Legislature(1997 - 1998)
01/21/1998 09:10 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 21 January 1998 9:10 A.M. TAPES SFC-98, Tape 2, Sides A and B CALL TO ORDER Senator Drew Pearce, Co-chair, convened the meeting at approximately 9:10 a.m. PRESENT In addition to Co-chair Pearce, Senators Sharp, Phillips, Donley, Torgerson, and Adams were present at the meeting. Also present: Wilson Condon, Commissioner, Department of Revenue; Charles Logsdon, Chief Petroleum Economist, Department of Revenue; Senator Jerry Ward; Senator Rick Halford; Mike Greany; Dave Tonkovich, Fiscal Analyst, Division of Legislative Finance; Clark Gruening; aides to committee members and other members of the Legislature. Via teleconference: Ann-Louise Hittle, Director, World Oil Team, Cambridge Energy Research Associates. SUMMARY INFORMATION ^OVERVIEW: PETROLEUM PRICE FORECAST Co-chair Pearce announced that there would be a work session on results-based budgeting with Craig Holt. She noted that childcare programs would be used as an example of going through the process of developing a results-based budget. On Friday morning there would be a review of the current and projected state employment situation by the Department of Labor. There would then be a report by Ross Kinney of the Department of Revenue (DOR) on the state of Constitutional Budget Reserve (CBR), the Office of Management and Budget (OMB) would provide an update, and Commissioner Boyer would provide a status report on the collective-bargaining contracts. WILSON CONDON, COMMISSIONER, DEPARTMENT OF REVENUE, provided introductory remarks to the presentation on the petroleum price forecast. He stated that DOR staff had worked with professional assistants from the Department of Natural Resources (DNR), the Department of Labor (DOL), OMB, and economists from the University of Alaska to complete the annual long-term price forecast in early November. Since then, the Alaska North Slope (ANS) spot price for deliveries on the West Coast had dropped to around $5 per barrel. Instead of the $18.11 per barrel average ANS delivered price forecast for FY 98, the department believed the average price for the current year would be $16.65 per barrel, a reduction of $1.50 per barrel. Commissioner Condon reported that the corresponding reduction in unrestricted general funds for the current fiscal year would be approximately $131 million, or less than the November forecast. For FY 99, the department had forecast an ANS price of $18.22; the fall forecast would use the quoted futures price for WTI [West Texas Intermediate] and make the appropriate quality adjustment. The ANS price for FY 99 currently would be $16.45 per barrel, or $1.75 below the forecast; the resulting reduction would be about $161 million in general fund revenue. Commissioner Condon noted that the state had learned to live with volatility in the crude-oil markets over the past twenty years. Four years prior, the ANS price was $11 per barrel. He believed the real question facing the state was whether the dip in price being experienced represented the fundamental change in the market that had been experienced for the past decade. Commissioner Condon pointed to the first chart ("ANS-WC, Nominal $'s, 6-87-12/97, 127 months") in the handouts (copy on file) as a depiction of the market for the past ten and one-half years; 80 percent of the time, prices fell within the range of about $14 per barrel to $20.50 per barrel. He explained that the squiggly line on the chart represented the rolling twelve-month average of ANS prices; at any point time, the number was an average of the previous twelve months (delivered prices on the West Coast). Commissioner Condon explained that the second chart ("Distribution of ANS West Coast Spot Prices") represented the average monthly price for each month for the same time period covered in the first chart, but broken down into $0.50 intervals by frequency. He underlined that the monthly prices were distributed in a classic bell curve. The most frequent interval had been $17.00 to $17.50 per barrel, and the average price over the same ten and one- half year period had been about $17.35. He stressed that over the time period, the trading range for ANS crude delivered on the West Coast had fallen generally in the range of $15 to $18 per barrel. Commissioner Condon offered that the question was whether there had been a longer-term change in the trade range. He stated that the department did not think so, but the question would be addressed later in the presentation. Senator Phillips queried the average price per barrel over the past twenty years. Commissioner Condon responded that the average price over the past twenty years was about $21 per barrel. CHARLES LOGSDON, CHIEF PETROLEUM ECONOMIST, DEPARTMENT OF REVENUE, directed the committee to the third page of the handout, "ANS West Spot Price (May 1987-Jan 1998)." He believed a similar chart had been used in the past by the committee to reflect the cyclical nature of oil price movements; he stressed that prices had fallen to very low levels before. The most recent dip was almost exactly four years prior when the price was below $11 per barrel in December 1993 and just above $11 per barrel in January 1994. Dr. Logsdon detailed that the first significant crash was a response to an OPEC [Organization of the Petroleum Exporting Countries] agreement which brought production under control following the crash of 1986; however, OPEC overproduced when the price got better and there was another crash in 1989. He noted that a number of people from Alaska and other states went to Vienna in 1989 to attend an OPEC meeting. The next significant crash was in the 1990s; some argued that overproduction by Kuwait precipitated the Persian Gulf War. He continued that the most recent slide in oil prices had occurred about four years prior for several reasons, including the economic recovery in the U.S. in 1992 and non-OPEC production. Dr. Logsdon noted that prices were high in 1995 through 1997 and that the fairly long period of high prices had led many to talk of a fundamental shift upward. The forecast prepared the previous fall projected prices coming down, but things had deteriorated faster than anticipated. Dr. Logsdon pointed to a trend line in the middle of the third chart ("ANS West Spot Price") showing that since May 1987, the price of oil had tended to trend upward at a very modest rate. So far, the long-term average from May of 1987 through December of 1997 was $17.35 per barrel. He noted that the interval was chosen because of data available and because he wanted to stick with the ANS West Coast Spot Price, which did not start reporting reliably until about May 1987. Dr. Logsdon questioned why the state had been caught by surprise. He stated that the fundamental, bottom line was that supply had succeeded demand in the past year, based on IEA [International Energy Authority] numbers comparing supply and demand for the fourth quarter of 1996 and the fourth quarter of 1997; about 700,000 barrels per day came into the market in excess of what was consumed. He referred to the third chart illustrating the beginning of the slide in oil prices in January 1997, which coincided with the initiation of oil exports from Iraq ("food for oil exports"). At the same time, OPEC production had grown by 1.8 million barrels per day in 1997, which was ratified by the cartel in late November when they raised their quota from 25 million to 27.5 million barrels per day. Dr. Logsdon noted that there was an additional factor affecting the supply and demand that the department was not able to analyze at the time of the forecast: the impact of the financial crisis in Asia on the real economy, which was still unfolding. He did not know the outcome, but asserted that a great deal of uncertainty had been introduced into the oil markets. He believed there would be significant additional downward pressure on the market. There was also concern related to additional production coming out of OPEC that had led to prices in the $14 per barrel range once again. Dr. Logsdon moved to the next table, which depicted the situation the state was facing. He reminded the committee that the forecast was not supported by current market information. Every month, the department put a newsletter called "Revenues" on its home page, which assessed the market based strictly on projections by the NYMEX [New York Mercantile Exchange]/WTI contract. Quality adjustments were made, and the department came up with a market forecast. He noted that the forecast was not based on a qualitative and quantitative evaluation of trends and key supply/demand perimeters, which was done when an official forecast was made; it presented a way to keep track of how well the official forecast matched up with what the market said was happening. The $16.64 market number was based on the previous Friday's futures prices and a revenue projection of $1.95 billion in 1998 and $1.84 billion unrestricted general funds forecast for FY 99; the prices were roughly around $16.50 per barrel. The state was about $131 million below the fall forecast and about $161 million below FY 99. Dr. Logsdon maintained that the paper markets could not tell too much about FY 2000 and beyond. The paper markets were not liquid once out a couple of months; most of the buying and setting activity occurred in a short horizon. He reported market prices in the $16.50 per barrel range through 1999, but in the fall forecast, they thought the price would grow up to $19.50 per barrel. Dr. Logsdon turned to the next chart, "Unrestricted General Fund Revenues for Different Oil Price Scenarios," showing the fall forecast compared with calculations for $17.35 per barrel and a low case of $15 per barrel. He explained that the purpose of the chart was to illustrate the potential range of oil prices over the next five years. He believed the state could maintain revenues something in excess of $1.9 billion per year for the next five years; at the $15 per barrel price, revenues could be as low as $1.5 billion by 2003. Dr. Logsdon thought the question was whether something had changed to verify that there was a new trading range. He provided two bar charts comparing DOR forecasts with other forecasters for the years 2000 and 2005. He pointed out that the charts were displayed in 1997 dollars (adjusting for inflation). The 2000 chart ranged from a lower-end forecast by Petroleum Information Research Associates (a consulting firm out of New York providing oil analysis and price forecasting mostly for the industry) at $15.00 per barrel, to a higher-end forecast by the U.S. Department of Energy at close to $19.00 per barrel. He emphasized that DOR was in the bottom group. The 2005 chart showed similar results, with the bottom at $15.00 per barrel (by the Petroleum Information Research Associates) and the top at around $27.00 per barrel (by the International Energy Administration); DOR's forecast was at around $17.00 per barrel. Dr. Logsdon concluded with remarks about the oil price market. He noted the price had been $14.00 per barrel before, and it was likely that the price would be $14.00 per barrel again in the future. Over time, the only thing that could be known with certainty was that oil prices were volatile. Statistically, the average had been about $17.35 per barrel since 1987; prices were below $14.00 per barrel roughly 10 percent of the time. He believed the long-term price should not be changed. He anticipated that DOR would be making fundamental assessments of trends in the market when the spring update was done in March. He was confident that the approach was good. Senator Sharp queried the average price increase related to the third page of the handout ("ANS West Spot Price") [testimony garbled]. Dr. Logsdon replied that the average would be dropped to about $16.50 per barrel if the spike were removed; however, the trend would still be upward because of good prices in the past 18 to 20 months. Senator Adams asked whether OPEC would be setting a different world daily-prediction quota, which included the production rate of Iraq and other non-OPEC nations so that OPEC could stabilize or control the price of oil. Dr. Logsdon responded that OPEC's price-monitoring committee had a monthly meeting and that a meeting would be coming up the following month. He noted that Saudi Arabia was not involved, but OPEC was designed to address the described issues. He added that OPEC's track record had not been excellent; however, when prices were very low ($10.00 to $12.00 per barrel), OPEC had been able to control production to a certain extent and the prices started to move back up. He noted that DOR would be watching the situation closely. His understanding was that the position of key countries with large reserves (Saudi Arabia's official position in the late November meeting) was that the economy would grow enough to absorb increased production coming out of OPEC; they also believe that non- OPEC production increases would fall short of target. He thought a change could occur in the position if the market continued to erode, but in the short term, he did not think OPEC would do something that would support oil prices and move them back up again. Senator Adams pointed to a chart that did not include Alaska production. He wanted a chart showing the daily and yearly production rate of Alaska oil in the next five years related to future oil prices. Dr. Logsdon replied that he could provide the information. Senator Phillips asked whether there could be consideration of an amount representing the 10-year, 15-year, and 20-year average price of oil, with anything above the amount going into the CBR and anything below taken out of the CBR. He opined that the price per barrel should be chosen at $16.50 or $17.00 for the year-to-year budget, and the CBR should be used as a balancing fund for price fluctuation. Dr. Logsdon responded that the idea had been discussed; in essence, the state was doing that, except that the policy spiked when oil was roughly $21 per barrel. Money had been put into the CBR fund. However, many other changes would have to be made in the financial planning process to build arrangements around $16.00 or $17.00 per barrel prices. Senator Phillips wanted to act rather than react. He thought his proposal would help build confidence that there was a stable year-to-year process. Dr. Logsdon responded that steps had been taken in the described direction by establishing the CBR fund and then taking actions to ensure that it had a balance of $3.1 to $3.2 billion. Co-chair Pearce queried which percentage of world-wide oil production came from OPEC between 1987 and 1997. She wondered whether OPEC's share was going up or down. Dr. Logsdon replied that OPEC's share had gone down but had been increasing over the past five years. He noted that OPEC's market share peaked in the late 1970s, when they were moving 30 million barrels per day and had about half the world's production. Currently, OPEC was producing about 27 million of the world's consumption of 70 million barrels per day and the market share was lower than in 1979. He added that market-share issues were very important to OPEC, and was one of the key target variables that were considered in terms of allocating quotas. He referred to speculation related to Saudi Arabia and Venezuela. ANN-LOUISE HITTLE, DIRECTOR, WORLD OIL TEAM, CAMBRIDGE ENERGY RESEARCH ASSOCIATES (via teleconference), offered a presentation on the organization's price outlook for ANS. She referred to a committee handout, "The 1995-99 Oil Price Environment: ANS." She explained that the overall view on prices had always been that prices would be lower in 1998 from 1997; the extent of the downward price move had been accentuated by recent developments, many of which were discussed in the previous presentation. According to Cambridge Energy calculations, ANS averaged $19.00 per barrel in 1997; given the range of uncertainties in the market (including the outcome of the Asian currency crisis), the numbers anticipated in 1998 were in the range of $16.00 per barrel on the high side on an annual average basis to $13.50 per barrel on the low side. Ms. Hittle explained that during 1997, Cambridge Energy used a down-side price risk well below their standard outlook, called the "modified good sweating" because of the possibility that Saudi Arabia in particular had a market- share decline related to Venezuela and others in OPEC such as Algeria, Qatar, and Nigeria, which increased their market share; in an attempt to stake out market share for themselves before sanctions were lifted against Iraq, Cambridge Energy felt that the threat or possibility of going into modified good sweating mode existed during 1997. She detailed that modified good sweating was a term they had borrowed from John D. Rockefeller which referred to "sweating out" the competition of other producers by increasing one's own production and therefore dramatically lowering prices and forcing other producers to cut production. Ms. Hittle continued that there had been a move in the direction of modified good sweating at the November 1997 OPEC meeting and the current lower-price range. At the meeting, the Saudis pressed for a quota increase from 8 million to 8.76 million barrels per day and an overall lift in the quota to 7.5 [million barrels per day]. She thought they had a very bullish view on world economic growth and Asian demand. At the time, the approach was not that unwarranted; a lot of the worsening of the currency crisis had occurred since that OPEC meeting. In particular, the unraveling of the situation in Korea occurred very much towards the end of the year, well after the OPEC meeting. The timing issue was of significance because if OPEC was to try and do something in the current year to address the situation, they could argue that while they agreed to the new quota, there was room to move back to the lower previous quota for a temporary period of time on the judgment that they misgauged demand growth. Therefore, the timing on applying the higher quota was off, and for a given amount of time, they might want to move to the lower quota. Ms. Hittle stressed that it was not likely that OPEC would maneuver coherently and at the right time. She thought it would be difficult to pull off, but was one way OPEC could handle the situation with lower prices, given enough price pressure, and given the fact that the Saudis were very determined not to move back into a swing-producer role by themselves. Ms. Hittle added that there were four factors spelled out in the fourth quarter that could unravel prices: · Worsening of the Asian currency crisis; · Mild winter weather in key heating regions in the U.S., Europe, and Asia (because of high inventories building); · Weakening of economies in the U.S. and Europe; and · Increase in the amount of oil that Iraq was allowed to export. Ms. Hittle reported that three of the factors were in development (the first two and the last). Iraq's limited oil exports were expected to be increased by 50 percent towards the end of the quarter, adding another 400,000 barrels per day of Iraqi crude oil into the market beyond the 1997 rate. The Asian currency crisis had had a direct affect on oil-demand growth outlooks; in the middle of 1997, Cambridge Energy was expecting total world oil-demand growth in 1998 to be about 1.9 million barrels per day, but the growth rate was lowered to 1.5 million barrels per day. Cambridge Energy was in the process of reconsidering each country in the region of Asia, with a very likely outcome of adjusting the 1998 growth rate downward and possibly having an effect on the total world oil demand of up to 100,000 to 200,000 barrels per day. The trend was likely to continue into 1999, until there was recovery in the Asian currency situation. Ms. Hittle turned attention to how the ANS oil price (annual average basis) could fall along the $16.00 to $13.50 per barrel range. She listed developments that could occur to push to the high side of the range: · Iraq deciding again to hold limited oil exports for a significant period of time. Iraq's overall strategic imperative was to get sanctions lifted. · Non-OPEC production could come in lower than expected. The current outlook was for non-OPEC production to increase 1.2 million barrels per day over 1997 in 1998. There had been delays and problems. · Quicker recovery than expected from the Asian currency crisis. · Stronger U.S. growth and oil-demand growth than expected; Cambridge Energy assumed U.S. economic gross domestic product (GDP) growth for the year of 2 to 2.5 percent. Ms. Hittle turned attention to the middle of the range, or the modified good sweating, where the current situation was; the annual average on an ANS basis was around $14.70 per barrel for 1998, assuming the fundamentals, including: · Non-OPEC increase of 1.2 million barrels per day; · An increase in OPEC production of about 1.5 millions per day; · Increase in OPEC NGOs of about 100,000 barrels per day; and · A total of 2.8 million barrels per day, against the demand-growth assumption of 1.5 million barrels mentioned earlier. Ms. Hittle continued that the numbers would arrive at an annual average of around $14.00 per barrel for the ANS. Ms. Hittle turned to the downside risk and the "lower band." She believed the situation would be very much driven by the Asian currency crisis, if it worsened and spread to having a significant effect on China's economic situation and oil demand. She noted that there had been little adjustment for Chinese oil-demand outlook for 1998 since the crisis occurred; most of the adjustment had been made on the non-OECD [Organization for Economic Co-operation and Development] nations. The situation could move towards the downside of the range (roughly $13.50 per barrel) if the crisis significantly affected China's oil demand and economy and started to affect the U.S. and European economies. Ms. Hittle directed attention to the year 1999. Cambridge Energy anticipated prices moving up a bit as the market came more in balance. She stated that the fundamentals for 1999 (based on the modified good sweating outlook, a fairly optimistic recovery rate on the Asian currency rate in 1999) anticipated that world oil demand would increase to around 1.6 to 1.7 million barrels per day (a "moving target" given the uncertainty of the crisis). On the supply side, the expectation for 1999 was: · Non-OPEC increase of about 1.3 million barrels; · OPEC crude increasing at a slower rate of about 700,000 barrels per day; · OPEC NGOs increasing at 100,000 barrels per day; and · A total increase of 2.1 million barrels per day. Ms. Hittle reiterated that Cambridge Energy anticipated a bit of a recovery in prices for 1999. She indicated the chart, showing some weakness in the third quarter because of the potential for oversupply; on an average annual basis, the average rate would be around $15.40 per barrel in the modified good sweating scenario. Ms. Hittle reported that the upside range could be $16.70 per barrel; the downside numbers could occur if the currency crisis worsened. [SFC-98, Tape 2, Side B] Ms. Hittle spoke to the longer-term forecast. She relayed that one year prior, Cambridge Energy would have predicted that prices in 1998 and 1999 would be weaker than they previously had been. The "disruption" had delayed the expected tightening in the market from around 2000 and 2001 to 2002. For example, in 2000, prices for ANS might average a move up towards $16.00 per barrel (assuming a robust recovery in the Asian currency crisis) and start to move up after the year 2000. The long-term outlook was towards the flat nominal under world economic growth of 2 to 2.5 percent occurring in the 2001 and 2002 period. A stronger world economic growth of 3 to 3.5 percent would move higher. She reminded the committee that the numbers were averages and to keep in mind that there was ample room for volatility, but over the longer run, the tendency would be in the described direction, with weakness in the interim as the Asian currency crisis was weathered. She added that the recovery in price would be pushed further into the future if the currency crisis worsened significantly. SENATOR JERRY WARD asked for details about the Asian currency crisis and how it had been factored into the projections. Ms. Hittle warned against overplaying the effect; what had occurred in the current market had happened on both the demand and the supply sides. She emphasized that the effect of OPEC deciding to go for a higher quota should not be minimized; it brought a lot more oil into the market. The importance of the Asian currency crisis was that before 1998, there had been strong demand growth in Asia and Latin America (and North America in 1997) that kept supply and demand more or less in balance. The imbalance was created by the loss of the demand growth as well as the increase of OPEC production. In addition, the continuing increase of Venezuela's capacity (300,000 barrels per day in 1998) and its determination to produce regardless of any quotas was important. Ms. Hittle addressed the Asian currency crisis. She reported that Cambridge Energy was going country by country and product by product looking at the balance between gas and oil and trying to figure out the effect of the crisis. For example, the sharp devaluation of the currency had hurt demand; people were losing jobs and commuting less, and refineries were producing but not selling. There was still demand growth overall year-on-year, but the weakening of the economy was having an effect in Asia. She still expected growth in North America; Europe was on its own because of strong gas competition there. Cambridge Energy had tried to deal with the situation by looking at the downside risk. Senator Sharp queried the process of measuring the effect of the currency crisis on the economies of various Asian countries, especially the actual reductions from projected consumption. Ms. Hittle replied that the effect varied country to country. Cambridge Energy was trying to get numbers that were as current as possible. She offered to get more information about exact time lag for key countries. She thought there would be readings by April for the first quarter. Senator Sharp asked when the OPEC meeting was scheduled. Ms. Hittle replied that the monitoring committee meeting would be the following week. SENATOR RICK HALFORD queried indications of upward or downward movement, such as how various countries were affected one way or the other, so that the legislature would have "signposts" to work with. Ms. Hittle replied that the next country Cambridge Energy was worried about was Malaysia. The next key country to watch was China. Taiwan so far had been insulated as its economy was oriented towards service, but she felt it needed to be watched as well. On the political side of the equation, she suggested watching what happened to Indonesia in terms of stability. She mentioned elections in Thailand and Korea in terms of the ability of the governments to deal with the issue. Overall, the situation in Thailand was somewhat stable, and they hoped that would continue. She added that another signpost would be relations between Iraq and the U.S.; for example, if the U.S. took military action against Iraq during the quarter (although the U.S. wanted the limited exports to continue moving, even if military action was taken). She noted that the decision whether to increase Iraq's volumes would be made in March; another window of opportunity would occur in June or early July. For Asia overall, she believed the concern was about political stability. Senator Halford asked for examples of countries on the upside as well. Ms. Hittle responded that uncertainty resulting from Iraq's decisions not to hold to the limited oil sales plan was a factor. From an export point of view, if Iraq did the same thing again, about 1 million barrels per day would be taken out of the market, which would have an effect on the supply side of the equation. Secondly, there were non-OPEC problems. For example, there could be possible delays in Columbia. Cambridge Energy's outlook for Columbia to increase production the previous year was based on the start-up of the new pipeline, which was in progress. However, the terrorism situation could have an effect on exports, and that would help lower non-OPEC production. Finally, she pointed to larger-than-expected oil demand in North America as something to watch. Cambridge Energy's outlook assumed oil-demand growth in 1998 of between 200,000 and 250,000 barrels per day. Stronger-than-expected oil-demand growth and economic growth in the U.S. would help offset the Asian currency crisis. In addition, OPEC might ultimately try and come up with an interim solution related to lower quotas. Senator Halford queried the differentials between ANS, West Texas Intermediate, and Saudi Arabia oil prices. He wondered whether there was a pattern. Ms. Hittle answered that Cambridge Energy had a quarter-by-quarter historical database of the differential. She noted that the prices on the earlier-discussed chart were based on an annual average of the differentials, looking forward. The differential used was $1.60 for 1998 and 1999; it was used on the assumption there was nothing drastically altered on an annual basis. She agreed that there were lows of volatility in the interim. Cambridge Energy did not see reason to adjust annually. The Asian currency crisis, for example, was considered; their analysis was that overall there would be a crude shortage, which would not significantly weaken ANS [prices]. Co-chair Pearce reviewed future plans for meetings. ADJOURNMENT Co-chair Pearce adjourned the meeting.
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