Legislature(1993 - 1994)
01/13/1994 09:00 AM Senate FIN
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* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+ teleconferenced
= bill was previously heard/scheduled
HB 370 - APPROP: FY 95 OPERATING AND LOAN BUDGET Presentations were made by Commissioner Darrel Rexwinkel and Dr. Charles Logsdon of the Department of Revenue. A presentation was also made by Mike Greany, Director, Legislative Finance Division. DEPARTMENT OF REVENUE OVERVIEW Co-chair Frank invited Commissioner of Revenue Darrel Rexwinkel and Dr. Charles Logsdon, Chief Economist of Oil and Gas Audit Division, Department of Revenue, to join the members at the committee table and proceed with the department presentation. COMMISSIONER REXWINKEL directed attention to a ten page handout with a cover sheet entitled "FY 1994 Petroleum Revenue Executive Update" dated January 6, 1994 (copy on file). Commissioner Rexwinkel said oil revenues still account for 85 percent of the total state general fund unrestricted revenues. He said oil prices were at the lowest prices since the crash of 1986. At that time the average was $9.72 a barrel. Adjusted to 1993 dollars that figure is $12.13. December 17, 1993 was the lowest price for oil this year, west coast $9.94, and the gulf coast $11.68 averaging $10.54. Brought forward into 1993 dollars this is less than the 1986 price. The spread at the low point in December was $1.74 a barrel between the west coast and the gulf coast. The spread has fluctuated substantially over time. The significant spread between the gulf and west coast now is an indication of the glut of oil on the west coast markets further deteriorating Alaska prices. He pointed out the export ban is very important to the state and emphasized the Governor and others are working to get the ban lifted. Commissioner Rexwinkel concluded his brief overview and invited Dr. Logsdon to speak. DR. CHARLES LOGSDON, Chief Economist of Oil and Gas Audit Division, Department of Revenue, informed the committee his presentation would speak to FY 94 with a forecast for FY 95. He pointed out oil prices had dropped incredibly low unlike the spring forecast that had used the price of $18 a barrel. At the time of the spring forecast the hope was that more OPEC oil would be needed because of an overall rise in the market economy as a result of global expansion and the fall of communism. At $18.38 a barrel the mid-case scenario showed an income of $2.3 billion for FY 94. Soon after that forecast was made, several things began to happen. When OPEC met in June, Kuwait did not sign the agreement to produce at the quota that OPEC had given them. The market immediately began to fall and even though most forecasters held that the price would improve, oil prices continued to deteriorate. By September, analysts were talking about an "Iraq risk premium", giving it a rate of about $2 a barrel. Although it was felt the market was not glutted, Iraq continued to hang over the market causing it to be soft. Dr. Logsdon explained that by the time the fall forecast was begun, the barrel price had dropped to approximately $16. The department's low scenario showed $15/barrel oil price but the forecast was written at $16/barrel, showing an income of $2.16 billion. This put the budget $320M below the spring target at the low scenario. After the fall forecast, OPEC met and raised their quota. The price of oil continued at $10 to $12 a barrel. He directed the committee's attention to page one of the handout showing the FY 94 market forecast of $1.771 billion general fund as a new low. Moving on to FY 95 on the second page he noted that, based on the projections of how much oil the world would need, the low scenario was targeted at $15 a barrel. He felt that the OPEC market share would remain somewhere below 25 million barrels day. REPRESENTATIVE TERRY MARTIN expressed his concern that the forecast for FY 94 and FY 95 were overly optimistic. He asked if today's prices are at $10 to $12 a barrel why would the FY 95 forecast be figured at $15. Mr. Logsdon defended his low scenario stand by explaining that the forecast was accomplished by taking the anticipated production during FY 95 and selling it on the futures market. Turning to page 3, he indicated it was difficult to lock in a number for the low scenario on the futures market explaining the futures market is a reflection of today's cash market with some premium or discount on today's sales depending on how the professional speculators feel the market will go in the future. He maintained that the demand for oil will grow and also maintained the futures market projection underpinned the low scenario. Commissioner Rexwinkel pointed out that the futures market had been backed off by $3 a barrel to arrive at the ANS average price and is an approximation. He also stated that the market forecast did not include the $135M settlement money in question that was deposited into the general fund instead of the constitutional reserve fund. Mr. Logsdon pointed out the graph on page 6 which showed oil prices since 1970. In a long term sense, 18 months to 5 years, the market could return to the $15-20 area. Many analysts say the new trading range is $10-15. On page 7, the five year average, 1989-1993, indicates we are into the post 1986 market. The December '93 spot at a $10.57 a barrel shows a low not seen since 1986. This raises the question, what happened to drop the price to $10.57? Dr. Logsdon offered that we had entered a new trading range and directed attention to the graph on page 8 which pictures the extreme drop in the price of oil by over $5 a barrel from the end of October to December. Turning his attention to the table on page 9, he recalled his comment regarding the planning for a boost in OPEC oil production and a consensus from OPEC planners banking on producing more oil. He indicated the dotted lines represent the OPEC quota and production, and the solid line represents a trend line which shows an upswing. In 1993, OPEC was unable to stay on that trend line. In trying to explain why, he said that many people failed to acknowledge that global economy was relatively stagnant almost due entirely to the economic recession that continued in Europe and Japan. Secondly, non-OPEC production had done very well, Russian exports were up, and inventories had built up. In a market that is as finely balanced as the crude oil market, even a few barrels over made this market a nervous one. When OPEC met in November and did not cut their quota, the result was a $10 a barrel price. Dr. Logsdon felt that at present there was a division among the analysts who watch this market. Information received from more than half of the pundits point to a new trading range of $10 to $13 for the next year or so. The first reason for this is that OPEC is pursuing a market share type policy that is not doing anything to support prices. They continue to let the paper market dictate where the price will go. The non-OPEC countries will not cooperate because at low oil prices they are under even greater pressure to produce absolutely every barrel they can. He stated that he still believed economic growth will kick in and more oil will be needed when that happens. He also pointed out that as long as oil prices remain low, things happen that will increase oil demand. He felt that Saudi Arabia is a key player since they have so many discretionary barrels. Eventually growth will cause oil prices to rise. When OPEC meets in March it needs to do two things to cause oil prices to return to the $18 range. OPEC needs a credible plan, an agreed upon quota system which includes Iraq. Secondly, they need to talk seriously about a market share policy that would attempt to prorate in a fair fashion the production, and take some barrels off the market. Dr. Logsdon directed the committee to page 10 of the handout, FY 94 weekly average ANS production. He said that it was expected that more oil would be put into the pipeline in 1995 than in 1994 because of Point McIntyre, Prudhoe Bay, GHX2, and later, Niakuk. On the other hand, the reserves have not been replaced on the slope and the long term decline rate is estimated at about 5% a year. That seems gradual enough so the state will have time to deal with the depleting reserve base in the realm of royalties and taxes. He also felt BP's Cascade seems worth developing and may contribute a Niakuk-size field. Thus concluding his presentation, he asked for questions from the committee. CO-CHAIR DRUE PEARCE said that she heard Dr. Subroto, Secretary General of OPEC, speak in late November. After OPEC brought their quota up to meet production, he publicly pointed out production in Columbia and Russia as being the reason for the fallen prices. She said that Iran was in line to take over the Secretary General position after Dr. Subroto retired and questioned its effect on oil prices. Dr. Logsdon agreed that the position was a diplomatic and not a policy making position. He felt it should have a neutral effect on the market but was hard to predict if Iran would indeed take over that position. They both agreed Dr. Subroto has been a very stabilizing influence on OPEC. Dr. Logsdon pointed out that one theory said the reason the Saudis are content to bite the bullet on low prices was it hurt their enemies worse than it hurt them. The Saudi royal family is concerned about the existence of hostile neighbors, Iran being one of them. REPRESENTATIVE BEN GRUSSENDORF stated his views differed widely from Dr. Logsdon. He argued the statement that the fall of communism would contribute to the consumption of oil. It was his understanding one must consider an industrial war machine's petroleum oil and lubricants use, and once that consumption ceased, realize it would not be replaced by the private sector. He asked if the forecasters in any way took this into consideration. It seemed like common sense that oil from Russia going onto the market would cause problems. He felt economic growth sounded good but after the dismantling of the a machine, prices would go down. Dr. Logsdon said on one hand there were supply side effects and consumption side effects. With the attraction of foreign capital the Russian central plan system for developing oil resources high-graded because of pressure to meet production targets. Representative Grussendorf again stated he wanted the forecasters to consider the variable of the amount of oil consumed in the name of defense. He expressed his view that economic growth in the private sector is not going to come close to that demand, and dismantling could cause a surplus for a long time. Dr. Logsdon agreed the disruption effect was under estimated. SENATOR STEVE RIEGER stated that Russian production was going to be down since Russian export production was collapsing even faster than the economy. Dr. Logsdon confirmed this factor was unexpected in the market as well. Senator Rieger commented that since pundits were forecasting in the range of $11 to $15 a barrel, was the top barrel price estimate $26-27 if the supply and demand forces were normal. Dr. Logsdon said it could happen and pointed out that Merrill Lynch projected the WTI to return to $20 in the next two quarters. He commented it was the highest forecast at this time. REPRESENTATIVE THERRIAULT asked if the department's forecast included Pt. McIntyre coming on-line. Dr. Logsdon answered affirmatively. Representative Therriault said he understood the warm weather causing inefficiency of the equipment had slowed production. Dr. Logsdon said both construction activity related to gas handling expansion and the warm weather reduced production more than expected. He said Pt. McIntyre went over 100,000 barrels a day more quickly than expected. Barring technical disruptions, FY 95 was expected to be a more productive year. Representative Therriault asked if the effect of weather would be viewed in the forecasts. Dr. Logsdon agreed it would be taken into consideration but he felt extended shutdowns because of construction activities had impacted the production more than weather. End SFC-93 #1, Side 1 Begin SFC-93 #1, Side 2 Senator Kerttula stated Russia was going to receive a subsidy of about $20 billion to assist and develop oil fields. He felt it not in the best interests of western development. Further, Senator Kerttula voiced his concern over the possibility that Pt. McIntyre was going to be involved in a legal battle with EXXON possibly reducing the royalty income projected. Dr. Logsdon stressed that the forecast was issued under the state's position that there is no allowance for a processing deduction like Prudhoe Bay. Senator Kerttula maintained that should have been resolved before Pt. McIntyre went into production. Co-chair Frank asked Dr. Logsdon to comment on world- production, excess production relative to consumption, the Iraq situation and how it relates to world-wide and OPEC production, and what effect Iraq's return to the market would have on the market. Dr. Logsdon said that FY 93 world-wide production would average 66.1 million barrels a day based on a best guess. OPEC at 24.7 barrels is producing about 35 percent of the world's oil. Most importantly most of that oil is exported, therefore causing the focus on OPEC. OPEC fills the market with the barrels others cannot produce themselves. He estimated energy and oil requirements would grow at a rate of about 1-3 percent, for the short run forecast - not a good ratio. In regard to excess capacity, Dr. Logsdon explained that not only do we need to estimate how much oil is coming out of the ground, but also how much people have stored above the ground. Changes of inventory can mean either higher or lower prices, depending upon whether people are stocking up because the price is low or destocking because there is a surge in demand. People try to identify the production/consumption gap and adjust the numbers for seasonal factors. There may be as little as an additional 100-200,000 barrels a day on the market. That's why the pundits were saying if OPEC cut 200,000 barrels a day, it could stabilize the market. He did not put a lot faith in the surplus numbers but the information the department is receiving says that the surplus is not large. Dr. Logsdon said that Iraq's reentry into the market is a heavy weight on the market. Iraq has complied with most requirements in order to obtain a partial removal of the embargo in order to sell $1.7 billion. The border between Iraq and Kuwait is still not agreed upon. Iraq does not want a partial lift but a total lifting of the embargo. The UN would like to lift the embargo and use that $1.7 billion to help fund peace keeping in Somalia, Bosnia, etc. The pundits have come up with a $2 risk premium. If Iraq did come on line, how long and how much would they produce? The pundits estimate that it would take about 12 months to come on line, and estimate production at 1.6 million barrels a day. Dr. Logsdon said it would be more realistic to expect Iraq to come on line in one month but that 1.6 million barrels a day seemed very possible. In response to Co-chair Frank, Dr. Logsdon said that Saudi Arabia almost completely filled the void left by Iraq, increasing their production from 5.5 to 8.5 million barrels a day. Explaining why, when OPEC met, they looked to Saudi Arabia to reduce their production. Discussion followed between Co-chair Frank and Dr. Logsdon why OPEC is refusing to cut production. He said that the OPEC meeting in March would tell a better story. REPRESENTATIVE LYMAN HOFFMAN referred to page 9 of the handout and said that OPEC production is around 24.7 million barrels a day. He asked how far does OPEC predict its quotas and what are they. Dr. Logsdon said that OPEC quotas are in place until they change and since OPEC meets about every six months, the quotas are on the table at that time. The fall forecast listed the quotas for the individual countries as follows: Saudi Arabia - 8 million/day; United Arab Emirates - 2.16; Venezuela - 2.3; Nigeria - 1.865; Qatar - 378,000; Libya - 1390; Kuwait - 2 million; Iraq - 400,000 (recognizing Iraq's internal use). He noted that Iraq is probably exporting an extra 300-400,000 barrels/day through Iran and Jordan. In response to Representative Hoffman's inquiry regarding the possibility of OPEC changing their quota before March, Dr. Logsdon said it was unlikely. He felt since they just met in December, it would seem like they would keep their March meeting date. Representative Martin stated that aside from world oil prices, Alaska must take care of itself, especially since our oil production is decreasing at approximately 5 percent a year. He asked what looked good in Alaska's future, are there new leases, and what incentives could we use for more exploration. He voiced his opinion that American companies were going to the world market for discoveries. Dr. Logsdon answered that the Department of Natural Resources would be able to answer that question more fully. Especially in areas of new leases, Alaska is under somewhat of a psychological handicap in that new explorations have been disappointing. The environmental movement has caused some tradeoffs in development although we have an attractive tax environment. An oil company receives 50 cents and Alaska and the federal government split the other 50 cents after development costs. He directed the question again to the Department of Natural Resources because they may be looking at credits or direct subsidization. REPRESENTATIVE EILEEN MACLEAN asked what impact the Alyeska pipeline would have with the non-compliance of the pipeline on royalties and tariffs. Dr. Logsdon said at this point he did not know the exact cost or to what extent the cost could be put into the tariff. Every dollar the cost of the pipeline increases, the state pays 25 cents. He was emphatic that these costs be audited and proved legitimate. The Department of Law is presently auditing spill expenses, etc. to insure this very thing. Representative Maclean asked if these costs were taken into consideration when forecasting the production level. Dr. Logsdon said the theory of the pipeline settlement agreement was the owners would recover costs up front with high tariffs in early years and therefore tariffs would be lower in the 90s. This has kept the tariff in the $3/barrel range. This feels more like a long-term problem as far as field development. He agreed with Representative Maclean that it would have a negative impact. Co-chair Frank invited Mike Greany, Director, Legislative Finance Division to come before the committee and give a report on the rule of thumb, severance tax and zero royalty point. MIKE GREANY, Director, Legislative Finance Division, directed the committee to a handout prepared by Legislative Finance and Dr. Logsdon addressing the low oil prices (copy on file). He explained that below $10 per barrel, the rule of thumb effect on state revenue is approximately $75 million per barrel. The lower the price, the less Alaska will lose, but of course, the less profit is made. The two major sources of revenue are severance tax and royalty. At $10 per barrel the severance tax is at its minimum, 74 cents a barrel. At $5.45 a barrel the state receives zero royalty revenue. The three major costs are field costs (lifting and gathering) estimated at 70 cents per barrel, transportation costs through the pipeline at $3.25 a barrel, and tankerage costs at $1.50 per barrel. In addition, the handout lists historical ANS prices for FY 83 through FY 94 YTD. REPRESENTATIVE KAY BROWN asked if the new low range rule of thumb on the handout referred to market destination sales prices or net effect prices. Mr. Greany said it referred to lower 48 market prices. Co-chair Frank would prefer to see the separate markets split. Co-chair Pearce asked if tankerage costs were audited and/or approved like the high point tariff. Dr. Logsdon said tankerage costs were an important part of the oil and gas audit program and specific accounting rules in regulations outline what is allowed and subject to state audit. This has resulted in some settlements. In response to a question by Co-chair Pearce, Dr. Logsdon said costs were projected by numbers reported from the companies each month. There is an important distinction between the severance tax revenues implied and the royalties. Because of a formula basis Exxon receives $1.25 while ARCO actually receives a transportation allowance which is a fixed percentage of the value of the royalty market basket used to assess the west coast price of oil. It is a buffer when oil prices get low, since the ARCO transportation percentage is a lower number. There is a difference between what we allow for transportation on the severance tax side and what is allowed on the royalty side which is a direct function of the royalty settlements that were cut with the major companies over the last couple of years. Representative Martin asked what it meant to the state per day if one assumed a well head value at $10.45. In addition, he asked after $5.45 was deducted per barrel would the state receive 27 percent of the remainder. Dr. Logsdon said when the price falls below $10 a barrel the actual percentage increases. He agreed it was a close estimate but to remember that percent includes the Permanent Fund contribution making the final amount a little smaller percentage. ADJOURNMENT The meeting was adjourned at approximately 11:00 a.m.
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