Legislature(2013 - 2014)SENATE FINANCE 532

01/24/2013 09:00 AM Senate FINANCE


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09:03:52 AM Start
09:04:09 AM Department of Revenue - State Savings Accounts Update.
10:36:31 AM Adjourn
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+ Department of Revenue - State's Savings TELECONFERENCED
Accounts Update
Overview of Fall 2012 Revenue Forecast
                 SENATE FINANCE COMMITTEE                                                                                       
                     January 24, 2013                                                                                           
                         9:03 a.m.                                                                                              
                                                                                                                                
                                                                                                                                
9:03:52 AM                                                                                                                    
                                                                                                                                
CALL TO ORDER                                                                                                                 
                                                                                                                                
Co-Chair Kelly called the Senate Finance Committee meeting                                                                      
to order at 9:03 a.m.                                                                                                           
                                                                                                                                
MEMBERS PRESENT                                                                                                               
                                                                                                                                
Senator Pete Kelly, Co-Chair                                                                                                    
Senator Kevin Meyer, Co-Chair                                                                                                   
Senator Anna Fairclough, Vice-Chair                                                                                             
Senator Click Bishop                                                                                                            
Senator Mike Dunleavy                                                                                                           
Senator Lyman Hoffman                                                                                                           
Senator Donny Olson                                                                                                             
                                                                                                                                
MEMBERS ABSENT                                                                                                                
                                                                                                                                
None                                                                                                                            
                                                                                                                                
ALSO PRESENT                                                                                                                  
                                                                                                                                
Bryan  Butcher, Commissioner,  Department Of  Revenue; Bruce                                                                    
Tangeman, Deputy  Commissioner, Tax Division,  Department of                                                                    
Revenue; William Barron, Director,  Division of Oil and Gas,                                                                    
Department  of  Natural  Resources;  Angela  Rodell,  Deputy                                                                    
Commissioner, Treasury Division, Department of Revenue;                                                                         
                                                                                                                                
PRESENT VIA TELECONFERENCE                                                                                                    
                                                                                                                                
SUMMARY                                                                                                                       
                                                                                                                                
DEPARTMENT OF REVENUE - STATE'S SAVINGS ACCOUNTS UPDATE:                                                                      
OVERVIEW OF FALL 2012 REVENUE FORECAST                                                                                        
                                                                                                                                
                                                                                                                                
^DEPARTMENT OF REVENUE - STATE SAVINGS ACCOUNTS UPDATE.                                                                       
     OVERVIEW OF FALL 2012 REVENUE FORECAST                                                                                   
                                                                                                                                
9:04:09 AM                                                                                                                    
                                                                                                                                
BRYAN   BUTCHER,   COMMISSIONER,  DEPARTMENT   OF   REVENUE,                                                                    
presented  the  PowerPoint  presentation "Overview  of  Fall                                                                    
2012 Revenue and Price Forecast" (copy on file).                                                                                
                                                                                                                                
Commissioner Butcher turned to slide 2 "Outline.":                                                                              
                                                                                                                                
   · Fall 2012 Revenue Forecast                                                                                               
        o Ten-year overview                                                                                                     
        o Comparison to Spring 2012 Forecast                                                                                    
        o Total Revenue                                                                                                         
        o Unrestricted Revenue                                                                                                  
        o Oil          and          Non-Oil          Revenue                                                                    
                                                                                                                                
   · Components of Production Tax Forecast                                                                                    
        o Oil Production                                                                                                        
        o Oil Price                                                                                                             
                                                                                                                                
Commissioner Butcher discussed  slide 4, "Price, Production,                                                                    
State General  Fund Unrestricted  Revenues FY 2012  - 2022."                                                                    
The blue  row showed the  projected price forecast  over the                                                                    
next  10 years;  the expectation  was that  the price  would                                                                    
hover around $108 to $112  bbl., increasing gradually as the                                                                    
years  progressed.   The  yellow  row  was   the  production                                                                    
forecast  and reflected  that production  would continue  to                                                                    
decline  as it  had  over  the past  several  decades. As  a                                                                    
result  of   the  decline  the  general   fund  unrestricted                                                                    
revenues were projected to drop as well.                                                                                        
                                                                                                                                
Commissioner  Butcher discussed  slide 5,  "Comparison: Fall                                                                    
2012  forecast with  Spring 2012  forecast." He  highlighted                                                                    
that  the price  of oil  was down  approximately $1.77  from                                                                    
what had  been forecasted in  the spring and  production was                                                                    
down  about  10,000  barrels. The  primary  reason  for  the                                                                    
reduction was  because at the  beginning of the  fiscal year                                                                    
the  production had  been at  a  lower level  than had  been                                                                    
anticipated  when the  data had  been  collected. He  shared                                                                    
several  factors  that  had   contributed  to  the  decline:                                                                    
spending on the  North Slope was higher  than anticipated in                                                                    
spring which  had resulted  in less  revenue coming  in from                                                                    
production  taxes,  corporate  taxes   were  down,  and  the                                                                    
investment   income   was    several   million   less   than                                                                    
anticipated.  He  stated  that  the  fall  forecast  used  a                                                                    
slightly  higher  oil price  and  29,000  barrels less  were                                                                    
expected  in  FY  14  than   had  been  anticipated.  Higher                                                                    
spending  was being  forecast on  the North  Slope than  the                                                                    
department  had   anticipated,  which  had  resulted   in  a                                                                    
forecast  of  $678 million  less  than  had been  presented.                                                                    
Combining FY 13  and FY 14 resulted in $1.6  billion less in                                                                    
the most  recent forecast than  had been anticipated  in the                                                                    
spring.                                                                                                                         
                                                                                                                                
9:10:00 AM                                                                                                                    
                                                                                                                                
Commissioner Butcher stated that  an updated spring forecast                                                                    
would  come  out   in  April  and  would   include  new  and                                                                    
unanticipated factors.                                                                                                          
                                                                                                                                
Senator Hoffman asked about FY  14 and the justification for                                                                    
the reduction of the 29,000 barrels.                                                                                            
                                                                                                                                
Commissioner Butcher  responded that  he could not  get into                                                                    
the  specifics of  companies  projects.  In general  project                                                                    
delays  and   reduced  performance  expectations   had  been                                                                    
observed by the department.                                                                                                     
                                                                                                                                
9:11:11 AM                                                                                                                    
                                                                                                                                
Commissioner  Butcher  discussed  Slide  6,  "Total  Revenue                                                                    
Forecast: FY  12, 13  & 14  (million$)," Which  compared the                                                                    
actuals for FY 12 to the forecasts  for FY 13 and FY 14.  He                                                                    
stated that  the forecasted dip in  the unrestricted general                                                                    
fund reflected  the department's attempt to  be conservative                                                                    
about  what the  state's investment  revenue would  bring in                                                                    
considering  the  continued  low  interest  rates.  Notably,                                                                    
investment revenue under  other restricted revenue reflected                                                                    
actuals of  $109 million; the forecast  for FY 13 and  FY 14                                                                    
were up  over $3 billion  thanks to the permanent  fund. The                                                                    
permanent fund had a flat year  in FY 12 but was expected to                                                                    
increase.                                                                                                                       
                                                                                                                                
9:13:07 AM                                                                                                                    
                                                                                                                                
Commissioner  Butcher  discussed   slide  7,  "General  Fund                                                                    
Unrestricted Revenue."  He stated  that the majority  of the                                                                    
revenue  was from  the  production  tax. Approximately  $1.5                                                                    
million  could be  attributed to  the corporate  income tax,                                                                    
with property tax averaging $100 million.                                                                                       
                                                                                                                                
Commissioner Butcher  discussed slide 8,  "Unrestricted Non-                                                                    
Oil  Revenue." He  said that  the total  was just  over $600                                                                    
million. He  noted that 90  percent of the state  budget was                                                                    
paid for by oil revenues.                                                                                                       
                                                                                                                                
Commissioner Butcher turned to  slide 9, "Production History                                                                    
and Forecast."  The slide provided the  breakdown of Prudhoe                                                                    
Bay and the Prudhoe  satellite fields. Slide 10, "Production                                                                    
History  and  Forecast" showed  a  close-up  of more  recent                                                                    
history from 2002  to 2022, which was the 10  years that the                                                                    
department was  looking forward in their  forecast. He noted                                                                    
that the large effect that  current legacy fields would have                                                                    
on  the  department's future  forecasts.  He  said that  the                                                                    
projection was  that 10 years  into the future  the majority                                                                    
of the oil  will come from legacy fields, with  less than 50                                                                    
percent coming from new fields.                                                                                                 
                                                                                                                                
9:15:13 AM                                                                                                                    
                                                                                                                                
Commissioner   discussed    slide   12,    "Price   Forecast                                                                    
Methodology":                                                                                                                   
                                                                                                                                
   · Four components to price forecast                                                                                        
        o DOR oil price forecast session October 2, 2012                                                                        
          with 31 participants from DOR, DNR, DOL, OMB,                                                                         
          University, Legislative Finance and outside                                                                           
          participants                                                                                                          
             ƒConsider    supply,   demand,    geopolitics,                                                                    
               financial markets, outside expert forecasts,                                                                     
               etc.                                                                                                             
             ƒAsked  to forecast Alaska North Slope (ANS)                                                                      
               crude  price directly,  not to  forecast West                                                                    
               Texas   Intermediate   and  adjust,   as   in                                                                    
               previous years, due  to widening differential                                                                    
               of ANS to WTI.                                                                                                   
        o Energy Information Agency (EIA) forecast                                                                            
        o New York Mercantile Exchange (NYMEX) - futures                                                                      
          market                                                                                                              
        o Analyst forecast                                                                                                    
   · Forecast is an average of DOR participant forecast                                                                         
     from Forecasting Session "blended" (averaged) equally                                                                      
     with NYMEX, EIA, and analysts to derive price                                                                              
     forecast.                                                                                                                  
                                                                                                                                
Commissioner Butcher  stated that  a number  of participants                                                                    
from around the state and  the country attended the 2012 oil                                                                    
forecast  session. The  department  blended the  forecasting                                                                    
session, along  with worldwide analyst's forecasts  in order                                                                    
to determine price forecast for the next 10 years.                                                                              
                                                                                                                                
Commissioner   Butcher  continued   to   slide  13,   "Price                                                                    
Forecasts as  of October 2012." The  slide illustrated where                                                                    
the price of oil had been over  the past 5 years, as well as                                                                    
expert forecasts  into the next 5  years.  The lines  on the                                                                    
graph indicated where different  analysts believed the price                                                                    
of  oil  would  land.  He  noted  that  the  department  had                                                                    
received  kudos for  the  conservative  price forecasts.  He                                                                    
assured  the committee  that the  goal was  to forecast  not                                                                    
only conservative numbers but accurate numbers.                                                                                 
                                                                                                                                
9:20:07 AM                                                                                                                    
                                                                                                                                
Senator  Hoffman asked  if the  new approach  in methodology                                                                    
would allow for more accurate projections.                                                                                      
                                                                                                                                
Commissioner   Butcher  felt   that  the   department  would                                                                    
continue to improve the projections.                                                                                            
                                                                                                                                
9:20:46 AM                                                                                                                    
                                                                                                                                
Commissioner Butcher  informed the committee that  slide 14,                                                                    
"General  Fund  Unrestricted  Revenue Price  Sensitivity  FY                                                                    
2013-2013."  He  stated  that the  slide  dealt  with  price                                                                    
sensitivities.  The  slide   reflected  what  the  projected                                                                    
production   was,  as   well  as   how  much   general  fund                                                                    
unrestricted  revenue the  state  could expect  to bring  in                                                                    
under varying price levels.                                                                                                     
                                                                                                                                
Senator Olson asked  about slides 9 and  10, which reflected                                                                    
the   downslope   in   production.   He   queried   offshore                                                                    
exploration and the expectation for more oil in TAPS.                                                                           
                                                                                                                                
Commissioner  Butcher  responded  that  the  department  had                                                                    
discussed  offshore drilling;  however, there  had not  been                                                                    
any wells  drilled or  analysis done  for the  department to                                                                    
give a solid estimate on  when production could begin or the                                                                    
level of production  that could result. He  noted that there                                                                    
were things  on the  horizon that has  not been  included in                                                                    
the forecast  because the department lacked  the information                                                                    
form industry to make projections.                                                                                              
                                                                                                                                
Senator  Olson  understood  that   the  department  was  not                                                                    
anticipating any offshore production before 2022.                                                                               
                                                                                                                                
Commissioner Butcher  clarified that the department  did not                                                                    
have enough information from industry to make projections.                                                                      
                                                                                                                                
Co-Chair  Kelly  asked  about   any  possible  revenue  from                                                                    
offshore drilling.                                                                                                              
                                                                                                                                
Commissioner Butcher responded that  there was not projected                                                                    
revenue from  offshore oil. Theoretically,  more oil  in the                                                                    
pipe  would  reduce  the tariff,  which  would  benefit  the                                                                    
state.                                                                                                                          
                                                                                                                                
9:24:31 AM                                                                                                                    
                                                                                                                                
Vice-Chair   Fairclough   asked  about   future   discussion                                                                    
regarding investments.                                                                                                          
                                                                                                                                
Commissioner Butcher responded  the department would provide                                                                    
a presentation on investments.                                                                                                  
                                                                                                                                
9:27:12 AM                                                                                                                    
                                                                                                                                
BRUCE   TANGEMAN,   DEPUTY   COMMISSIONER,   TAX   DIVISION,                                                                    
DEPARTMENT OF REVENUE,  presented "Oil Production Forecast."                                                                    
copy  on file.  He  noted that  oil  revenue constituted  90                                                                    
percent of the  state revenue. He said that  it was critical                                                                    
that the decision makers from  both the executive branch and                                                                    
the   legislative   branch   receive  the   best   available                                                                    
information   for   short-term   budgeting   and   long-term                                                                    
planning. He discussed slide 2, "Statutory Concerns.":                                                                          
                                                                                                                                
     AS 37.07.020 (b) - Ten Year Fiscal Plan.                                                                                   
                                                                                                                                
     Declares   that   OMB   "must   set   out   significant                                                                  
     assumptions  used  in  the projection  with  sufficient                                                                  
     detail to enable the legislature  to rely on the fiscal                                                                  
     plan  in   understanding,  evaluating,   and  resolving                                                                  
     issues of state budgeting,"                                                                                                
                                                                                                                                
Mr. Tangeman  discussed slide  3, "Comparing  the Production                                                                    
Forecasts  Over Time."  The  slide  cross sectioned  various                                                                    
forecasts  over the  last decade  and depicted  consistently                                                                    
overoptimistic  production  forecasts.  He  noted  that  the                                                                    
lines were  close for the first  two years, but the  years 6                                                                    
to  10 out  illustrated  an increased  error  rate of  40-65                                                                    
percent. The process that the  department had relied on over                                                                    
the  past decade  needed  input from  industry  in order  to                                                                    
formulate  the  production   forecast.  The  department  had                                                                    
noticed that the  group of people working  on the production                                                                    
forecast  had been  incomplete. The  department had  hired a                                                                    
consultant  that  was  a petroleum  engineer  who  spoke  to                                                                    
fellow petroleum  engineers from  industry in order  to come                                                                    
up  with  possible  production numbers.  At  that  time  the                                                                    
budget people  from industry  had not  been involved  in the                                                                    
process, which  resulted in the best  case scenario evolving                                                                    
into  the  production  forecast;   budgets  were  not  being                                                                    
considered.                                                                                                                     
                                                                                                                                
Senator  Bishop  asked  whether  industry  had  alerted  the                                                                    
department that they would be  making turn around changes in                                                                    
production.                                                                                                                     
                                                                                                                                
WILLIAM  BARRON,   DIRECTOR,  DIVISION   OF  OIL   AND  GAS,                                                                    
DEPARTMENT OF NATURAL RESOURCES,  responded that each summer                                                                    
the North  Slope producers did  turnarounds at  various flow                                                                    
station or general gathering centers.  This was done because                                                                    
production was  typically lower  in the  summer than  in the                                                                    
winter.  He  could  not  specifically  address  whether  the                                                                    
companies  had informed  the state  that the  turnaround was                                                                    
occurring,  but it  would be  intuitive that  the department                                                                    
should expect it.                                                                                                               
                                                                                                                                
Senator Bishop asked  if the testifier was an  engineer or a                                                                    
geologist.                                                                                                                      
                                                                                                                                
Mr. Barron responded that he was a petroleum engineer.                                                                          
                                                                                                                                
Mr. Tangeman  discussed the quotes on  slide 4, "Legislative                                                                    
Direction.":                                                                                                                    
                                                                                                                                
     Request for improved production forecast that better                                                                     
     incorporates variables:                                                                                                  
                                                                                                                                
        · "Is it possible for the department to come                                                                            
          forward   with   a   plan   for   providing   more                                                                    
          accountability  to the  productions forecasts?"  …                                                                    
          "I'm  looking at  a graph,  from your  department,                                                                    
          that  shows  the  forecast, starting  in  2001  to                                                                    
          2010,  and it  seems that  the trend  is that  the                                                                    
          department is  optimistic in  its forecast  of the                                                                    
          production.  I'm   wondering  if  you   take  into                                                                    
          account, relooking  at how you are  assessing, how                                                                    
          you're figuring out what the forecast will be."                                                                       
        · Rep. Costello, House Finance Committee, February                                                                      
          18, 2011                                                                                                              
                                                                                                                                
        · "What I am asking is that I be given something                                                                        
          that  will  give  me   more  confidence  that  the                                                                    
          projections that we see  are, not necessarily 100%                                                                    
          accurate, but  that they  have taken  into account                                                                    
          everything that  they can, and we've  got the best                                                                    
          shot we can get."                                                                                                     
        · Rep. Doogan, House Finance Committee, February                                                                        
          18, 2011                                                                                                              
                                                                                                                                
Mr.  Tangeman  relayed  that  the questions  had  led  to  a                                                                    
discussion about  the department, the Department  of Natural                                                                    
Resources and the  Division of Oil and  Gas working together                                                                    
on the forecasting process.                                                                                                     
                                                                                                                                
9:34:44 AM                                                                                                                    
                                                                                                                                
Mr. Barron addressed  slide 5, "Forecast Errors  by Years in                                                                    
Advance  being Forecast."  He described  the spider  diagram                                                                    
which detailed the various errors  by year in the production                                                                    
forecasts.  He called  attention  to the  diagram and  noted                                                                    
that the  outward spiral gained  uncertainty and  error with                                                                    
each passing  year. He stated  that he was not  surprised by                                                                    
the diagram given the past forecasting methods.                                                                                 
                                                                                                                                
9:36:46 AM                                                                                                                    
                                                                                                                                
Mr.  Barron  discussed  slide   6,  "Department  of  Revenue                                                                    
Response.":                                                                                                                     
                                                                                                                                
   · Addressing consistent over-estimation of production                                                                        
     began in 2009.                                                                                                             
                                                                                                                                
   · In 2012, a DOR team analyzed past forecasts comparing                                                                      
     them to actual production.                                                                                                 
        o This developed a reasonable range of "confidence                                                                      
          bands" for future production.                                                                                         
                                                                                                                                
Mr. Barron explained that  slide 7, "Historical Production",                                                                    
illustrated  a statistical  measure  standard deviation.  He                                                                    
noted that a change of scale  had been made on the "Y" axis;                                                                    
it was  not a  logarithmic scale.  He stated  that typically                                                                    
engineers  looked at  production forecasting  and production                                                                    
decline   in  a   semi-log  manner;   if  the   decline  was                                                                    
exponential it would be linear  on a semi-log exhibit. If it                                                                    
were a hyperbolic, it would  still be closer to representing                                                                    
a straight line than what  would be reflected in a Cartesian                                                                    
plot.                                                                                                                           
                                                                                                                                
Co-Chair  Kelly  admitted  that  he  could  not  follow  the                                                                    
testifier's specific language.                                                                                                  
                                                                                                                                
Mr.  Barron  said that  changing  the  scale allowed  for  a                                                                    
clearer understanding  of decline.  He added that  the green                                                                    
dotted line was a  confidence range using production decline                                                                    
from 1992-2011. The other interval,  the purple dotted line,                                                                    
used the  2002-2006 confidence range of  production decline.                                                                    
He stated  that the  flattening was  a comparison  of Alpine                                                                    
and Prudhoe Bay. He stated  that there were four tranches to                                                                    
the equation, but  that in a production  forecast only three                                                                    
were addressed.                                                                                                                 
                                                                                                                                
9:40:23 AM                                                                                                                    
                                                                                                                                
Mr. Barron  detailed slide 8, "Components  of the Production                                                                    
Forecast."                                                                                                                      
                                                                                                                                
     o Currently Producing  ("Old Oil"):                                                                                        
          ƒOil from wells that are in production and                                                                           
             following   typical    reservoir    engineering                                                                    
             optimization without major investment.                                                                             
                                                                                                                                
     o Under Development (UD):                                                                                                  
          ƒOil from projects that will add incremental oil                                                                     
             to existing fields or will bring new fields                                                                        
             into production.                                                                                                   
          ƒProject must have senior management approval                                                                        
             and be allocated funds in the company's budget.                                                                    
     o Under Evaluation (UE):                                                                                                   
          ƒOil from projects that are likely to occur in                                                                       
             the future, but have not met the requirements                                                                      
             of the previous category.                                                                                          
          ƒRequires that oil reserves are known and                                                                            
             recovery is technically possible with current                                                                      
             technology.                                                                                                        
                                                                                                                                
     Under Development + Under Evaluation = "New Oil"                                                                           
                                                                                                                                
     ***These definitions  are not equivalent to  those used                                                                    
     by  the   Society  of  Petroleum  Engineers   (SPE)  or                                                                    
     Securities &  Exchange Commission (SEC) and  should not                                                                    
     be used as such***                                                                                                         
                                                                                                                                
9:44:02 AM                                                                                                                    
                                                                                                                                
Mr. Barron  noted that the  fourth tranche was  not included                                                                    
in any  production forecasts. He explained  that exploration                                                                    
was so speculative  that it would not be wise  to include in                                                                    
any forecast  of production. He  listed that the  work being                                                                    
done by Shell, Repsol, and Great Bear was exploratory.                                                                          
                                                                                                                                
Senator Dunleavy asked whether  the forecasts dealt with oil                                                                    
that the  state would  receive revenue from;  were off-shore                                                                    
and other fields included in the forecasts.                                                                                     
                                                                                                                                
Mr.  Barron responded  no.  He offered  the  example of  the                                                                    
exploratory work  being done by  Repsol. Repsol  had several                                                                    
wells  already  drilled  which  were  still  categorized  as                                                                    
exploration activities. If after  the winter drilling season                                                                    
the  company felt  that it  was  a project  that would  move                                                                    
forward  then  the  company  would   issue  a  forecast  the                                                                    
following   year  that   would  be   classified  under   the                                                                    
evaluation category.                                                                                                            
                                                                                                                                
9:45:51 AM                                                                                                                    
                                                                                                                                
Mr. Barron discussed slide 9, "The concept of Risk"                                                                             
                                                                                                                                
    · "Risk is the probability of an event occurring and the                                                                    
      potential impact of that occurrence.                                                                                      
                                                                                                                                
    · "Good E&P business decisions require assessment of                                                                        
      both technical and non-technical risk"                                                                                    
                                                                                                                                
    · "The ability to convey the relative riskiness of                                                                          
      various O&G projects in a consistent manner is an                                                                         
      elusive and desirable goal."                                                                                              
                                                                                                                                
Mr. Barron stated  that the industry was trying  to send the                                                                    
message that as the time  reached further out there was less                                                                    
confidence in the production profile.                                                                                           
                                                                                                                                
9:46:46 AM                                                                                                                    
                                                                                                                                
Mr.  Barron addressed  slide 10,  "Accounting for  the Risks                                                                    
Appropriately"                                                                                                                  
                                                                                                                                
   · "Currently Producing" oil was not risked in this                                                                       
     forecast                                                                                                                   
                                                                                                                                
   · The "New Oil" portion of the forecast was adjusted for                                                                   
     these risks starting in FY2015                                                                                             
                                                                                                                                
   · The "Under Evaluation" portion of the forecast was                                                                       
     risked at a greater rate than "Under Development"                                                                        
                                                                                                                                
   · Technical and Non-Technical risk must be considered                                                                      
                                                                                                                                
Mr. Barron stated  that the DOR consultant  had examined all                                                                    
of the  production profiles and  had built them up  from the                                                                    
ground up, well by well, and  rolled it into an aggregate at                                                                    
the  participating  field  level.   The  field  graphs  were                                                                    
examined for  reasonability; the currently  producing levels                                                                    
were reasonable.                                                                                                                
                                                                                                                                
Mr.  Tangeman  interjected that  the  process  that DOR  had                                                                    
followed  did not  apply to  FY 13  or FY  14. The  forecast                                                                    
applied to FY 15.                                                                                                               
                                                                                                                                
Senator Hoffman  asked how fracking impacted  the production                                                                    
forecasting and the accounting of risk.                                                                                         
                                                                                                                                
Mr. Barron stated that hydraulic  fracturing was very common                                                                    
in the field  today. Roughly 25 percent of all  wells in the                                                                    
state had been hydraulically  fracture stimulated. He stated                                                                    
that the practice would not  impact the forecasts because it                                                                    
was a common occurrence.                                                                                                        
                                                                                                                                
Senator Dunleavy  understood that the fracking  in the state                                                                    
was not associated with shale oil.                                                                                              
                                                                                                                                
Mr. Barron explained that the  fracking was a method used by                                                                    
the industry for over 100  years and had improved over time.                                                                    
While  it  was typically  associated  with  shale it  was  a                                                                    
common approach  to increase  production from  classic sand-                                                                    
stone formations and carbonates.                                                                                                
                                                                                                                                
Senator Dunleavy asked if the  state presently had any shale                                                                    
oil on line.                                                                                                                    
                                                                                                                                
9:49:48 AM                                                                                                                    
                                                                                                                                
Mr.  Barron said  that shale  oil  was not  included in  the                                                                    
forecast because  it would be  classified as  an exploration                                                                    
component.                                                                                                                      
                                                                                                                                
Mr.  Barron  relayed  that there  were  technical  and  non-                                                                    
technical  risks.  He noted  that  the  longer it  took  for                                                                    
projects to progress the lower  the confidence levels in the                                                                    
project.                                                                                                                        
                                                                                                                                
Co-Chair Meyer  thought that it  was important to  point out                                                                    
that it was  highly speculative that drilling  for shale oil                                                                    
would work in  the Arctic. He highlighted  that the drilling                                                                    
for  shale  oil  in  Alaska   would  be  significantly  more                                                                    
difficult than in the lower 48.                                                                                                 
                                                                                                                                
Mr.  Barron  declared  that  shale  oil  continued  to  hold                                                                    
promise,  but  the  risk  was  so great  that  it  would  be                                                                    
virtually unseen in the forecast.                                                                                               
                                                                                                                                
Mr.  Tangeman  stated  that  the  potential  for  shale  was                                                                    
applicable, but  the infrastructure  was not  yet available.                                                                    
He stated  that the price of  oil needed would need  to rise                                                                    
to make drilling for shale oil economically viable.                                                                             
                                                                                                                                
Co-Chair Meyer recalled  that Great Bear had  issued a press                                                                    
release that  stated they had stopped  drilling activity for                                                                    
the time being.  He understood that in planning  for new oil                                                                    
the department  would meet with  the producers in  an effort                                                                    
to  ascertain each  company's  five-year  plan for  existing                                                                    
fields.                                                                                                                         
                                                                                                                                
Mr. Barron concurred that the  first step was to gather each                                                                    
company's gross  production data.  He said that  the preview                                                                    
of  the  data allowed  for  preparation  of a  forecast.  He                                                                    
relayed  that   the  engineers   tended  to   be  optimistic                                                                    
regarding forecasting sessions.                                                                                                 
                                                                                                                                
9:55:32 AM                                                                                                                    
                                                                                                                                
Mr.  Tangeman   interjected  that  discussions   with  other                                                                    
explorers also occurred so that  the department could assess                                                                    
where the companies were in the process.                                                                                        
                                                                                                                                
Mr. Barron discussed slide 11,  "Risk Factor 1: Delays." The                                                                    
slide charted  historical predictions  of new  fields coming                                                                    
on line. He read a quote from the slide:                                                                                        
                                                                                                                                
     "Over 35% of projects are over budget and exceed cycle                                                                     
     time by over 10%"                                                                                                          
               -Booze Allen & Hamilton                                                                                          
                                                                                                                                
He shared that  the quote was an industry  statement and was                                                                    
not  Alaska  specific, but  he  highlighted  the point  that                                                                    
overtime  things  tended  to  cost  more  and  were  usually                                                                    
delayed; the slide illustrated that point.                                                                                      
                                                                                                                                
9:58:00 AM                                                                                                                    
                                                                                                                                
Mr. Barron  detailed slide 12,  "Risk Factor  2: Performance                                                                    
Deviates from  Expectations." The  slide listed  the various                                                                    
projects along with their varying levels of success.                                                                            
                                                                                                                                
Senator Dunleavy  said that the oil  associated with Prudhoe                                                                    
Bay had exceeded predictions over the years.                                                                                    
                                                                                                                                
Mr. Barron agreed.                                                                                                              
                                                                                                                                
Senator  Dunleavy   furthered  that  the  majority   of  the                                                                    
projects that were further out had underperformed.                                                                              
                                                                                                                                
Mr. Barron  replied that there  were many projects  that had                                                                    
been successful, but just as many that had not.                                                                                 
                                                                                                                                
Senator Dunleavy  asked whether  Prudhoe Bay  producing more                                                                    
than projected  had played into  the overall  projections of                                                                    
oil production.                                                                                                                 
                                                                                                                                
Mr. Barron  replied that the  increase of  the stabilization                                                                    
of  production   had  been   included  in   the  statistical                                                                    
assumption.                                                                                                                     
                                                                                                                                
10:01:00 AM                                                                                                                   
                                                                                                                                
Senator  Dunleavy  understood  that  the  overproduction  of                                                                    
Prudhoe Bay became the norm for projecting.                                                                                     
                                                                                                                                
Mr. Barron agreed.                                                                                                              
                                                                                                                                
Mr.  Tangeman  added  that  if  Revenue  Source  books  from                                                                    
previous years were examined it  would be found that by year                                                                    
10 it  was nearly  a 50/50 mix  of old oil  and new  oil. He                                                                    
said  that  the  current  revenue source  book  changed  the                                                                    
numbers to  approximately 75/25; more  of the total  oil was                                                                    
coming from the currently  producing section. The department                                                                    
recognized   the  upside   of  the   under-development/under                                                                    
evaluation, but it was not  being assumed that the oil would                                                                    
come on line by year 10.                                                                                                        
                                                                                                                                
Mr. Barron discussed slide  13, "Historical Production." The                                                                    
slide illustrated the bounds  of reasonable expectations for                                                                    
future production based on historical production.                                                                               
                                                                                                                                
10:04:05 AM                                                                                                                   
                                                                                                                                
Mr.  Barron  highlighted  slide 14,  "Applying  the  refined                                                                    
method." He  explained the definitions of  each line related                                                                    
to the confidence intervals.                                                                                                    
                                                                                                                                
Mr.  Barron  explained  slide   15,  "Applying  the  refined                                                                    
method." The lines on the  graph illustrated the historical,                                                                    
forecasted, high case,  and low case projections  in the un-                                                                    
risked  total,  FY  13   forecast  and  currently  producing                                                                    
scenarios.                                                                                                                      
                                                                                                                                
10:06:52 AM                                                                                                                   
                                                                                                                                
Mr.  Barron displayed  slide  16, "New  Oil  share of  Total                                                                    
Production."  The bar  graph reflected  a considerably  less                                                                    
optimistic  forecast for  2012  than had  been predicted  in                                                                    
2011.                                                                                                                           
                                                                                                                                
10:07:34 AM                                                                                                                   
                                                                                                                                
Mr.  Barron   discussed  slide  17,  "Testing   the  refined                                                                    
method."  He explained  that the  red curve  represented the                                                                    
average; and the blue curve  represented the new projections                                                                    
made  with room  for error.  He stated  that the  answer was                                                                    
somewhere  in  between.  He   offered  that  the  projection                                                                    
removed  50  percent of  the  error  from what  historically                                                                    
would have been included in a forecast.                                                                                         
                                                                                                                                
10:08:49 AM                                                                                                                   
                                                                                                                                
Mr. Tangeman  displayed slide 18,  "This will be  an ongoing                                                                    
process.":                                                                                                                      
                                                                                                                                
     …of assessing the risk associated with Under                                                                             
     Development and Under Evaluation.                                                                                      
                                                                                                                                
                                                                                                                                
     "The ability to convey the relative riskiness of                                                                           
     various O&G projects in a consistent manner is an                                                                          
     elusive and desirable goal."                                                                                               
          Development and Implementation of an Integrated                                                                       
          Risk Assessment Methodology. Cutten, Evoy, Grecu.                                                                     
          SPE conference paper 1993                                                                                             
                                                                                                                                
Mr.  Tangeman said  that the  undertaking by  the department                                                                    
was  to  reset a  more  conservative  baseline for  decision                                                                    
makers, while  recognizing the  upside that  state resources                                                                    
could possibly provide.                                                                                                         
                                                                                                                                
Vice-Chair Fairclough wondered  whether the projections were                                                                    
conservative or realistic.                                                                                                      
                                                                                                                                
Mr.  Tangeman  believed  both. He  stressed  that  the  main                                                                    
concern  for the  department and  the governor  was how  the                                                                    
process  would  be viewed  by  Wall  Street and  the  rating                                                                    
agencies. He  noted that  the state  had maintained  its AAA                                                                    
rating with  Moody's and  SMP; additionally,  Fitch advanced                                                                    
the  state to  an AAA  rating  in 2013.   He  quoted an  SMP                                                                    
analysis:                                                                                                                       
                                                                                                                                
     "The  state's Department  of Revenue  has a  good track                                                                    
     record  forecasting  year-ahead prices  and  production                                                                    
     levels.  A big  issue for  the state  is measuring  the                                                                    
     long-term  rate   of  oil  production   decline.  Since                                                                    
     peaking in 1988, the average  annual rate of decline in                                                                    
     production has  been around  5.5 percent;  however, the                                                                    
     state's long-term  forecast has  consistently projected                                                                    
     a long-term  rate of annual  decline of  oil production                                                                    
     of just under  2.5 percent - or lower. As  a result the                                                                    
     state's long-term  forecast has tended  to overestimate                                                                    
     actual production  levels. With its fall  2012 forecast                                                                    
     the Department  of Revenue has revised  the methodology                                                                    
     used  to develop  its longer-term  production forecast.                                                                    
     The new  approach applies risk factors  to discount the                                                                    
     projected  oil  production  from oil  fields  that  are                                                                    
     still  under development  or in  an evaluations  stage.                                                                    
     Previously,  production  estimates  and  the  forecasts                                                                    
     from such fields were not  adjusted downward to account                                                                    
     for their higher level of uncertainty."                                                                                    
                                                                                                                                
Mr. Tangeman  stated that the  process would  be continually                                                                    
reviewed and  revised in  an effort  to craft  more accurate                                                                    
projections.                                                                                                                    
                                                                                                                                
10:12:54 AM                                                                                                                   
                                                                                                                                
Senator  Dunleavy asked  if Kuparuk  was considered  part of                                                                    
Prudhoe Bay when considering the  slope curve on the big oil                                                                    
fields.                                                                                                                         
                                                                                                                                
Mr. Barron replied that Kuparuk  was not part of Prudhoe Bay                                                                    
but it was considered part of the Alaska North Slope.                                                                           
                                                                                                                                
Senator   Dunleavy  asked   whether  Kuparuk   had  exceeded                                                                    
expected production similar to Prudhoe Bay.                                                                                     
                                                                                                                                
Mr. Barron replied that Kuparuk  had over-performed from the                                                                    
initial development concepts.                                                                                                   
                                                                                                                                
10:13:59 AM                                                                                                                   
AT EASE                                                                                                                         
                                                                                                                                
10:19:20 AM                                                                                                                   
RECONVENED                                                                                                                      
                                                                                                                                
ANGELA  RODELL,  DEPUTY   COMMISSIONER,  TREASURY  DIVISION,                                                                    
DEPARTMENT OF REVENUE, presented  "State of Alaska An Update                                                                    
on the State's Savings Accounts."                                                                                               
                                                                                                                                
Ms. Rodell began with slide  3, "General Fund and other non-                                                                    
segregated  investments." She  relayed that  as of  December                                                                    
31, 2012  the general  fund had  a balance  of approximately                                                                    
$11,670,000. The  main portion of the  funds, $5.48 billion,                                                                    
was  located in  the statutory  budget reserve.  The reserve                                                                    
had  nearly  doubled  since  2011 due  to  a  $1.75  billion                                                                    
deposit made in FY 12, a  $250 million deposit made in FY 13                                                                    
and an  additional $805  million from  FY 12  surpluses. The                                                                    
additional  portion  was  in   the  Alaska  Housing  Finance                                                                    
Corporation  (AHFC) and  Alaska Housing  Capital Corporation                                                                    
(AHCC).  She  stated  that  the fund  had  a  moderate  risk                                                                    
profile  with a  short to  intermediate investment  horizon.                                                                    
The department was  expecting a return rate  of 1.52 percent                                                                    
for  2012. The  projected 10  year  rate was  2.87. To  date                                                                    
there was a  return of 0.37 percent. She  opined that short-                                                                    
term  cash  treasury bills  were  not  yielding any  notable                                                                    
return.                                                                                                                         
                                                                                                                                
10:22:51 AM                                                                                                                   
                                                                                                                                
Ms.  Rodell   discussed  slide  4,   "Constitutional  Budget                                                                    
Reserve Fund (main  and sub)." The balance of  the main fund                                                                    
on  December 31,  2012 was  approximately $5.7  billion. The                                                                    
sub fund  had a balance  of $5.5  billion. She noted  that a                                                                    
deposit into  the fund of  $160 million was made  by British                                                                    
Petroleum  (BP)  per  a  settlement.   The  balance  of  the                                                                    
settlement  went to  the public  school trust  fund and  the                                                                    
permanent fund corporation. She said  that the FY 12 return,                                                                    
to date,  was 3.22  percent on the  CBR main  fund primarily                                                                    
because that  fund was kept in  intermediate and short-term,                                                                    
low  or moderate  risk investments.  The sub  fund had  been                                                                    
carved off to take a higher  risk profile and had 60 percent                                                                    
in equities, yielding a higher  return, but also maintaining                                                                    
a higher volatility.                                                                                                            
                                                                                                                                
Ms.  Rodell  detailed  slide  5,  "Power  Cost  Equalization                                                                    
Fund." The  fund had a  balance of $787 million  on December                                                                    
31,  2013,  which was  primarily  invested  in equities  and                                                                    
fixed  income.  The  PCE  fund had  a  higher  risk  profile                                                                    
because there was  a 7 percent targeted payout  on the fund.                                                                    
The FY 12 return was 7.3 percent.                                                                                               
                                                                                                                                
Ms.  Rodell introduced  slide 6,  "Public School  Trust Fund                                                                    
(Principal  and Income  accounts)"  The fund  had a  current                                                                    
balance  of  $487 million.  She  relayed  that the  interest                                                                    
earning were  put in the income  fund which had a  very low-                                                                    
risk,  short  investment  horizon  and the  money  was  then                                                                    
appropriated out to schools for  the foundation formula. The                                                                    
fund  had 27  percent  equity in  the  principal fund  which                                                                    
generated income.                                                                                                               
                                                                                                                                
10:26:12 AM                                                                                                                   
                                                                                                                                
Ms. Rodell  discussed slide  7, "PERS  and TRS."  She stated                                                                    
that  both funds  had moderate  risks. The  target actuarial                                                                    
assumed rate of return for both  funds was 8 percent and the                                                                    
asset  allocations  had  been  designed  for  that  rate  of                                                                    
return.  A certain  amount  of cash  in  low and  short-term                                                                    
investments needed to  be maintained in order to  be able to                                                                    
make benefit payouts. The Balance  of the PERS account as of                                                                    
December 31, 2012 was $12 billion,  the FY 12 return was .52                                                                    
percent. She  said that the fund  was off to a  better start                                                                    
for 2013  and had a FYTD  of 5.63 percent. The  TERS balance                                                                    
as of  $5 billion and had  a return for 2012  of .59 percent                                                                    
with a FYTD return of 5.68 percent.                                                                                             
                                                                                                                                
10:27:39 AM                                                                                                                   
                                                                                                                                
Ms.  Rodell  explained  slide  8,  "APFC."  She  stated  the                                                                    
corporation had a balance of  approximately 44 billion as of                                                                    
December 31, 2012. The FY 12  return was .02 percent and was                                                                    
currently at 7.34 percent for the FYTD.                                                                                         
Ms. Rodell  introduced slide 10,  "FY 13  Investment Revenue                                                                    
Forecast." She  stated that  rather than  using the  10 year                                                                    
return  assumption  on  cash of  2.87,  the  department  had                                                                    
looked  at  actual earnings  on  cash  which was  closer  to                                                                    
somewhere between  .3 and  .6; the  department was  using .6                                                                    
for the  forecast. The slide reflected  that some investment                                                                    
income was  lower than it had  been in the past  in order to                                                                    
take into  account current market conditions  for the short-                                                                    
term market.                                                                                                                    
                                                                                                                                
Senator  Bishop asked  what the  historical average  percent                                                                    
was on the permanent fund return.                                                                                               
                                                                                                                                
Commissioner  Butcher responded  that  the department  would                                                                    
provide the information  at a later date. He  added that the                                                                    
projection  of  5  percent  was  not  unrealistic  based  on                                                                    
history.                                                                                                                        
                                                                                                                                
10:30:46 AM                                                                                                                   
                                                                                                                                
Vice-Chair  Fairclough whether  an allocation  on a  capital                                                                    
budget  appropriation would  move  into a  higher risk  pool                                                                    
when   moved  from   long-term   investment  to   short-term                                                                    
investment.                                                                                                                     
                                                                                                                                
Ms. Rodell  stated yes. She noted  that if the money  was in                                                                    
the general  fund it would  not change. The risk  would only                                                                    
change if the move was out of the CBR.                                                                                          
                                                                                                                                
Vice-Chair   Fairclough   asked   whether  the   state   was                                                                    
experiencing  any  disadvantage  due to  the  large  capital                                                                    
budgets  of the  past two  years; general  fund revenue  had                                                                    
been used and some of the  allocations would not be used for                                                                    
a  number  of   years  and  should  be   left  as  long-term                                                                    
investments.                                                                                                                    
                                                                                                                                
Commissioner  Butcher   suggested  that  Gary   Bader  could                                                                    
provide a  more in-depth answer.  He noted that  a challenge                                                                    
for the  general fund  and the retirement  fund as  well was                                                                    
the balancing  act between  how much  should be  kept liquid                                                                    
and how much could be invested long-term.                                                                                       
                                                                                                                                
10:33:22 AM                                                                                                                   
                                                                                                                                
Ms.  Rodell  added  that  the  state  had  approximately  47                                                                    
percent  of the  general  fund  investments in  intermediate                                                                    
term bonds which  had a one to three year  horizon. This was                                                                    
helping to  push the yields  closer to the one  percent mark                                                                    
but when averaged along with  the liquidity needs, the state                                                                    
was not seeing a return.                                                                                                        
                                                                                                                                
Vice-Chair Fairclough wondered  whether the committee should                                                                    
look into the policy decision.  She noted that the state was                                                                    
making  incremental payments  on  the PERS  and TERS  system                                                                    
directly out  of the  general fund. She  asked if  the funds                                                                    
were  moved into  higher risk  investments  the state  could                                                                    
experience a greater rate of return.                                                                                            
                                                                                                                                
10:34:49 AM                                                                                                                   
                                                                                                                                
Senator Dunleavy  asked if the  department had  any specific                                                                    
concerns over the next five years.                                                                                              
                                                                                                                                
Commissioner   Butcher    responded   that    the   greatest                                                                    
uncertainty was with the global economy.                                                                                        
                                                                                                                                
10:36:31 AM                                                                                                                   
                                                                                                                                
Senator   Hoffman  discussed   legislation  that   had  been                                                                    
previously  considered that  would  make  deposits into  the                                                                    
PERS and TRS funds;  primarily, because drastic increases in                                                                    
deposits from the general fund  were expected. He understood                                                                    
that the  general fund deposits  for FY  14 would not  be as                                                                    
large  as in  FY 15,  FY16  and FY  17. He  wondered if  the                                                                    
administration had  any solutions to the  increasing deposit                                                                    
size.                                                                                                                           
                                                                                                                                
Commissioner  Butcher responded  that many  options existed.                                                                    
He said  that the various  solutions were being  examined in                                                                    
order to make the most prudent decision going forward.                                                                          
                                                                                                                                
Senator  Hoffman asked  whether  the department  had a  time                                                                    
table  for   when  the  proposals  would   come  before  the                                                                    
legislature.                                                                                                                    
                                                                                                                                
Commissioner Butcher  noted that an ARM  board meeting would                                                                    
happen in February.                                                                                                             
                                                                                                                                
ADJOURNMENT                                                                                                                   
                                                                                                                                
The meeting was adjourned at 10:38 a.m.                                                                                         

Document Name Date/Time Subjects
13 01 24 Oil Production Forecasting - FINAL.pdf SFIN 1/24/2013 9:00:00 AM
DOR Budget Overview
APFC201212.pdf SFIN 1/24/2013 9:00:00 AM
DOR Budget Overview
Senate Finance Fall 2012 Revenue Forecast OVERVIEW vFINAL2 01242013.pdf SFIN 1/24/2013 9:00:00 AM
DOR Budget Overview
State of AK GOs - 2013 Fitch Report.pdf SFIN 1/24/2013 9:00:00 AM
DOR Budget Overview
State of AK GOs - 2013 Moody's Report.pdf SFIN 1/24/2013 9:00:00 AM
DOR Budget Overview
State of AK GOs - 2013 SP Report.pdf SFIN 1/24/2013 9:00:00 AM
DOR Budget Overview
State Savings Accounts Update 1 22 13.pdf SFIN 1/24/2013 9:00:00 AM
DOR Budget Overview