Legislature(2009 - 2010)SENATE FINANCE 532

02/05/2009 09:00 AM Senate FINANCE


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09:02:22 AM Start
09:06:13 AM Presentation: Revenue Forecast & January 2009 Update
11:14:04 AM Adjourn
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+ Revenue Forecast: Pat Galvin, TELECONFERENCED
Commissioner, Dept of Revenue
Bills Previously Heard/Scheduled
                  SENATE FINANCE COMMITTEE                                                                                      
                      February 5, 2009                                                                                          
                         9:02 a.m.                                                                                              
                                                                                                                                
9:02:22 AM                                                                                                                    
                                                                                                                                
                                                                                                                                
CALL TO ORDER                                                                                                                 
                                                                                                                                
Co-Chair Stedman called the Senate  Finance Committee meeting                                                                   
to order at 9:02 a.m.                                                                                                           
                                                                                                                                
MEMBERS PRESENT                                                                                                               
                                                                                                                                
Senator Lyman Hoffman, Co-Chair                                                                                                 
Senator Bert Stedman, Co-Chair                                                                                                  
Senator Charlie Huggins, Vice-Chair                                                                                             
Senator Johnny Ellis                                                                                                            
Senator Kim Elton                                                                                                               
Senator Donny Olson                                                                                                             
Senator Joe Thomas                                                                                                              
                                                                                                                                
MEMBERS ABSENT                                                                                                                
                                                                                                                                
None                                                                                                                            
                                                                                                                                
ALSO PRESENT                                                                                                                  
                                                                                                                                
Pat  Galvin,  Commissioner,  Department   of  Revenue;  Jerry                                                                   
Burnett,   Deputy   Commissioner,   Division   of   Treasury,                                                                   
Department of Revenue.                                                                                                          
                                                                                                                                
PRESENT VIA TELECONFERENCE                                                                                                    
                                                                                                                                
Cheryl  L. Nienhuis,  Acting Chief  Economist, Department  of                                                                   
Revenue; Dudley Platt, Consultant, Department of Revenue.                                                                       
                                                                                                                                
SUMMARY                                                                                                                       
                                                                                                                                
^Presentation: Revenue Forecast & January 2009 Update                                                                           
                                                                                                                                
OVERVIEW OF FALL 2008 REVENUE  FORECAST & JANUARY 2009 UPDATE                                                                 
                                                                                                                                
Co-Chair  Stedman  reported  that the  updated  FY09  revenue                                                                   
projections  had been  recently  released and  he wanted  the                                                                   
committee to be aware of changes.                                                                                               
                                                                                                                                
PAT GALVIN,  COMMISSIONER, DEPARTMENT OF  REVENUE, introduced                                                                   
the  overview   of  the   revenue  forecasting  process.   He                                                                   
emphasized the importance of understanding  forecasting given                                                                   
the volatility of oil prices.                                                                                                   
                                                                                                                                
9:06:13 AM                                                                                                                    
                                                                                                                                
CHERYL  L. NIENHUIS,  ACTING CHIEF  ECONOMIST, DEPARTMENT  OF                                                                   
REVENUE   (testified   via   teleconference),    provided   a                                                                   
PowerPoint  presentation,  "Overview  of  Fall  2008  Revenue                                                                   
Forecast & January 2009 Update" (Copy on File).                                                                                 
                                                                                                                                
Ms.  Nienhuis  explained  that   there  are  three  variables                                                                   
considered in forecasting both royalty and production tax:                                                                      
                                                                                                                                
    · Production levels,                                                                                                        
    · Price, and                                                                                                                
    · Costs, which can also be seen as investment.                                                                              
                                                                                                                                
Ms.  Nienhuis  added  that  up   until  the  passage  of  the                                                                   
Petroleum  Production Tax  (PPT), production  and price  were                                                                   
the  only  variables  that  had to  be  considered.  The  net                                                                   
profits  tax passed  with PPT  under the  Alaska's Clear  and                                                                   
Equitable Share  (ACES) required forecasting  operating costs                                                                   
as well as the level of potential investment.                                                                                   
                                                                                                                                
Ms.  Nienhuis  pointed out  that  the variables  interact  on                                                                   
several levels, and  all the variables must  be considered in                                                                   
production   tax   and  royalty   forecasts.   The   economic                                                                   
fundamentals of  supply and demand  affects price,  and price                                                                   
has  a relationship  to both  supply and  demand. Price  also                                                                   
affects  production; if  price is high,  production  might go                                                                   
up,  because price  drives investment  decisions, which  also                                                                   
drives  production  levels.  Price  also  affects  costs  and                                                                   
investments.  If  the  price  is high,  there  will  be  more                                                                   
investment and higher  costs. The price of oil  drives up the                                                                   
cost of producing oil.                                                                                                          
                                                                                                                                
9:09:29 AM                                                                                                                    
                                                                                                                                
Ms. Nienhuis addressed  a graph on Slide 5,  "ANS Production,                                                                   
History  and Forecast"  illustrating  the  history of  Alaska                                                                   
North Slope (ANS) production and  the contribution of various                                                                   
oil fields.  She highlighted  that Alaska is  in a  period of                                                                   
declining  oil production.  The peak of  two million  barrels                                                                   
per day  was reached in the  late 1980s, followed by  a rapid                                                                   
decline. The  forecast is for  a slightly lesser  decline and                                                                   
includes a number of lesser fields.                                                                                             
                                                                                                                                
Co-Chair  Stedman asked  if the  oil fields  depicted on  the                                                                   
graph  showing  an  early  spike   and  rapid  tapering  were                                                                   
reflective of basins globally.                                                                                                  
                                                                                                                                
9:11:42 AM                                                                                                                    
                                                                                                                                
DUDLEY PLATT,  CONSULTANT, DEPARTMENT  OF REVENUE  (testified                                                                   
via  teleconference),  answered  that  the trend  of  a  peak                                                                   
followed by  a steep  decline is typical  to the  extent that                                                                   
there is not often  a lot of surplus capacity  to produce, as                                                                   
experienced  in  the  Organization   of  Petroleum  Exporting                                                                   
Countries  (OPEC). The  trend  is irreversible.  He  believed                                                                   
that ANS production had turned a corner.                                                                                        
                                                                                                                                
9:12:44 AM                                                                                                                    
                                                                                                                                
Co-Chair  Stedman  asked  for an  explanation  of  production                                                                   
graphs.                                                                                                                         
                                                                                                                                
Mr. Platt  replied that  large alpine  fields are complex.  A                                                                   
great  deal of science  and engineering  is  used to get  the                                                                   
most oil out of the ground. The  usual extraction expectation                                                                   
is  30   percent.  Enhancing   techniques  will   enable  ANS                                                                   
operators  to  get  two-thirds  out of  the  ground,  leaving                                                                   
another third. He listed methods  that can be used to recover                                                                   
more  oil, including  admissible injection  projects and  re-                                                                   
injecting carbon dioxide. One  challenge is water in the oil.                                                                   
Water  is a  by-product of  producing the  oil; dealing  with                                                                   
water is expensive.                                                                                                             
                                                                                                                                
Mr.  Platt  described  production   from  other  basins  with                                                                   
similar  trends from  peaks to  plateaus  and then  declining                                                                   
production.                                                                                                                     
                                                                                                                                
9:15:38 AM                                                                                                                    
                                                                                                                                
Co-Chair  Stedman  asked  if  industry  wanting  to  maximize                                                                   
production  as  quickly as  possible  shaped  the trend.  Mr.                                                                   
Platt replied in the affirmative.                                                                                               
                                                                                                                                
Senator Huggins  asked about  Point Thompson production.  Mr.                                                                   
Platt  answered  that  the  issue   had  been  sensitive.  He                                                                   
forecasts  for purposes of  cash flow.  He does not  forecast                                                                   
for anything  that does  not exist  and he  tries to  get the                                                                   
timing right. He  does not want to suggest  that something is                                                                   
going to happen sooner than it realistically will happen.                                                                       
                                                                                                                                
Mr. Platt explained that Point  Thompson can be developed two                                                                   
ways. One is a gas cycling project,  requiring compressors to                                                                   
overcome high  pressure as  well as  building a pipeline  for                                                                   
the liquids. The  expense would be high. The  North Slope gas                                                                   
commercialization  issues resulted  in a second  alternative,                                                                   
producing  some of the  gas first.  Exxon Mobile  Corporation                                                                   
has proposed infrastructure  in order to produce  200 million                                                                   
cf/d  of  liquid  condensate   for  a  $1.3  billion  capital                                                                   
investment  for   2014.  It  is  the  job   of  a  production                                                                   
forecaster to discern the right course of action.                                                                               
                                                                                                                                
Mr. Platt emphasized that he assumes  a major gas sale-driven                                                                   
project, ten years down the road.                                                                                               
                                                                                                                                
9:19:36 AM                                                                                                                    
                                                                                                                                
Co-Chair Stedman  asked how Point Thompson would  look on the                                                                   
chart viewed  from the  standpoint of  a decade earlier.  Mr.                                                                   
Platt conjectured  that the project  would be seven  or eight                                                                   
years out.  Co-Chair Stedman  thought  it would be  producing                                                                   
revenue.                                                                                                                        
                                                                                                                                
Commissioner Galvin  added that the graph shows  the layering                                                                   
of multiple  fields beginning  at different times.  He called                                                                   
attention to the width of the bands depicting production.                                                                       
                                                                                                                                
9:21:52 AM                                                                                                                    
                                                                                                                                
Senator  Elton   asked  if   production  in  out-years   were                                                                   
predicated on  lower shipping  costs. Mr. Platt  replied that                                                                   
the forecast for Point Thompson  was based on a scenario that                                                                   
more closely resembles  a major gas project.  The question is                                                                   
where the gas would  come from. There is gas  in other fields                                                                   
on the North  Slope other than Prudhoe Bay.  Prudhoe Bay will                                                                   
be needed.  There  will be less  oil production  if gas  were                                                                   
taken  from  Prudhoe  Bay  now  at the  rate  of  4.5  bcf/d.                                                                   
Companies are mitigating the lower  gas production by pumping                                                                   
additional  water  into the  gas  cap  to keep  pressure  up.                                                                   
Pressure   keeps  oil   production   going;  lower   pressure                                                                   
ultimately  means lower  production. The  Alaska Oil  and Gas                                                                   
Conservation Commission (AOGCC)  has been tasked with solving                                                                   
the problem.                                                                                                                    
                                                                                                                                
9:23:29 AM                                                                                                                    
                                                                                                                                
Co-Chair  Stedman  asked  if it  were  reasonable  to  expect                                                                   
Prudhoe  Bay and  other  oil fields  to  produce two  million                                                                   
barrels  per day. Commissioner  Galvin  answered that  it was                                                                   
not physically  possible to produce  that much; the  time has                                                                   
passed. The question  is whether smaller fields  will be cost                                                                   
effective.                                                                                                                      
                                                                                                                                
Senator  Thomas asked  if heavy  oil were  considered in  the                                                                   
chart. Mr. Platt answered that  there is a lot of opportunity                                                                   
at  Oooguruk, where  BP and  ConocoPhillips  are testing  new                                                                   
technologies.  The  projections   do  not  include  oil  from                                                                   
Oooguruk. West Sak is producing  about 16,000 barrels per day                                                                   
and has been  an underperformer. ConocoPhillips  is trying to                                                                   
produce  more oil  out of West  Sak, which  is a  challenging                                                                   
project.  He delayed  West Sak  heavy oil  production in  the                                                                   
forecast. He thought that out  of the 5 to 15 billion barrels                                                                   
of West Sak oil in place, only  400 million barrels have been                                                                   
recovered, leaving a lot of opportunity.                                                                                        
                                                                                                                                
9:26:12 AM                                                                                                                    
                                                                                                                                
Commissioner  Galvin  agreed  that  there  is  potential  but                                                                   
technical hurdles  have to be  overcome before  including the                                                                   
resource in the forecast.                                                                                                       
                                                                                                                                
Senator  Thomas  asked  whether   the  state  would  want  to                                                                   
encourage   the  development   of   the  needed   technology.                                                                   
Commissioner  Galvin replied that  the current tax  structure                                                                   
encourages heavy oil development.                                                                                               
                                                                                                                                
9:27:29 AM                                                                                                                    
                                                                                                                                
Ms. Nienhuis continued  with a graph on Slide  6, "Forecasted                                                                   
ANS Production, FY 2009 to 2030,"  showing oil from currently                                                                   
producing projects  and oil expected  from new  projects. She                                                                   
agreed that the  net profit tax encourages  investment, which                                                                   
increases production  several years  before the oil  comes on                                                                   
line. The slide highlights the fields coming on-line.                                                                           
                                                                                                                                
Ms. Nienhuis turned to the second  of the forecast variables,                                                                   
price.  In order  to  forecast price,  an  oil price  "Delphi                                                                   
session" is held where stakeholders  meet with experts in the                                                                   
field and  discuss variables  approximately twice  each year.                                                                   
The timeline, depicted  on slides 8 and 9, is  a process that                                                                   
takes several months.                                                                                                           
                                                                                                                                
Ms. Nienhuis  detailed  the timeline for  developing  a price                                                                   
forecast.  A Delphi  session  was held  in  October of  2008.                                                                   
Next, final FY08 revenues were  compiled and reviewed. At the                                                                   
end of  October, the  production forecast  was finalized.  On                                                                   
November 6, the fall forecast  was finalized, and on November                                                                   
10, the  cost forecast  was finalized.  Cost forecasting  was                                                                   
new  for  the  group;  it  is  done  by  reviewing  plans  of                                                                   
development,  looking  at  global   costs,  looking  at  data                                                                   
submitted   at  monthly   information   forums,  and   asking                                                                   
companies  for   their  best  guess  of   upcoming  expenses.                                                                   
Throughout the  following month, a number of  things occurred                                                                   
to finalize the  forecasts. Then a fiscal model  was created,                                                                   
which takes  the large forecasting  model and  cycles through                                                                   
the Department  of Revenue (DOR), the Treasury  division, the                                                                   
Alaska Permanent  Fund Corporation (APFC), and  the Office of                                                                   
Management and  Budget (OMB).  The fiscal model  incorporates                                                                   
revenue  forecast  variables   for  the  years  covered.  The                                                                   
various agencies work with the model and contribute input.                                                                      
                                                                                                                                
9:33:29 AM                                                                                                                    
                                                                                                                                
Co-Chair  Stedman  asked if  anything  was different  in  the                                                                   
process  this  year. Ms.  Nienhuis  replied that  there  more                                                                   
people  were invited  to  the  fall forecast  price  session,                                                                   
including   Legislative   Finance,    the   University,   the                                                                   
governor's office,  and the  Department of Natural  Resources                                                                   
(DNR). The department wanted more  people with a stake in the                                                                   
forecast.                                                                                                                       
                                                                                                                                
Co-Chair Stedman  asked who attended  from OMB.  Ms. Nienhuis                                                                   
replied that John Boucher participated.                                                                                         
                                                                                                                                
Co-Chair  Stedman  asked  why  the  department  did  not  use                                                                   
published   reports  and   outside   experts  that   forecast                                                                   
regularly.  He  wondered how  to  keep  politics out  of  the                                                                   
process.                                                                                                                        
                                                                                                                                
9:36:17 AM                                                                                                                    
                                                                                                                                
Commissioner  Galvin did  not think  the participants  listed                                                                   
would  be  considered   part  of  a  political   process.  He                                                                   
explained that the  method used has been in place  at DOR for                                                                   
ten  years and  is  based  on a  process  that  draws from  a                                                                   
variety  of views. The  collective input  provides a  broader                                                                   
perspective. The  Delphi system  has been the  primary method                                                                   
used for the forecasts.                                                                                                         
                                                                                                                                
Commissioner   Galvin   stated   that  the   department   was                                                                   
uncomfortable with  the Delphi results the previous  year, so                                                                   
they  ended up  blending  in  other input.  The  department's                                                                   
intent was to be timely. He assured  the committee that there                                                                   
was no political motivation to the process.                                                                                     
                                                                                                                                
9:38:41 AM                                                                                                                    
                                                                                                                                
Senator  Elton  agreed  that  the  issue  of  timeliness  was                                                                   
important. He  thought other oil  price forecasters  are more                                                                   
flexible and  came up  with numbers  faster. He wondered  why                                                                   
the  state  did   not  take  a  blend  of   other  well-known                                                                   
forecasts.   Commissioner    Galvin   suggested    that   the                                                                   
presentation would  clarify the question. He  stated that the                                                                   
lag  is related  to the  established  budgeting process.  The                                                                   
department  is  trying  to address  the  issue  by  providing                                                                   
interim  revenue forecasts  during  the legislative  session.                                                                   
Typically,  volatility  is  relatively  minimal,  making  two                                                                   
forecasts  adequate  for  the budgetary  process.  This  year                                                                   
volatility renders  two forecasts inadequate.  The department                                                                   
is responding by using interim  steps to augment the process.                                                                   
                                                                                                                                
9:41:30 AM                                                                                                                    
                                                                                                                                
Senator  Elton  opined that  the  state  could get  the  same                                                                   
results faster  using the  International Energy Agency  (IEA)                                                                   
[Energy  Information   Administration  (EIA)].   Commissioner                                                                   
Galvin  replied that  the  process was  not  the problem.  It                                                                   
takes time  to get a  revenue number  from a price.  Once the                                                                   
price is  settled, there  is still a  lengthy process  to get                                                                   
the  revenue forecast  number. He  believed the  department's                                                                   
process of doing an independent  analysis was appropriate and                                                                   
reasonably successful.  He did not want to be  subject to the                                                                   
biases of other forecasting mechanisms.                                                                                         
                                                                                                                                
9:45:05 AM                                                                                                                    
                                                                                                                                
Co-Chair  Stedman asked  what  the price  was  on October  7,                                                                   
2008.                                                                                                                           
                                                                                                                                
Ms. Nienhuis finished the forecasting timeline (Slide 9):                                                                       
                                                                                                                                
   · Revenue Forecast  Summary to OMB for  Budget Development                                                                   
     (11/14)                                                                                                                    
   · Prepare   Narrative   and   Tables  for   RSB   [Revenue                                                                   
     Sourcebook] (First Draft 11/18)                                                                                            
   · Internal Review,  Revisit Models, RSB to  Printer (Final                                                                   
     Draft 12/8)                                                                                                                
   · Fall 2008 Forecast Released (12/9)                                                                                         
   · Governor's Budget Released (12/15)                                                                                         
   · Updated Revenue  Forecast & Budget Released  for FY 2009                                                                   
     (2/2)                                                                                                                      
                                                                                                                                
Ms.  Nienhuis turned  to Slide  10 and  explained the  Delphi                                                                   
session in more detail:                                                                                                         
                                                                                                                                
   · Modified "Delphi" technique                                                                                                
   · Oct 7, 2008: Prices averaging $92.85                                                                                       
   · Expanded  Invitee  List:  50 Invitees,  29  participants                                                                   
     from DOR, DNR, DOL, OMB, University, Legislative                                                                           
     Finance, Legislature, outside participants                                                                                 
   · Presentations:    Fundamentals   (supply    &   demand),                                                                   
     geopolitics, financial markets, analyst expectations,                                                                      
     etc.                                                                                                                       
   · 28 forecasts  received; Delphi forecast is  the "median"                                                                   
     forecast of the participants                                                                                               
                                                                                                                                
Ms. Nienhuis pointed out that  adding one more forecast would                                                                   
have  little impact  on the  whole. She  emphasized that  the                                                                   
Delphi technique had been used frequently in the past.                                                                          
                                                                                                                                
9:49:00 AM                                                                                                                    
                                                                                                                                
Co-Chair Stedman  asked for the numerics for  November 12 and                                                                   
14. Ms.  Nienhuis said  the Bloomberg  price for November  13                                                                   
was $58.24.  She pointed  out that the  price was  settled on                                                                   
November 6 as $60.77.                                                                                                           
                                                                                                                                
9:51:11 AM                                                                                                                    
                                                                                                                                
Senator Thomas asked  what the price was when  the governor's                                                                   
budget was  released on December  15. Co-Chair  Stedman asked                                                                   
for prices for  various points on the timeline.  Ms. Nienhuis                                                                   
provided the numbers:                                                                                                           
                                                                                                                                
    · November 14: $57.04                                                                                                       
    · December 9: $42.07                                                                                                        
    · December 15: $44.51                                                                                                       
    · February 2: $40.08                                                                                                        
                                                                                                                                
9:52:42 AM                                                                                                                    
                                                                                                                                
Ms.  Nienhuis  explained  that  significant  time  was  spent                                                                   
looking at  other forecasts towards  the end of  the process,                                                                   
including  forecasts  from  the  EIA, IEA,  and  the  analyst                                                                   
average available  through Bloomberg.  Slide 11  demonstrates                                                                   
the price  forecasts available  for the  period of  July 2008                                                                   
through June 2010.  Through the entire period,  Goldman Sachs                                                                   
was  around $110  to  $125; the  EIA  was higher  than  that;                                                                   
Merrill Lynch  saw the price  going down;   and the  New York                                                                   
Mercantile Exchange  (NYMEX), which is updated  daily, showed                                                                   
prices  coming   down  and  leveling  off  and   then  slowly                                                                   
climbing.                                                                                                                       
                                                                                                                                
Ms. Nienhuis turned  to Slide 12, "Oil Price  Volatility: 80%                                                                   
decline  in 5  months:  Historical ANS  and  WTI [West  Texas                                                                   
Intermediate] Crude Prices, May  1986 through December 2008."                                                                   
She pointed  out that by  the time of  the fall  2008 Revenue                                                                   
Sources  Book update,  the price  had  not come  down to  the                                                                   
range  it went to  in December  and January.  There was  huge                                                                   
decline in just five months.                                                                                                    
                                                                                                                                
9:55:20 AM                                                                                                                    
                                                                                                                                
Ms. Nienhuis described  Slide 13, "Oil Price  Volatility: Two                                                                   
of  the  Most  Volatile  Years   in  History."  The  economic                                                                   
research group  looked at  about thirty  years of prices  and                                                                   
did a measure  of volatility. The analysis  demonstrated that                                                                   
1991 and  2008 were the most  volatile years. In  1991, there                                                                   
was  a huge  price  drop  with the  first  Gulf  war, then  a                                                                   
leveling  out.  In 2008  there  was  not  the same  level  of                                                                   
volatility, but the year started out relatively calm.                                                                           
                                                                                                                                
Ms.  Nienhuis turned  to  Slide 14,  "Price  Forecasts as  of                                                                   
11/6/2008," the  date the price  forecast was  finalized. The                                                                   
graph  shows how  the  EIA,  NYMEX, Analyst  Median,  Goldman                                                                   
Sachs, Merrill Lynch, and DOR compare in their forecasts.                                                                       
                                                                                                                                
9:58:34 AM                                                                                                                    
                                                                                                                                
Commissioner Galvin  pointed out that the graph  reflects the                                                                   
available forecasts on November  6, the expectations of those                                                                   
following the market. The department  was significantly lower                                                                   
than other  forecasts on  that day.  The revenue forecast  in                                                                   
comparison was higher than DOR's estimate.                                                                                      
                                                                                                                                
Ms. Nienhuis discussed  Slide 15, which shows  DOR's forecast                                                                   
as  a blend.  One forecast  incorporated was  a low  scenario                                                                   
prepared  in fall  2007. Slide  16 depicts  what DOR  started                                                                   
with and  ended up with.  The Delphi median was  consistently                                                                   
in the $90  per barrel range  in the last three  quarters and                                                                   
projected  into 2010 in  the same  range. The department  was                                                                   
uncomfortable with  the number as it did not  seem realistic.                                                                   
The official  fall 2008 forecast  was obtained by  adding the                                                                   
NYMEX, EIA, and  the DOR fall 2007 low scenario  forecasts to                                                                   
the Delphi meridian.                                                                                                            
                                                                                                                                
10:03:37 AM                                                                                                                   
                                                                                                                                
Ms.  Nienhuis explained  that Slide  17, "Fall  2008 DOR  Oil                                                                   
Price Forecast,"  shows the ANS forecast in  nominal and real                                                                   
dollars.  She revisited  the idea that  forecasting often  is                                                                   
advantageous, illustrated  by Slide 18, which  shows that the                                                                   
analysts' forecasts follow price.  When the forecast was made                                                                   
influenced how  much the forecast  was. Slide 19  depicts the                                                                   
DOR fall 2008 forecast  in the low $60 range.  Slide 20 shows                                                                   
recent forecasts, with DOR right in the middle.                                                                                 
                                                                                                                                
10:05:37 AM                                                                                                                   
                                                                                                                                
Ms. Nienhuis described  Slide 21, "Updated FY  2009 Oil Price                                                                   
Forecast." The  forecast was assembled  January 20,  based on                                                                   
MYMEX prices.  The average  includes the  high prices  of the                                                                   
first quarter. The FY09 average for ANS is $63.28.                                                                              
                                                                                                                                
Ms.  Nienhuis  moved from  the  price  forecast to  the  cost                                                                   
forecast for  oil and  gas revenue, which  is new  since PPT.                                                                   
There was  not a lot of data  to base the price  forecast on.                                                                   
She  described   the  transition  investment   credit,  which                                                                   
provided for companies  taking a certain percentage  of their                                                                   
costs leading up to the PPT as a credit.                                                                                        
                                                                                                                                
Ms. Nienhuis admitted  the department was still  learning how                                                                   
to forecast costs.                                                                                                              
                                                                                                                                
10:07:52 AM                                                                                                                   
                                                                                                                                
Ms.  Nienhuis  discussed  Slide  23, which  shows  the  lease                                                                   
expenditures  as  projected in  the  fall forecast.  She  has                                                                   
asked for adjusted  expenditure forecasts from  the companies                                                                   
investing on the  North Slope; those will be  incorporated in                                                                   
future.  Companies  are  cutting  back  because  of  low  oil                                                                   
prices. Operating  expenditures are relatively  flat; capital                                                                   
expenditures  bend as costs  are expected  to be high.  There                                                                   
appears to be a one to two year  lag, so capital expenditures                                                                   
may come down. She emphasized  that capital expenditures lead                                                                   
up  to  production  and  are not  necessarily  in  line  with                                                                   
production. The figure includes future production.                                                                              
                                                                                                                                
Ms.  Nienhuis   turned   to  Slide  24   showing  the   lease                                                                   
expenditures  per barrel, separated  by operating  (OPEX) and                                                                   
capital expenditures  (CAPEX). Capital spent per  barrel is a                                                                   
future projection.                                                                                                              
                                                                                                                                
Co-Chair Stedman asked about a  50 percent delay in CAPEX. He                                                                   
wanted  the  date  the  CAPEX  numbers  were  solidified  and                                                                   
elaboration  on how  the  changing market  conditions  affect                                                                   
them.                                                                                                                           
                                                                                                                                
10:10:43 AM                                                                                                                   
                                                                                                                                
Commissioner Galvin explained  that the figures are forecasts                                                                   
for  actual  costs.  When  the figures  are  built  into  the                                                                   
revenue  forecast, the  issue  of allowable  capital  credits                                                                   
arises.  Fifty percent  of capital credits  are allowable  in                                                                   
the year  they accrue and fifty  percent have to lag  a year.                                                                   
The  numbers on  Slide  24 do  not reflect  the  lag but  are                                                                   
projections  for  the  actual expenditures.  He  referred  to                                                                   
Slide 8, the  schedule for developing the fall  forecast. The                                                                   
numbers reflect information available  at the time. Companies                                                                   
have indicated  expectations of  reduced spending,  but there                                                                   
are not  formal numbers. Various  tools are used  to estimate                                                                   
expenditure levels.  The interim  forecast looks at  price as                                                                   
the  primary variable  for updating  the  numbers. The  other                                                                   
variables will not change significantly.                                                                                        
                                                                                                                                
Co-Chair  Stedman expressed  concern regarding  the delay  of                                                                   
$1.2 billion in FY10. He asked  how the flow of the net would                                                                   
be   affected.   Commissioner   Galvin  answered   that   the                                                                   
structural  lag in  the  application of  the  credits to  the                                                                   
revenue  stream  is already  incorporated  into  the  revenue                                                                   
forecast.                                                                                                                       
                                                                                                                                
Co-Chair Stedman  talked about  effects of the  price falling                                                                   
rapidly.                                                                                                                        
                                                                                                                                
10:14:34 AM                                                                                                                   
                                                                                                                                
Commissioner   Galvin   stated   that  the   revenue   number                                                                   
incorporates  the structural  lag in  the application  of the                                                                   
credit to  the revenue  forecast. The  bottom line  number is                                                                   
buffered   from  changes   in  expenditure   levels  in   any                                                                   
particular  year. The  margin of difference  between  what is                                                                   
forecasted and what  is experienced could be  half the amount                                                                   
in any particular year. The justification  for making the lag                                                                   
part  of the  process is  to assist  in  the rolling  revenue                                                                   
forecast process.                                                                                                               
                                                                                                                                
Co-Chair  Stedman  thought the  fifty  percent  lag was  good                                                                   
policy.                                                                                                                         
                                                                                                                                
10:16:21 AM                                                                                                                   
                                                                                                                                
Ms. Nienhuis continued with Slide  25, the capital portion of                                                                   
Slide 24, showing the history  for capital lease expenditures                                                                   
and  illustrating that  investment credits  help. High  price                                                                   
may help  as well.  Companies are  reporting projected  costs                                                                   
that are probably conservative. The costs could come down.                                                                      
                                                                                                                                
Ms. Nienhuis  turned to Slide  26, FY09 total  revenue. There                                                                   
was a  $1.2 billion difference  from the fall  forecast. Most                                                                   
of  the amount  is  attributable to  price.  The slide  shows                                                                   
unrestricted  revenue, or that  which is available  generally                                                                   
for legislative  appropriation,  and restricted revenue.  The                                                                   
revenue is  restricted from  DOR's point  of view.  Slide 27,                                                                   
"Restricted vs. Unrestricted Revenues":                                                                                         
                                                                                                                                
   · All revenue is classified as either "Restricted" or                                                                        
     "Unrestricted."                                                                                                            
   · All amounts in the presentation are Unrestricted                                                                           
     Revenue only.                                                                                                              
   · Restricted = Use of this revenue is restricted by                                                                          
     constitution,  state  or  federal  law,  trust  or  debt                                                                   
     restrictions,  or  customary  practice. This  means  the                                                                   
     legislation  normally appropriates  money  back to  fund                                                                   
     programs.                                                                                                                  
   · Unrestricted    =   Revenue   available    for   general                                                                   
     appropriation. This is the amount typically discussed                                                                      
     in budget context.                                                                                                         
                                                                                                                                
10:19:47 AM                                                                                                                   
                                                                                                                                
Co-Chair  Stedman returned  to  Slide 26  and  asked why  the                                                                   
investment earnings  number is so large.  Commissioner Galvin                                                                   
explained  the number  represented unrealized  losses to  the                                                                   
value of  the permanent  fund and  the constitutional  budget                                                                   
reserve (CBR).                                                                                                                  
                                                                                                                                
Co-Chair Hoffman  asked the actual  unrealized losses  at the                                                                   
end of December.                                                                                                                
                                                                                                                                
JERRY  BURNETT, DEPUTY  COMMISSIONER,  DIVISION OF  TREASURY,                                                                   
DEPARTMENT  OF  REVENUE,  answered  that  he  could  get  the                                                                   
information.                                                                                                                    
                                                                                                                                
Co-Chair   Hoffman  asked  if   the  department   anticipated                                                                   
positive or  negative earnings for  the last six  months. Mr.                                                                   
Burnett  responded  that  there   was  no  reason  to  expect                                                                   
negative earnings for the next  six months. However, negative                                                                   
earnings were not expected for  the year. Commissioner Galvin                                                                   
offered to provide a breakdown of the numbers.                                                                                  
                                                                                                                                
Co-Chair Stedman asked for the  December 31, 2008 and January                                                                   
31,  2009  balances  of realized  and  unrealized  gains  and                                                                   
losses on the  permanent fund and the CBR balances  with sub-                                                                   
account breakdowns.                                                                                                             
                                                                                                                                
10:23:03 AM                                                                                                                   
                                                                                                                                
Commissioner Galvin clarified  that the question was based on                                                                   
the FY09  forecast of the investment  loss, and how  much was                                                                   
based on actuals compared to projections.                                                                                       
                                                                                                                                
Co-Chair Stedman added and that  the committee wanted figures                                                                   
as they were compiled in order to make policy decisions.                                                                        
                                                                                                                                
Ms.  Nienhuis  covered  Slide 28,  "Sources  of  Unrestricted                                                                   
Revenue":                                                                                                                       
                                                                                                                                
   · Oil - Property tax, Corporate Income Tax, Production                                                                       
     Tax (ACES), Royalties. Oil will make up 87% of                                                                             
     unrestricted revenue in FY09                                                                                               
   · Investment Earnings on General Fund                                                                                        
   · Other Non-Oil-Taxes, Charges for Services, Fines and                                                                       
     Forfeitures, Licenses and Permits, Rents and Royalties,                                                                    
     Miscellaneous                                                                                                              
                                                                                                                                
                                                            rd                                                                  
Ms. Nienhuis expanded  on the effects of HB 11  [from the 23                                                                    
Legislature], the  bill that changed the amount  of royalties                                                                   
deposited to the permanent fund  to 25 percent for all leases                                                                   
until  it had  a $20  or more  impact on  the permanent  fund                                                                   
dividend, at  which time it would  be repealed. Based  on the                                                                   
dividend  calculation, HB  11 was repealed  in October  2008.                                                                   
The royalties  are back on  the old formula of  approximately                                                                   
32  percent.  The  change  is  reflected  in  a  decrease  in                                                                   
unrestricted   revenue  and  a   corresponding  increase   in                                                                   
restricted revenue.                                                                                                             
                                                                                                                                
10:26:40 AM                                                                                                                   
                                                                                                                                
Ms. Nienhuis continued with Slide  29, "FY09 Revenue Overview                                                                   
(General  Fund  Unrestricted  Revenue)."  Production  tax  is                                                                   
close to  50 percent of  the total revenue expected.  Non-oil                                                                   
revenue makes up about 13 percent.  Overall, about 87 percent                                                                   
of unrestricted revenue comes from oil.                                                                                         
                                                                                                                                
Ms.  Nienhuis  explained  Slide  30,  "FY09  Non-Oil  Revenue                                                                   
Detail."  The largest  part is  related  to corporate  income                                                                   
tax. Investments  are a significant part of  non-oil revenue.                                                                   
Typically non-oil  revenue has been from 10 to  12 percent of                                                                   
annual unrestricted revenue.                                                                                                    
                                                                                                                                
Ms.  Nienhuis  turned to  Slide  31, "FY09  Revenue  Forecast                                                                   
Comparison," which  compares the fall 2008 forecast  with the                                                                   
January 2009  update. The biggest  hit was to  the production                                                                   
tax  at about  a  25  percent  reduction. Overall  the  total                                                                   
revenue experienced an 18.2 percent  difference. Price is the                                                                   
primary driver;  production went down slightly,  and cost and                                                                   
investment remained the same.                                                                                                   
                                                                                                                                
10:29:21 AM                                                                                                                   
                                                                                                                                
Ms. Nienhuis listed conclusions on Slide 32:                                                                                    
                                                                                                                                
   · Record level oil price volatility                                                                                          
   · Price forecast in "ballpark" when issued                                                                                   
        o Reduced for interim forecast                                                                                          
   · Minimum production level changes from previous forecast                                                                    
   · Lower prices likely to impact future costs and possibly                                                                    
     investment                                                                                                                 
                                                                                                                                
Ms.  Nienhuis  added  that  Slide 33  shows  more  detail  on                                                                   
historical production  and price changes as of  fall 2008 and                                                                   
a  change  in  revenue  forecasting   from  "cash  basis"  to                                                                   
"accrual basis" accounting:                                                                                                     
                                                                                                                                
   · Timing issue: Production, prices, and revenue received                                                                     
     in July for June production changed from June to July                                                                      
   · Necessary due to significant monthly variation in oil                                                                      
     revenues                                                                                                                   
   · Shift in fiscal year affected historical production and                                                                    
     price, not revenue                                                                                                         
   · Greater accuracy in reporting                                                                                              
   · Alignment with state financial documents                                                                                   
                                                                                                                                
Ms. Nienhuis detailed  the change in accounting  systems made                                                                   
in order to be in alignment with other agencies.                                                                                
                                                                                                                                
10:34:12 AM                                                                                                                   
                                                                                                                                
Ms. Nienhuis said  that overall the change is  good, although                                                                   
the numbers look different. The  change is driven by the fact                                                                   
that progressivity  in the current  tax system  drives prices                                                                   
up  significantly. Price  volatility  results in  significant                                                                   
revenue volatility.                                                                                                             
                                                                                                                                
Co-Chair Stedman asked why the  change was made this year. He                                                                   
asked  if the  Revenue Sources  Book notified  people of  the                                                                   
change.  Commissioner  Galvin  answered  that he  decided  to                                                                   
change  the system  because of  disparities  between the  DOR                                                                   
report and the Comprehensive Annual  Financial Report (CAFR).                                                                   
Revenue  for June of  2008 was  significantly different  than                                                                   
June 2007  revenue and  caused a  disparity between  the CAFR                                                                   
and DOR's  report. The structure  of the 2008  budget created                                                                   
disparity between the flow of  funds and the CAFR. He decided                                                                   
to  make  the   change  as  historical  numbers   have  never                                                                   
completely added up in the past.                                                                                                
                                                                                                                                
Ms.  Nienhuis  added that  the  Revenue  Sources Book  has  a                                                                   
footnote  clarifying the  change.  Commissioner Galvin  added                                                                   
that the  note was  footnote number  1 on  page 116  (Revenue                                                                   
Sources Book, Fall  2008). He thought it might  be beneficial                                                                   
to  continue  to  publish  the  footnote  in  future  Revenue                                                                   
Sources Books.                                                                                                                  
                                                                                                                                
10:40:17 AM                                                                                                                   
                                                                                                                                
Senator Thomas queried  whether the motor fuel  tax listed on                                                                   
Slide 30  was still in existence.  Mr. Burnett  answered that                                                                   
the  motor fuel  tax was  not  suspended until  later in  the                                                                   
fiscal year, so there is a partial year reflected.                                                                              
                                                                                                                                
Co-Chair  Stedman asked  what date  the FY10  price could  be                                                                   
expected.  Commissioner  Galvin   thought  the  FY10  interim                                                                   
revenue  forecast would  be released  February  18 and  would                                                                   
include a new price forecast.                                                                                                   
                                                                                                                                
Senator Huggins  queried why the administration  had used the                                                                   
price of  $71 for oil  when the 2010  budget was based  on an                                                                   
oil price of approximately $74.  Commissioner Galvin answered                                                                   
that the  governor's 2010  budget had  numbers less  than the                                                                   
revenue forecast,  which was based on the $74  price. The $71                                                                   
was an  approximation of  the average  price used to  balance                                                                   
the governor's budget.                                                                                                          
                                                                                                                                
10:44:22 AM                                                                                                                   
                                                                                                                                
Senator  Huggins asked  if there  would be  a Permanent  Fund                                                                   
Dividend. Commissioner Galvin  stated that APFD is safe as it                                                                   
is based on a five year rolling number.                                                                                         
                                                                                                                                
10:45:20 AM                                                                                                                   
                                                                                                                                
Co-Chair Stedman  asked for explanation  of how  $200 million                                                                   
in  oil and  gas  taxes is  embedded  within  the budget  and                                                                   
whether it was an offset to revenue.                                                                                            
                                                                                                                                
Commissioner Galvin answered that  the bulk of the credits in                                                                   
the  tax  credit  program  are   factored  into  the  revenue                                                                   
projection.   The   credits   accrued   by   companies   with                                                                   
insufficient production  will be  reflected in the  budget as                                                                   
expenditures.  The  next  question   is  the  timing  of  the                                                                   
payment. The department  shows projections in  terms of costs                                                                   
in the year in  which they are accrued, but  when they filter                                                                   
into the  budget the  question  is when the  payment will  be                                                                   
made.  The department  thought  the system  would be  faster,                                                                   
that  the companies  would submit  credits  earlier and  that                                                                   
audit cost  reports would  be quicker. More  will need  to be                                                                   
paid out in FY09 than anticipated.  The lag time is reflected                                                                   
in the budget.                                                                                                                  
                                                                                                                                
10:49:18 AM                                                                                                                   
                                                                                                                                
Co-Chair  Hoffman   asked  if   the  expenditures   would  be                                                                   
considered  cash. He  thought the expense  should be  accrued                                                                   
and paid at a later time.                                                                                                       
                                                                                                                                
Senator  Elton  asked  what  creates  the  lag  time  between                                                                   
applications for  and payment of the credits.  He wondered if                                                                   
the  lag was  related to  a shortage  of  audit resources  or                                                                   
something   else   the   legislature   needs   to   consider.                                                                   
Commissioner Galvin  answered that the problem is  not a lack                                                                   
of resources but  the extra time required to adjust  to a new                                                                   
system.                                                                                                                         
                                                                                                                                
10:52:32 AM                                                                                                                   
                                                                                                                                
Co-Chair  Stedman  returned  to  the  issue  of  cash  versus                                                                   
accrual  accounting  and asked  for  a  timeline of  how  the                                                                   
credits should be paid. He stated  concerns about a shortfall                                                                   
for  the  2010  budget.  Commissioner   Galvin  promised  the                                                                   
information. If the process is  established, the need will be                                                                   
spread over several years. Co-Chair  Stedman stated concerns.                                                                   
Commissioner   Galvin   assured   the  committee   that   the                                                                   
department shared the concerns.                                                                                                 
                                                                                                                                
Co-Chair Hoffman  asked how DOR  was going to respond  to the                                                                   
governor's position on unallocated reductions.                                                                                  
                                                                                                                                
Co-Chair Stedman added concerns about the $390,000.                                                                             
                                                                                                                                
10:56:57 AM                                                                                                                   
                                                                                                                                
Commissioner Galvin  explained that the department  responded                                                                   
to the  governor's $390,000 cut  from the FYO9 budget  by not                                                                   
filling  vacant   positions.  Co-Chair  Stedman   noted  that                                                                   
because of the  timing, the action was not a  response to the                                                                   
collapse of the price of oil.  Mr. Burnett explained that the                                                                   
particular  cut  was decided  when  the governor  signed  the                                                                   
budget. The  department took  action and restricted  $390,000                                                                   
in spending.                                                                                                                    
                                                                                                                                
Co-Chair  Hoffman  emphasized  that  giving  departments  the                                                                   
ability to cut  services does not reflect policy  made by the                                                                   
legislature. He stated that he  would not allocate the amount                                                                   
to  the  department  on  that   basis  and  wondered  if  the                                                                   
department would  reduce the budget in areas  the legislature                                                                   
would not want.                                                                                                                 
                                                                                                                                
11:00:26 AM                                                                                                                   
                                                                                                                                
Commissioner  Galvin  recognized  the legislature's  role  of                                                                   
setting   priorities  and   establishing  authorization   for                                                                   
expenditures.  He  believed  the   governor  should  exercise                                                                   
discretion as well. He saw this  as part of the give-and-take                                                                   
between the two branches of government.                                                                                         
                                                                                                                                
Co-Chair  Stedman  asked  the  dollar  amount  of  the  DOR's                                                                   
reduction.  Mr. Burnett answered  $390,000. Co-Chair  Stedman                                                                   
pointed  out  that  $390,000  was  the  same  number  in  the                                                                   
supplemental.   He   confirmed   that   the  cut   had   been                                                                   
implemented.                                                                                                                    
                                                                                                                                
Co-Chair  Hoffman  did  not support  what  had  happened.  He                                                                   
stated that  if the governor  vetoes portions of  the budget,                                                                   
the  legislature  can  override  the  cuts.  He  thought  the                                                                   
governor was obligated  to provide the services  put in place                                                                   
by  the legislature;  he wondered  if  the department  agreed                                                                   
with that process.                                                                                                              
                                                                                                                                
Commissioner  Galvin  stated   that  he  was  not  trying  to                                                                   
establish the  administration's policy on the  matter. He did                                                                   
not  think  that  the  budget  set  policy  on  services.  He                                                                   
recognized  both  legislative  prerogative to  establish  the                                                                   
priorities  of the state  and executive  prerogative  to take                                                                   
action on the priorities.                                                                                                       
                                                                                                                                
11:04:38 AM                                                                                                                   
                                                                                                                                
Senator  Elton  thought  the  issue  [of  the  separation  of                                                                   
powers]  was important.  He  asked  if the  $390,000  savings                                                                   
implemented  within  the  department were  presented  to  the                                                                   
committee. Mr.  Burnett replied  that the department  had not                                                                   
yet  met with  sub-committee chairs  in either  the House  or                                                                   
Senate.                                                                                                                         
                                                                                                                                
Senator  Elton asked  if there  had been any  attempt in  the                                                                   
months since  the department made  the budget changes  to let                                                                   
the  relevant committees  know  that the  department was  not                                                                   
implementing the budget passed by the legislature.                                                                              
                                                                                                                                
Co-Chair  Stedman  added  that  he wondered  if  attempts  of                                                                   
notification  had   been  made  in  particular   to  the  two                                                                   
operating [budget] co-chairs.                                                                                                   
                                                                                                                                
Commissioner  Galvin surmised  that  the underlying  question                                                                   
was  whether   the  department  was  cutting   actual  public                                                                   
services. He  stated that  to the best  of his knowledge  the                                                                   
level  of service  has  not  been changed.  Individuals  were                                                                   
asked  to pick  up  more responsibilities  because  positions                                                                   
would not  be filled.  He stated that  DOR chose  to exercise                                                                   
the  governor's request  through  reducing personnel  service                                                                   
costs, and  that meant  to him that  they were stressing  the                                                                   
system a little.                                                                                                                
                                                                                                                                
Senator Elton  did not  think the  answer was sufficient  and                                                                   
wanted more information  from the department.  He wondered if                                                                   
the department  made a $390,000  mistake when  discussing the                                                                   
budget  with the  legislature  the previous  year. There  may                                                                   
have been million dollar mistakes  made in other departments,                                                                   
according to unallocated  cuts made in those  departments. He                                                                   
was not satisfied with answers given.                                                                                           
                                                                                                                                
11:07:18 AM                                                                                                                   
                                                                                                                                
Commissioner  Galvin  said  he   could  only  speak  for  the                                                                   
Department of Revenue.                                                                                                          
                                                                                                                                
Senator Huggins  asked how  many auditors  DOR was  short and                                                                   
how   the  hiring   freeze  would   affect  the   department.                                                                   
Commissioner  Galvin  stated that  auditors  were  a key  DOR                                                                   
component; the  department has been successful  in hiring the                                                                   
master auditors  discussed during  ACES. He  did not  know if                                                                   
there were  current auditor  openings. The governor's  hiring                                                                   
freeze allows  for exceptions if  a department can  justify a                                                                   
position as essential.  He stated that if a  critical auditor                                                                   
position needed to  be filled, the department  would pursue a                                                                   
waiver.                                                                                                                         
                                                                                                                                
Senator  Huggins  asked  if  there  were  any  new  personnel                                                                   
positions in the current budget  request. Mr. Burnett did not                                                                   
believe DOR had new positions in the operating budget.                                                                          
                                                                                                                                
11:09:35 AM                                                                                                                   
                                                                                                                                
Co-Chair  Stedman stated  that  the committee  has  questions                                                                   
about  the  viability  of  using the  $200  million  oil  tax                                                                   
credit. The  committee also has  interest in the  $50 million                                                                   
put  in as  a  placeholder  in  the supplemental  budget.  In                                                                   
addition, he  had questions  about unallocated expenses  that                                                                   
have  already  taken  place,  such as  in  DOR.  Finally,  he                                                                   
wondered about  new spending of $38.3 million.  The committee                                                                   
needed  to  know  about  new general  fund  spending  if  the                                                                   
unallocated reductions have already been made.                                                                                  
                                                                                                                                
Commissioner  Galvin clarified that  the unallocated  cut was                                                                   
built into the DOR budget as directed  by the governor, which                                                                   
meant  it would be  achieved over  the course  of the  fiscal                                                                   
year.                                                                                                                           
                                                                                                                                
Co-Chair  Stedman  stated  that   the  committee  would  sort                                                                   
details out  with OMB  and determine  a response for  revenue                                                                   
differences in the FY09 budget.                                                                                                 
                                                                                                                                
11:14:04 AM                                                                                                                   
                                                                                                                                
ADJOURNMENT                                                                                                                   
                                                                                                                                
The meeting was adjourned at 11:13 AM.                                                                                          

Document Name Date/Time Subjects
Galvin Revenue Forecast 020509.pptx SFIN 2/4/2009 9:00:00 AM
SFIN 2/5/2009 9:00:00 AM
DOR Investment Revenue Proj SenFinance 20090219.pdf SFIN 2/5/2009 9:00:00 AM