Legislature(1995 - 1996)
01/20/1995 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
MINUTES SENATE FINANCE COMMITTEE January 20, 1995 9:00 a.m. TAPES SFC-95, #1 Side 1 (000-end) SCF-95, #1 Side 2 (end -560) CALL TO ORDER Senator Steve Frank, Co-chair, convened the meeting at approximately 9:00 a.m. PRESENT: The following members attended: Co-Chair Frank Senator Donley Senator Phillips Senator Rieger Senator Zharoff ALSO ATTENDING: Senator Torgerson, Senator Green, Co-chair Halford arrived soon after the meeting began. Commissioner Wil Condon, Dr. Charles Logsdon, Chief Petroleum Economist, Department of Revenue, Annalee McConnell, Director, Office of Management and Budget, Mike Greany, Director, Legislative Finance Division; and aides to committee members and other members of the legislature. SUMMARY INFORMATION: OVERALL FY-96 REVENUE FORECAST Presentation was made by Dr. Charles Logsdon of the Department of Revenue CO-CHAIR FRANK invited Dr. Charles Logsdon, Chief Petroleum Economist, Department of Revenue, to join the members at the committee table and proceed with the Department presentation. DR. CHARLES LOGSDON gave a presentation on the state revenue outlook with emphasis on FY-96. In reviewing the materials provided, he drew attention to, The "Revenue Resources Book" which contains a detailed presentation of all the state general fund unrestricted revenues with emphasis on oil (which represents 85% of the income into the treasury). The FY-95 Petroleum Revenue Executive Update will be faxed monthly to the committee members. This information gives a summary of the current fiscal year with respect to revenue and how we are tracking since we receive payments for the royalties and severence taxes on a one month basis. On a more general distribution, the chart shows oil revenues, which is a summary of what has gone on during the last month that impacts oil revenues. Dr. Logsdon brought attention to The Executive Update which explains how much has been collected along with expectations to get through to the end of the year. It points out how much the state would have if it liquidated its anticipated production on the futures market. On that basis, for FY-95, it is $1.91 billion which is below the current projection. Applied to FY-96, with anticipated production and valued at futures market, it is $1.88 billion. That compares to $1.94 billion base case. Dr. Logsdon referenced a series of graphs. The first graph entitled "GF Unrestricted Revenues" points out the FY-95 estimate for base case (which is the middle line) is $1.95 billion. That assumes an oil price of $16.39/bbl. This year the average price has been $16.40/bbl. We are within a penny on the price side which is good. We are under on the production side. Looking beyond to FY-96, it shows $1.96 billion, which would assume an oil price of $16.72/bbl. Characterizing the revenue curve, if we can assume oil prices stay robust ($16/bbl and up range), we should be able to bring in, at the top, $2 billion per year until year 2000. Dr. Logsdon pointed out that the second graph entitled "Alaska Oil Production Forecast" shows what is driving this ultimate decline in revenue. There are three scenarios. The oil production is modeled so that the higher the oil price the more attractive investments are both in existing fields and also in devloping existing fields, which are currently not economic. West Sax provides the best example. The slope of the curve and ultimate decline does not indicate a dispute that is negative. There is a financial technical question as to whether or not it will decrease at a much greater rate (illustrated by the bottom curve), or a lesser rate (the upper curve). We are conservative in our estimates with respect to production fields that we know have been discovered and which have been deliniated. We do not carry much in the way of speculative oil that would be discovered and produced within this time period. Dr. Logsdon continued by discussing the oil market. Demand side fundamentals are very strong. The oil economy is starting into the second year of robust growth. As economies grow so does oil consumption. Last year the world burned an extra 1.1 billion bbl/day. The forecast is another 1.1 billion bbl/day increase next year. On a percentage basis that is a 1-1/2% growth rate. Mitigating that information, however, is the fact that non-OPEC sources picked up about 700,000 bbl/day in 1994. Some comes from the North Sea and other sources, including robust supplies from Russia. Russia managed to export 1.8 million bbl/day. OPEC does not have much room to move oil prices up this next year. If Iraq stays embargoed, it will increase the likelihood that prices will remain firm and even drift upward. That is our base case. Dr. Logsdon directed the attention of the committee to the map showing the placement of Chechnia with respect to the Black Sea and Caspian Sea. The primary oil pipeline carries 525,000 bbl/day for export. This is a volatile region with open conflict. So far this has not influenced oil markets more than it has. This could be why oil markets have firmed up during the last three weeks. In watching Russia, we keep in mind it is the primary sponsor in the U.N. for lifting the embargo on Iraq. If Iraq becomes a part of the world community again, it could mean a major managment problem for OPEC to keep from glutting the market. This is a major downside risk. Our base case assumption is, this will not happen, and Iraq will remain outside the market. Dr. Logsdon went on to explain the next graph "FY-95 Weekly Average ANS Production Crude, Condensate, NGL's". In FY-95, the graph shows that we are 30,000 bbl/day below anticipated production. There will be meetings with other resource agencies within a couple of weeks revising these figures. There was overoptimism regarding GHX2 and what it would do for Prudoe Bay. We might be reducing our 1995 production assumption down to account for that. On the price side, the news is good. We are using $16.39 bbl/day. We are averaging $16.40 bbl/day this year. Dr. Logsdon pointed out that the graph entitled "West Texas Intermediate and Alaska North Slope L-48 Spread". He pointed out that the difference between the price of WTI and ANS has shrunken in the last three years. In 1991 there was a $3.50 difference. Now the difference is down to $1.75. Good news. Dr. Logsdon finished with two last comments regarding price: the first, FY-94 price was, in nominal and real dollar terms, the lowest annual price since the Iran/Iraq revolution. Secondly, the last graph (extracted from "Oil and Gas Jounral", January 2, 1995) shows that 50% of the price since world war II has been below $14.95 and 50% has been above, so that the median is $15. The average is $18. Dr. Logsdon concluded by saying that the price of oil is going to stay between $15-$18. SENATOR RIEGER questioned the "Oil & Gas Journal" graph showing 1993 wellhead prices, and asked how it compares to market prices. DR. LOGSDON responded that the price compares to the market price in Texas. SENATOR RIEGER asked for clarification regarding the $11 price shown on the map for 1994. DR. LOGSDON pointed out that it was done in 1993 dollars. 1994 was a very bad year for prices. Alaskan oil averaged $14.22 on a FY basis. SENATOR RIEGER asked if there was an inflation assumption in the long term price forecast and unrestricted revenues. DR. LOGSDON responded affirmatively to the inflation assumption. The figures indicate nominal dollars. "The Revenue Sources" book lists the assumption on page 32. The inflation rate for a base case is 4-1/2%. SENATOR ZHAROFF asked what would happen to the price prediction of $15-$18 if the oil export ban was lifted. DR. LOGSDON indicated that it would help push us to the upper range of that price. It is estimated that if the ban were lifted today, we would get at least a fifty cent increase/bbl in resource value. Bringing us to the upper part of the $15-$18 range. SENATOR HALFORD questioned how differential and transportaion costs to the gulf coast effect the spot market average. How does the model take out the fact that it costs considerably more to get the oil to the gulf coast? DR. LOGSDON responded that the price falls between the two. In our model there is a marketing assumption. We begin by calculating how much oil goes to the gulf coast and how much goes to the west coast. Based on the transportation costs, we net those back. A fifty cent differential is not enough increase in the gulf to offset the higher transportation costs to the gulf. Therefore, the net backprice of the gulf is lower. SENATOR HALFORD voiced his understanding that if the average spotprice is $15.50, and the gulf coast and west coast prices are fairly close together, the assumption is we are getting a higher net than is actual, due to the transportation differential. DR. LOGSDON responded by saying that numbers given take into account that factor. The spot averaging statement gives you a rough idea of what is going on in the lower 48. In order to be more specific, information regarding the volume weighted transportation costs would have to be subtracted. Ultimately, the worth of the product when it comes out of the ground is our primary interest. That is the value for post severence tax and royalty purposes. SENATOR HALFORD asked if the affect is lower than the lower of the two spot prices as long as west coast is lower than gulf coast. DR. LOGSDON suggested focusing on west coast prices. The predominance of oil goes to that market. As demand for oil on the west coast goes up and our crude production goes down, there will be less need to ship to any other market besides the west coast. SENATOR HALFORD inquired concerning the net benefit to the state in lifting the export ban if the west coast and gulf coast prices have come together. DR. LOGSDON responded that if the prices are at parody (west coast/ gulf coast) and we lifted the export ban, we would still make $20 million per year just in transportation costs. This price however is not very stable. If oil is selling for more on the west coast than it is on the gulf coast, it will tend to bring oil into the west coast from other areas (esp. from Equador, Canada, or Columbia). When it hits parody that means something is occurring. Basically what is happening is that the ANS surplus issue is probably going away. The sooner the ban is lifted the sooner there is an opportunity to make money. CO-CHAIR FRANK questioned what happens to the actual oil if the export ban is lifted. Does it change the actual patterns of flow of ANS? DR. LOGSDON responded that out of Valdez it would be a new marketing dynamic. Dr. Logsdon's personal opinion is that it would have effects on OPEC and how the middle eastern countries want to jump into that market. The middle eastern countries have not had to worry about Alaska as a competitor in the far east markets. SENATOR PHILLIPS observed that the lower 48 has had a warmer winter this year and asked for observations relating to effects of consumption relating to price. He also wanted verification that this is the first time the U.S. is importing more than 50% of our oil. DR. LOGSDON responded that the warmer weather dominated the crude oil market in December for ANS (and all U.S. crude oils). Prices were fairly low. The graph on page 6 indicates prices dipped as low as $15.50 in December, which was a direct function of the warmer weather. Consumption was down 2% in December from the year prior. That is short term. Over the long term, consumption of oil in the U.S. was up 2% for the entire year. Insofar as the 50% increase of oil importation, that is a trend of an overall increase in consumption and decrease in production in the U.S. This will have an effect on energy policy as we go forward. SENATOR PHILLIPS stressed the importance of the opening of ANWR in terms of increased dependency on foreign oil. SENATOR RIEGER questioned the long-term supply and demand of oil. How many million/bbl from the North Sea could be expected as a potential source for increased production? DR. LOGSDON concluded that it was a question mark whether or not they can continue to develop new fields at the rate that they have been doing it. SENATOR RIEGER questioned Russian production at unsustainable rates that is causing field damage. DR. LOGSDON concourred that that was occurring, illustrated by the dramatic fall in production over the last eight or nine years. However, new investments made over the last three or four years have helped arrest that decline. The primary problem now is not their ability to produce, but to move the product to market. Existing pipelines are in bad shape. SENATOR RIEGER asked how long it would be before the market begins to run out of cheaply produced fuel and a secular tightening of the world oil supply occurs. DR. LOGSDON responded by saying that there is no consensus. There are two points to be made. Firstly, within the next five years scarcity of oil could occur and prices will esculate at a real growth rate for a number of years. Then we would have to go to OPEC for every barrel. Conversely, the other possibility is that the price could stay flat in nominal dollars for a long time. The main reason given for that is we will be there asking OPEC for oil and they will realize that they have to reinvest more than 10% of their income back into exploring and developing their existing oil fields. This is something that they have not had to do in years. Dr. Logsdon speculated that somewhere inbetween is where oil prices will average. CO-CHAIR FRANK questioned the production figures for Iraq, what their potential for export is, and what effect that is going to have. DR. LOGSDON responded that Iraq is producing at 700,000 bbl/day. It is felt that they are leaking another 100,000-200,000 bbl/day onto world markets. There is speculation that Iran is laundering crude oil for Iraq. We know they are trucking oil into Jordan. This is domestically consumed oil. Before the war they were producing 300,000 bbl/day. There is speculation that they could ramp up well over to a million to a million and a half very quickly. Once you get that flow of oil going it doesn't take very long to attract the investment to fix the problems to allow them to produce that amount. It might only be a short term problem, but certainly it would be a management problem for the cartel. CO-CHAIR FRANK inquired as to an OPEC quota. DR. LOGSDON responded that the quota is 700,000 bbl/day. The quota has been reduced since the war, although he indicated he would have to double check on that statement. CO-CHAIR FRANK asked if they are free to increase production within the cartel? DR. LOGSDON responded that they do not sign agreements. They are members of the cartel though they do not agree with their quota. CO-CHAIR FRANK asked if Dr. Logsdon had a matrix that would show what the price would go down to if another two million came onto the market? DR. LOGSDON responded that the short- run elasticity is fairly small. It suggests that the price would crater. You would go very rapidly down to $10/bbl. Over the longer term (6 months), you would see forces come into play that may tend to ameliorate that. Governments produce over 50% of the oil in the world today. That means there would be heavy politics to lift the embargo on Iraq. CO-CHAIR FRANK reiterated that Russia is the prime sponsor, yet you would think that they would be more concerned about their domestic budget. DR. LOGSDON responded that for economic reasons they would have an opportunity to do business with Iraq. Oil is one of Russia's major sources of hard currency. CO-CHAIR FRANK asked about tariff changes and the effects on Alaska's pipline. DR. LOGSDON responded that the tariff filing this year is up to $3.71/bbl (up fifty cents from last year). The primary reason behind that increase revolves around the unanticipated additional expenses for electrical and maintenance work. The pipeline has been running many barrels of oil for 15 plus years, and it is in need of maintenance. The tariff is designed to allow the pipeline to recover. Because of the impact of the wellhead value, the state is going to share roughly 25% of those costs as they are passed on to the shipper and affect the value of the oil at the point of production. CO-CHAIR FRANK discussed the tariff case and the settlement that it provided for a decline over time consistent with production. He said it appears we gave up something in the short run to gain something in the long run. DR. LOGSDON responded that it is a large investment. There is the initial outlay for construction, and there are operating and maintenance costs with any capital structure. Dr. Logsdon felt the shippers are interested in having a line that has integrity and those investments are necessary and are done in an efficient way. CO-CHAIR FRANK asked for Dr. Logsdon's perception of Iraq production. DR. LOGSDON responded that as long as Saddam Hussein is in Bagdad and we are getting most of our oil from the Saudis along with other historical interests in the middle east, "I don't believe the U.S. will ever allow that export ban to be lifted." The key variable is dependent on the head of Iraq. At this time it is Saddam Hussein. Dr. Logsdon said he does not believe the embargo will be lifted as long as he is in Bagdad. SENATOR ZHAROFF questioned the likelihood of the export ban being lifted. DR. LOGSDON responded that there is a very good chance the export ban could be lifted. However, this is a matter of federal policy and there are many interest groups who would be very much opposed to it. Their power has been diminished considerably. Letters were sent from the maritime unions to President Clinton supporting the lifting of the ban, as long as Jones' Act tankers are used to export the oil. If it is lifted, that will be the first condition. The refiners on the west coast would be very much opposed to this since their feed stock costs would go up. The environmental community along with some of the midwestern congressional delegation are also opposed to lifting the ban. End SFC-95, Side 1 Begin SFC-95, Side 2 ADJOURNMENT The meeting was adjourned at approximately 9:50 a.m.
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