                    
unprecedented  volatility  existing   but  he  believed  the                                                                    
quoted section  provided an  insight to  the public  on what                                                                    
can be  fulfilled and what  can not. He explained  that when                                                                    
this letter  was being prepared there  was an acknowledgment                                                                    
that the  world financial situation  was changing but  a lag                                                                    
time   in  information   still  existed.   The  Commissioner                                                                    
elaborated that  it was  necessary to  gage where  the world                                                                    
and U.S. economies  were going and how that  would play into                                                                    
price projections over the next  two years. He expressed the                                                                    
necessity  of  making assumptions  about  the  state of  the                                                                    
economy, the length of the  difficult times, and a time when                                                                    
demand  might  increase. The  department  brought  in a  low                                                                    
forecast  "if"  scenario  with   the  recognition  that  the                                                                    
economy may continue to struggle.  He reported that when the                                                                    
cover letter  was written the price  of oil was $90  to $100                                                                    
per  barrel so  the letter  was trying  to describe  why the                                                                    
department   was  estimating   at   $74   per  barrel.   The                                                                    
Commissioner  stressed that  this  was not  an intention  to                                                                    
downplay the  volatility of price  but to link the  price to                                                                    
the national economy.                                                                                                           
                                                                                                                                
2:29:26 PM                                                                                                                    
                                                                                                                                
Co-Chair Hawker  referred to  the chart  on page  12 showing                                                                    
the  dramatic  2008  downturn and  believed  that  when  the                                                                    
                                  th                                                                                            
report  was  released  on  the  15,   it  should  have  been                                                                    
emphasized that  there could be  a stronger  volatility more                                                                    
prominently included in the report.                                                                                             
                                                                                                                                
2:30:30 PM                                                                                                                    
                                                                                                                                
Commissioner Galvin defended his  forecast noting that every                                                                    
time a revenue forecast is  published there is a false sense                                                                    
of precision. It is an  exercise in describing an incredible                                                                    
range of  possibilities and a  pinpoint on where it  may be.                                                                    
He  remarked  that in  the  future  the cover  letter  would                                                                    
include a more precise description of the false precision.                                                                      
                                                                                                                                
2:31:19 PM                                                                                                                    
                                                                                                                                
Co-Chair Hawker believed  it was a disservice  to the public                                                                    
not   acknowledging    the   volatility    more   precisely.                                                                    
Commissioner Galvin noted that it  has been wrong every year                                                                    
but usually in a higher amount.                                                                                                 
                                                                                                                                
2:32:14 PM                                                                                                                    
                                                                                                                                
Representative Crawford  acknowledged the oil  price changes                                                                    
over the  years. He  referred to  the chart  on page  12 and                                                                    
indicated if the figures went  back to 1973 it would reflect                                                                    
tremendous hikes and  drops in price followed by  about a 10                                                                    
year  recovery. He  suggested that  a longer  timeline chart                                                                    
could help everyone make better predictions.                                                                                    
                                                                                                                                
2:34:14 PM                                                                                                                    
                                                                                                                                
Commissioner  Galvin agreed  that the  historic nature  is a                                                                    
factor in  looking at the  world today to  draw conclusions.                                                                    
He also indicated  that the supply and  demand functions are                                                                    
different  today than  during  similar price  spikes in  the                                                                    
early 70s,  making it  difficult to  replicate data  from an                                                                    
earlier time  period. The  Commissioner remarked  that there                                                                    
are experts who predict that oil  prices may stay at the $30                                                                    
a barrel  for years but others  who think that oil  may rise                                                                    
again soon to  $100 a barrel. He added  that new projections                                                                    
for the current  year will be provided within a  week and an                                                                    
update for  next year will  be forthcoming in  February with                                                                    
the Governor's amended budget.                                                                                                  
                                                                                                                                
2:36:49 PM                                                                                                                    
                                                                                                                                
Commissioner Galvin  mentioned that  the DOR must  decide on                                                                    
an  oil  price   number  and  make  it   the  official  one.                                                                    
Representative  Crawford agreed  the oil  price process  was                                                                    
difficult  but believed  if  the  available information  had                                                                    
been  viewed over  a  longer  time frame  there  would be  a                                                                    
visible  historical pattern  shown.  He noted  on the  chart                                                                    
that it  should have been  more obvious that the  high price                                                                    
of oil could not be sustained.                                                                                                  
                                                                                                                                
2:39:16 PM                                                                                                                    
                                                                                                                                
Ms. Nienhuis  maintained that today's oil  prices are viewed                                                                    
differently  from the  70s. She  contended that  oil markets                                                                    
today are  more global, with  the example of Asia  and China                                                                    
starting to  utilize more  petroleum products.  She stressed                                                                    
that although  the role of the  U.S. is still large,  it has                                                                    
been diminished. Ms. Nienhuis  emphasized that "easy" oil is                                                                    
increasingly getting scarcer and  that the world was looking                                                                    
to  more  unconventional   supplies  with  increased  costs.                                                                    
Representative  Crawford  agreed that  worldwide  production                                                                    
was accelerating  and influences are different  today but he                                                                    
reasoned that if the prices go  up, at some point, they must                                                                    
come down.  Commissioner Galvin reminded the  committee that                                                                    
the chart reflected  the actual not the  projected price and                                                                    
that was trying to keep within historic expectations.                                                                           
                                                                                                                                
2:43:50 PM                                                                                                                    
                                                                                                                                
Representative Salmon  questioned if the DOR  was predicting                                                                    
that  oil  prices would  drop  off  gradually or  drop  down                                                                    
drastically. Commissioner Galvin answered  that the price of                                                                    
oil changes  with the times.  He pointed out that  the price                                                                    
is determined for  the year, not daily.  The spring forecast                                                                    
was for  $80 a barrel, even  though the actual price  at the                                                                    
time was  $120 barrel. The Commissioner  signified that each                                                                    
price is set  for a six month period, whether  it goes up or                                                                    
down.                                                                                                                           
                                                                                                                                
Representative Gara  offered that projections in  oil prices                                                                    
have  often  been wrong.  He  believed  the report  was  not                                                                    
focused on what the price of  oil would be but a budget that                                                                    
would range from June 2009 until July 2010.                                                                                     
                                                                                                                                
2:46:38 PM                                                                                                                    
                                                                                                                                
Representative  Gara  wondered  what   the  relevance  of  a                                                                    
projected oil  price would be  on budget decisions  that are                                                                    
months away.                                                                                                                    
                                                                                                                                
Co-Chair Hawker noted  that a budget has to be  moved out of                                                                    
the  House Finance  Committee  by the  first  week in  March                                                                    
therefore  the  process  is to  receive  the  best  possible                                                                    
information  in order  to work  with  the administration  to                                                                    
make decisions  providing an open, transparent  and truthful                                                                    
discussion of the state's fiscal circumstances.                                                                                 
                                                                                                                                
Representative  Gara asked  the Commissioner,  regarding the                                                                    
presented  budget, how  close  the forecast  is  to what  is                                                                    
being  spent   in  the  budget  from   the  administration's                                                                    
perspective.   Commissioner   Galvin   asserted   that   the                                                                    
department would  not provide an  inappropriately optimistic                                                                    
or  pessimistic  projection  but reiterated  that  the  only                                                                    
relevance of  the revenue  projection is  to provide  a tool                                                                    
for  the budget  making process.  The Commissioner  stressed                                                                    
that when providing  the fall number then  combining it with                                                                    
the spring  projection, both pieces of  information would be                                                                    
used  to make  decisions on  spending levels.  He emphasized                                                                    
that  the  goal  of  the  department is  to  work  with  the                                                                    
committee to  provide an updated  revenue number to  work on                                                                    
spending. He  remarked that a  new number would  be provided                                                                    
in a week for the budget effective in July.                                                                                     
                                                                                                                                
2:51:14 PM                                                                                                                    
                                                                                                                                
Co-Chair  Hawker  remarked that  the  DOR  explains how  the                                                                    
money is  collected but OMB determines  how that information                                                                    
is utilized for the budget.                                                                                                     
                                                                                                                                
2:52:00 PM                                                                                                                    
                                                                                                                                
Ms. Nienhuis  continued with the presentation  moving to the                                                                    
price forecasts that were available  as of November 6, 2008,                                                                    
when the final  forecast was decided (p.  14). She described                                                                    
how  the forecast  came to  be  with a  blending of  various                                                                    
inputs (p. 15). She moved to  how the DOR formed their price                                                                    
forecast (p. 16).  Ms.  Nienhuis remarked that all forecasts                                                                    
were weighed equally to arrive  at the FY 2009 average price                                                                    
of $77.66.                                                                                                                      
                                                                                                                                
2:54:15 PM                                                                                                                    
                                                                                                                                
Co-Chair Hawker  reiterated that the price  amount came from                                                                    
the Delphi  process and it  predated the economic  change in                                                                    
the   world.  Commissioner   Galvin   emphasized  that   the                                                                    
department  went   through  the  normal  process   but  then                                                                    
adjusted their figures as the world rapidly changed.                                                                            
                                                                                                                                
2:55:20 PM                                                                                                                    
                                                                                                                                
Ms. Nienhuis continued the  presentation recapping the price                                                                    
forecasts for the fall showing  the Bloomberg Analyst Survey                                                                    
for January through  March of 2009 (p. 18).  She pointed out                                                                    
that  the dates  at the  bottom  showed the  dates when  the                                                                    
forecasts were  made. Ms. Nienhuis illustrated  another view                                                                    
of the  same period on  the following graph  showing outside                                                                    
company's forecasts in October and early November (p. 19).                                                                      
                                                                                                                                
2:57:24 PM                                                                                                                    
                                                                                                                                
Ms. Nienhuis  moved to the  last revenue  forecast variable,                                                                    
costs.  She  explained that  cost  forecasting  is a  recent                                                                    
process  therefore cost  data  information  is limited.  Ms.                                                                    
Nienhuis  remarked that  twice  a year  the department  asks                                                                    
operators on  the North  Slope to  give their  best estimate                                                                    
regarding cost structure. This  information coupled with the                                                                    
trends as  far as  costs of production  combine to  make the                                                                    
DOR  best  estimates (p.  22).  She  indicated that  capital                                                                    
expenditures are treated differently  in that they are given                                                                    
a credit  that signifies the  interest in production  on the                                                                    
North Slope. Ms. Nienhuis  continued with Lease Expenditures                                                                    
per  Barrel   (p.  23).  She  explained   that  the  Capital                                                                    
Expenditures  (CAPEX)  per barrel  is  for  projects on  the                                                                    
horizon as well as current  producing projects. She moved to                                                                    
the next  graph showing  the historical and  projected North                                                                    
Slope investment of reported,  not audited, expenditures (p.                                                                    
24).                                                                                                                            
                                                                                                                                
3:01:59 PM                                                                                                                    
                                                                                                                                
Ms.  Nienhuis continued  with FY  2009  Total Revenue  chart                                                                    
which included both restricted  and unrestricted revenue (p.                                                                    
25).  The  total  projection is  for  $13.5  million,  split                                                                    
evenly  between  restricted  and unrestricted  revenue.  Co-                                                                    
Chair  Hawker asked  for an  explanation for  the public  on                                                                    
restricted  and unrestricted  revenues which  were presented                                                                    
in the  next slide  (p. 26). Ms.  Nienhuis pointed  out that                                                                    
the DOR classifies restricted revenue  as the use of revenue                                                                    
restricted by the constitution,  state or federal law, trust                                                                    
or  debt restrictions,  or customary  practice. Unrestricted                                                                    
revenue is available for  general appropriation discussed in                                                                    
the revenue  forecast. Ms. Nienhuis continued  to Sources of                                                                    
Unrestricted  Revenue  which  included  oil  (property  tax,                                                                    
corporate   income   tax,    production   tax,   royalties),                                                                    
investment  earnings  and   other  non-oil  revenue  (taxes,                                                                    
charges for  services, fine  and forfeitures,  licenses, and                                                                    
permits, rents and royalties) (p.  27). She noted that until                                                                    
recently  25  percent of  royalties  were  deposited in  the                                                                    
permanent fund  and .5 percent  in the school fund  but that                                                                    
changed  with  the  repeal  of  HB11 and  now  some  of  the                                                                    
royalties  are  being  paid  at   a  higher  amount  to  the                                                                    
permanent fund.                                                                                                                 
                                                                                                                                
3:04:14 PM                                                                                                                    
                                                                                                                                
Commissioner  Galvin  elaborated  that  this  refers  to  an                                                                    
automatic  mechanical  repeal based  on  when  the bill  was                                                                    
passed. There was  a provision in the bill  that stated that                                                                    
once the  affect in the  reduction in the investment  of the                                                                    
permanent  fund affected  the  calculation  of the  dividend                                                                    
having a $20 impact on the  amount of the dividend, the bill                                                                    
would automatically  be repealed and the  amount returned to                                                                    
the original  distribution, where those leases  issued after                                                                    
1980 would be  at 50 percent. These include  the more recent                                                                    
lower producing leases, not the larger ones.                                                                                    
                                                                                                                                
3:05:25 PM                                                                                                                    
                                                                                                                                
Co-Chair Hawker reiterated that  25 percent to the permanent                                                                    
fund is in the constitution  but the legislature moved it up                                                                    
to 50 percent  for new leases when there was  a lot of money                                                                    
on the table. It reverted  to the constitutional formula but                                                                    
the  legislature  provided  that  if  it  ever  affects  the                                                                    
dividend by $20, no matter  what the financial circumstances                                                                    
of the  state, the extra  money would  be put back  into the                                                                    
permanent  fund.  Co-Chair  Hawker requested  the  benchmark                                                                    
number for how  much this would affect the  money taken from                                                                    
the  legislature's ability  to  appropriate  this year.  Mr.                                                                    
Burnett  remarked that  over  the years  it  has averaged  a                                                                    
little over  $100 million  a year but  with the  current oil                                                                    
prices it may be different.  Co-Chair Hawker remarked that a                                                                    
reasonable  benchmark would  be $100  million off  the table                                                                    
into unrestricted revenue.                                                                                                      
                                                                                                                                
3:07:31 PM                                                                                                                    
                                                                                                                                
Ms. Nienhuis  continued with the  next graph  indicating the                                                                    
FY   2009  Revenue   Overview  (General   Fund  Unrestricted                                                                    
Revenue) (p.  28) followed  by the  FY 2009  Non-Oil Revenue                                                                    
Detail  (p. 29).  Ms. Nienhuis  then presented  the FY  2009                                                                    
Revenue Forecast  Comparison with  the spring 2008  and fall                                                                    
2008 forecasts (p. 30).                                                                                                         
                                                                                                                                
Commissioner Galvin  directed attention to the  oil price at                                                                    
$77 a barrel  which reflected both the  summer prices (2008)                                                                    
at  over $120  per barrel  and  the short  term, January  to                                                                    
March (2009),  prices in  the low  $60s. Because  the summer                                                                    
prices were  no high, it  averaged the  price for the  FY 09                                                                    
year back up  to $77 per barrel.  The Commissioner indicated                                                                    
that the  next projection will  be much lower than  the fall                                                                    
forecasts because  the DOR  will be  averaging in  the lower                                                                    
prices of more recent months.                                                                                                   
                                                                                                                                
3:12:57 PM                                                                                                                    
                                                                                                                                
Commissioner  Galvin  recounted  that all  forecasters  have                                                                    
reduced expectations in the projection of oil prices.                                                                           
                                                                                                                                
Ms. Nienhuis  interjected that the production  taxes are not                                                                    
that  different from  the spring  forecast, even  though the                                                                    
price came down.  She elaborated that the  anomaly of having                                                                    
a  production  tax  with a  progressive  component  shows  a                                                                    
different set  of revenues as the  price changes, magnifying                                                                    
the revenue when prices are  high. The progressive surcharge                                                                    
built into the production tax  magnifies the revenue in high                                                                    
priced months  which make it  impossible to take  an average                                                                    
for the  year and arrive at  the same amount that  you would                                                                    
if  looking  at  each  month   separately  and  adding  them                                                                    
together. Co-Chair Hawker agreed  this is an important point                                                                    
in understanding this year's budget and forecast.                                                                               
                                                                                                                                
Ms. Nienhuis explained  that in the current  fiscal year the                                                                    
department  works  in  months, followed  by  quarters,  then                                                                    
years.  Co-Chair   Hawker  gave  an  example   that  in  the                                                                    
beginning  of a  fiscal  year  the price  spiked  to a  huge                                                                    
number, then lowered in other months,  but at the end of the                                                                    
year  it averaged  $74  per barrel.  He  remarked that  this                                                                    
number  is  different than  if  it  had averaged  $74  every                                                                    
month. Ms. Nienhuis agreed.                                                                                                     
                                                                                                                                
3:15:15 PM                                                                                                                    
                                                                                                                                
Commissioner  Galvin repeated  that the  department was  not                                                                    
expecting the price to at  this figure for all four quarters                                                                    
so  the  model shows  a  price  for each  quarter.  Co-Chair                                                                    
Hawker added that this is no longer a single variable.                                                                          
                                                                                                                                
Ms. Nienhuis  concluded that this year  experienced a record                                                                    
level of  oil price volatility  but when the  price forecast                                                                    
was  made  it  was  within the  ballpark  of  other  outside                                                                    
forecasts  (p.  31).  She  added  that  there  were  minimum                                                                    
production  level changes  from  the  previous forecast  but                                                                    
that  lower   prices  now  will  impact   future  costs  and                                                                    
investments.                                                                                                                    
                                                                                                                                
Ms. Nienhuis  presented the Historical Production  and Price                                                                    
Changes  as of  fall 2008  (p. 32).  She noted  that changes                                                                    
were  made  in  revenue  forecasting from  "cash  basis"  to                                                                    
"accrual"  accounting. She  noted that  when deposited  cash                                                                    
reflects  the  amount of  existing  revenue,  as opposed  to                                                                    
accrual accounting that is not  recorded until it is earned.                                                                    
She  noted that  cash accounting  resulted in  $1.2 billion,                                                                    
thought it  be for  FY 09,  being attributed  to FY  08. The                                                                    
decision was  made to change  the accounting to  the accrual                                                                    
method  so  that  it  would   be  in  alignment  with  state                                                                    
financial documents.                                                                                                            
                                                                                                                                
3:19:28 PM                                                                                                                    
                                                                                                                                
Co-Chair Hawker  asked if  there was  any disclosure  on the                                                                    
change.  Ms.  Nienhuis  remarked that  disclosure  was  made                                                                    
after being asked to do so.                                                                                                     
                                                                                                                                
Mr. Burnett  referred to the error  on page 84 of  the draft                                                                    
of  the Revenue  Sources  Book  that showed  a  loan to  the                                                                    
general fund that did not  occur. The original reason it was                                                                    
shown  was  in  FY  08  the  legislature  appropriated  $2.6                                                                    
billion to  the Constitutional Budget Reserve  (CBR) but the                                                                    
Commissioner decided  to move that,  plus $1.5  billion from                                                                    
the CBR to the subaccount  of the CBR. Mr. Burnett commented                                                                    
that this was  the first time money had been  moved from the                                                                    
main to sub  account of the CBR since  1998. Co-Chair Hawker                                                                    
requested information on the sub account.                                                                                       
                                                                                                                                
Mr.  Burnett   explained  that  the   constitutional  budget                                                                    
reserve has a  main account and, for  investment purposes, a                                                                    
sub  account. The  sub account  is money  invested in  fixed                                                                    
income and  equities but not  to be spent  for approximately                                                                    
five years. The  main account can be used in  a shorter time                                                                    
line as it is more liquid and available for spending.                                                                           
                                                                                                                                
3:22:03 PM                                                                                                                    
                                                                                                                                
Mr.  Burnett recounted  that when  the Revenue  Sources Book                                                                    
was first put  together, there was no  column reflecting the                                                                    
transfer to  the sub account  but this was  corrected before                                                                    
being sent  to the printer.  Co-Chair Hawker noted  this was                                                                    
simply  an  accounting  mistake  in  the  web  version.  Mr.                                                                    
Burnett agreed.  He also  noted that  a correction  was made                                                                    
regarding the $400 million deposit  to the CBR which was not                                                                    
accounted  for in  the  first  version. Commissioner  Galvin                                                                    
interjected  that this  was not  an  accounting mistake  but                                                                    
poorly recorded in revenue book.                                                                                                
                                                                                                                                
3:24:16 PM                                                                                                                    
                                                                                                                                
Commissioner Galvin summed up the presentation.                                                                                 
                                                                                                                                
3:24:55 PM                                                                                                                    
                                                                                                                                
Representative  Crawford  wondered  how the  subaccount  has                                                                    
performed as  opposed to  main account.  Commissioner Galvin                                                                    
reiterated  that the  main  account is  short  term and  not                                                                    
risked  money but  the sub  account is  at fifty-fifty.  Mr.                                                                    
Burnett did  not have  exact numbers  but revealed  that the                                                                    
two  accounts have  a total  of just  under $7  billion with                                                                    
approximately $1  billion unrealized  loss currently  in the                                                                    
sub account.                                                                                                                    
                                                                                                                                
Representative  Kelly asked  what was  changed in  the asset                                                                    
allocation and  by whom.  Mr. Burnett  replied that  this is                                                                    
the responsibility  of the Commissioner of  Revenue combined                                                                    
with input from investment staff.                                                                                               
                                                                                                                                
3:27:24 PM                                                                                                                    
                                                                                                                                
Commissioner Galvin  stressed that the asset  allocation for                                                                    
the main  and sub  account is set  by the  commissioner with                                                                    
staff consultation  but the strategy is  in conjunction with                                                                    
the  finance co-chairs.  He explained  that  when the  asset                                                                    
allocation  meets the  investment  strategy  with no  change                                                                    
then the  strategy remained  the same.  Representative Kelly                                                                    
questioned if  the lever the Commissioner  controlled is the                                                                    
liquidly not market timing.  Commissioner Galvin agreed that                                                                    
the  department   does  not  try   and  guess   the  market.                                                                    
Representative Kelly  asked if the Commissioner  and finance                                                                    
co-chairs would  be a looking  at the asset  allocation. The                                                                    
Commissioner  indicated that  there would  be several  items                                                                    
reviewed during the  discussions. Commissioner Galvin agreed                                                                    
to give the  public and the committees a better  idea of the                                                                    
purpose and function of the two accounts.                                                                                       
                                                                                                                                
3:29:57 PM                                                                                                                    
                                                                                                                                
Representative  Austerman asked  when the  money was  moved.                                                                    
Mr. Burnett  replied that all  of the money was  moved April                                                                    
2008. He added  that when the $2.6 billion  was deposited to                                                                    
the CBR by the legislature  last spring, the intent language                                                                    
was  in  the  budget.  Representative Kelly  asked  if  that                                                                    
intent  language  related  to   the  liquidity  future.  Mr.                                                                    
Burnett agreed that it was.                                                                                                     
                                                                                                                                
Co-Chair Hawker thanked the Commissioner.                                                                                       
                                                                                                                                
ADJOURNMENT                                                                                                                   
                                                                                                                                
The meeting was adjourned at 3:32 PM.                                                                                           
                                                                                                                                

Document Name Date/Time Subjects
HFinPresentFor012209 Final.pdf HFIN 1/22/2009 1:30:00 PM
Revenue Forecast Source Book pages.pdf HFIN 1/22/2009 1:30:00 PM