Legislature(2015 - 2016)SENATE FINANCE 532
01/26/2015 09:00 AM Senate FINANCE
| Audio | Topic |
|---|---|
| Start | |
| Presentation: Fall 2014 Forecast | |
| Adjourn |
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+ teleconferenced
= bill was previously heard/scheduled
SENATE FINANCE COMMITTEE
January 26, 2015
9:02 a.m.
9:02:20 AM
RECONVENED: CONTINUATION OF RECESSED MEETING ON 1/23/15.
CALL TO ORDER
Co-Chair Kelly called the Senate Finance Committee meeting
to order at 9:02 a.m.
MEMBERS PRESENT
Senator Anna MacKinnon, Co-Chair
Senator Pete Kelly, Co-Chair
Senator Peter Micciche, Vice-Chair
Senator Click Bishop
Senator Mike Dunleavy
Senator Lyman Hoffman
Senator Donny Olson
MEMBERS ABSENT
None
ALSO PRESENT
Randall Hoffbeck, Commissioner-Designee, Department of
Revenue; John Tichotsky, Chief Economist, Tax Division,
Department of Revenue; Representative Liz Vasquez.
SUMMARY
^PRESENTATION: FALL 2014 FORECAST
9:03:33 AM
Randall HOFFBECK, COMMISSIONER-DESIGNEE, DEPARTMENT OF
REVENUE, explained that the majority of the "Revenue
Forecast" presentation would be presented by Dr. John
Tichotsky, the Chief Economist for the Department of
Revenue (DOR) and the head of the department's economic
research group responsible for the revenue forecasting in
the Revenue Sources book. He referred to slide 3:
Methods: What Do We Forecast at DOR?
· We directly forecast Petroleum Revenue
· the largest component, accounting for 88% of state
unrestricted revenue in FY 2014
· "Petroleum Revenue" includes severance taxes,
royalties, corporate income tax, and all other
revenue from oil companies
· We directly forecast Non-petroleum Revenue
· We use someone else's forecast for Investment
Revenue
· We use the Federal Revenue authorized for spending
as the forecast
· It is typically 20%-30% more than actually gets
spent.
· DOR compiles all different revenue streams and
compiles them in the annual Revenue Sources Book
Commissioner Hoffbeck turned to slide 4:
"Oil Revenue Forecasting,"
Three Factors for Production Tax Revenue Forecast
REVENUE = (Net value * Tax Rate) - Credits taken
against liability
Net value = (Price*Production) - Costs
1. Price
2. Production
3. Costs
1. Capital expenditures
2. Operating expenditures
3. Transportation cost
Commissioner Hoffbeck noted that the three factors provided
structure for understanding the forecast.
Commissioner Hoffbeck discussed slide 5:
"Fall 2014 Highlights"
•Input changes relative to the 2014 Spring Forecast
•Oil price levels have been reduced sharply in the
near-term.
•Oil production has been increased for all years.
•Correspondingly, unrestricted revenues have been
revised downward.
•Revenue impacts largely due to changes in oil price
assumptions.
•Lease expenditure (or investment) in the oil fields
maintained high levels which has increased expected
production
Commissioner Hoffbeck explained that the slide summarized
the differences between the fall and spring forecast.
Vice-Chair Micciche asked whether Commissioner Hoffbeck
felt "comfortable" with the more conservative approach
employed in the current revenue forecast.
Commissioner Hoffbeck replied that he was comfortable with
the conservative methodology used in the current
forecasting. He noted that oil prices had further declined
since the fall forecast was published.
Vice-Chair Micciche wondered whether the department
included analysis of political and other investment climate
forces when constructing the revenue forecast.
JOHN TICHOTSKY, CHIEF ECONOMIST, TAX DIVISION, DEPARTMENT
OF REVENUE, answered that the department had access to a
broad range of analysts due to its relationship with the
Permanent Fund Corporation and the yearly price forecasting
session. The department maintained contact with the
analysts and relied on their expertise to "keep a pulse" on
the political and structural (supply and demand) issues
affecting the markets. The department strove to stay
informed as the predictive analysis developed. The
department analyzed ranges of prices with the eventual goal
of attempting to predict revenue. The current tax structure
did not impact revenue as greatly with low oil prices as it
did with higher prices.
Commissioner Hoffbeck noted an error in slide placement and
clarified that slide 7 will be addressed after slide 11.
Mr. Tichotsky explained slide 8, "Production History with
Adjusted Expected Investment Case." The graph depicted an
overview of production history heading into a decline
period from the high production period of the 1980's. He
drew attention to the bulk of the production coming from
Prudhoe Bay, which would continue to dominate production in
the future. In addition, new smaller fields coming online
contributed to increased production of over 500 thousand
barrels per day (bbl. /d).
Mr. Tichotsky cited slide 9, "ANS Production Comparison,"
which illustrated the contrast between the 2014 spring
forecast and the 2014 fall forecast. He relayed that the
department meticulously scrutinized any projections of new
production included in the oil companies production plans
before inclusion in the forecast.
9:14:26 AM
Senator Dunleavy asked whether models existed that
considered the "dramatic" and "precipitous" decline in
price, how it impacted production, and if a "lag time"
occurred between price change and production. He wondered
whether low oil prices spurred a decline in production and
high oil prices prompted increased production.
Mr. Tichotsky stated that production was related to
investment; Alaska was currently in a "strong" investment
period. He noted that investment lead to periods of future
production. He continued that the "timing between
investment and prices were not connected." Oil companies'
production plans were made "irrespective" of price
fluctuations because plans were made in the long-term.
Vice-Chair Micciche referenced slide 8, and noted the
predicted decline in oil production beginning in mid-2017.
He asked what the probability of declining oil production
was beyond 2017.
Mr. Tichotsky cautioned that the decline represented
"statistical uncertainty" since the forecast was difficult
to predict over longer periods of time. Production
forecasts were most reliable up to two years into the
future.
Vice-Chair Micciche surmised that if the current decline
"flattened out" in 2017, it would indicate that the decline
prediction would also even out.
Mr. Tichotsky agreed and concurred that as more definitive
information was available in the future the information
would be reflected in the forecast model. The department
forecasted a specific price for budget purposes but as the
model was projected over time the prediction was more of an
"image" of the future. He reiterated that the forecasting
data was much less reliable over longer periods of time.
Senator Hoffman asked that when forecasting "long-term
production outputs" how much consideration was given to the
current price of oil and market conditions and if the
department thought that the industry would "pull back"
production with sustained low oil prices.
Mr. Tichotsky answered that during the price forecast
session in October, oil prices were anticipated to decline
but not as low as what occurred. He maintained that
economists understood commodity market volatility; long
periods of price stability worried economists. Stability
was indicative of a supply and demand equilibrium that was
historically unusual. He was certain that if prices
continued to decline energy demand would increase, supply
curtailed and the equilibrium changed. The uncertainty was
the timeline of when that would occur. The department would
update and revise the information in the spring forecast as
conditions changed and information was received. He
speculated that some price recovery was on the horizon at
some point in the future.
Senator Hoffman wondered whether the department considered
Oil Producing and Exporting Countries (OPEC) pronouncements
of future projections when forecasting.
Mr. Tichotsky replied with uncertainty.
9:24:47 AM
Co-Chair MacKinnon asked whether the President's
announcement regarding "taking areas of the Alaska National
Wildlife Refuge (ANWR)" affected the revenue forecast.
Mr. Tichotsky replied in the affirmative. He detailed that
the department took into account federal policy,
international markets, and anything that would affect
supply and demand when developing the forecast.
Co-Chair MacKinnon asked whether the ANWR pronouncement
could be quantified so the legislature could send the
federal government a bill for lost revenue.
Commissioner Hoffbeck interjected that the current forecast
did not include oil from the ANWR areas because projects
were not slated in areas of the reserve. He thought that
the policy did have a "major impact" on new options for
additional revenue moving forward in a climate of low
revenue.
Co-Chair MacKinnon asked whether any of the "ANWR reserves
were banked on any of the producers books." She informed
the committee that producers banked reserves were factored
into a producer's credit worthiness. She wondered whether
producers had holdings on banked reserves in ANWR and what
the repercussions were on the United States economy and the
state of Alaska.
Commissioner Hoffbeck noted that he was not aware of
information available to DOR to determine whether any ANWR
holdings were "banked on producer's books."
Co-Chair MacKinnon related that she would inquire with the
state's producers for an answer.
Co-Chair Kelly referred to an article titled, "OPEC Meets
Adman Smith" he read decades ago and summarized that the
laws of supply and demand prevailed over curtailed
production. He believed that in the current situation
demand would increase as the price lowered but the scenario
would take a much longer period of time because currently
continuing to increase production did not make sense under
the low price environment. He wondered whether OPEC's
continued high production in the climate of low oil prices
affected prices in the long-term as opposed to producing
less in the a period of high oil prices.
Mr. Tichotsky replied that much "complexity" existed in the
markets. He predicted that as a "general rule," extremely
low prices in the near future would create a more volatile
market.
Co-Chair Kelly asked what natural forces in economics would
affect an increase in the price of oil in a scenario where
one producer continued to increase production in a low
price market.
Mr. Tichotsky answered that cheaper commodity prices
created more demand.
Co-Chair Kelly confirmed his understanding and clarified
that currently, OPEC seemed committed to increased
production regardless of the low price of oil, which was
counter to traditional market forces.
Mr. Tichotsky responded that Saudi Arabia was the "swing
producer" in OPEC because the country had the capacity to
boost production anytime. However; low oil prices created
instability in oil producing nations. He exemplified the
current situation in Russia. He explained that Russia's
currency was devalued and "issues with production" ensued.
He underlined that complex issues made predicting the price
of oil arduous.
Co-Chair Kelly concurred with Mr. Tichotsky's statements
and reiterated his belief that OPEC will produce more oil
to generate more revenue.
Mr. Tichotsky characterized his assumption as a reasonable
explanation, but cautioned not to underestimate the "great
uncertainty" of the market that could cause prices to lower
or raise. He surmised that "uncertainty will probably breed
volatility."
Senator Dunleavy contended that the future price of oil was
unknown and impossible to predict. He believed that basing
the budget on revenue forecasts was akin to basing the
budget on "winnings in Las Vegas." The world market forces
were changing and unpredictable and that the state needed
to base the budget on very low oil prices and very low
production estimates to create stability in state
budgeting.
9:37:50 AM
Co-Chair Kelly asked if Mr. Tichotsky could comment on
Senator Micciche's belief that Saudi Arabia was attempting
to "break North Dakota" with below $40/bbl. price of oil
and that the price would not rebound until the scenario
occurred.
Mr. Tichotsky replied that the scenario was not unlikely,
but reminded the committee that Alaskan oil did not
influence price. Alaska typically received anywhere from $2
billion to $5 billion in revenues from oil each year
regardless of price and thought that it was a reasonable
expectation.
Co-Chair MacKinnon pointed out that with regard to the
President's recent comments on new oil development, the
state received $35 million in offshore oil in 2014 (cited
on page 94 of the Revenue Sources Book) and was projected
to increase. She requested that DOR "run some numbers based
on what the federal government had proposed" and send the
government a bill.
Vice-Chair Micciche felt that the effect of speculation on
oil prices had radically decreased in the last year to 18
months. He asked whether the trend might continue.
Mr. Tichotsky opined that speculation was an important
"part of the process that created forward thinking and
expectations". He agreed that there was less speculation,
but felt as prices or uncertainty increased speculation
would also increase.
Mr. Tichotsky pointed to the word "offshore" on page 94, of
the Revenue Sources book. He clarified that "offshore"
referred to the territorial waters of Alaska or the three
to six mile revenue sharing zone. The state did not have
any sovereign or property rights beyond the 6 mile zone.
Mr. Tichotsky turned to slide 10:
ANS OIL PRODUCTION FORECAST
•Volumes from Developed Reserves (Currently
Producing):
•Oil from wells that are in production and following
typical reservoir engineering optimization without
major investment.
•These volumes are from projects already in place and
thus remain unadjusted for risk.
•Volumes from Undeveloped Reserves and
additional/accelerated Developed Reserves:
•Oil from projects that will add incremental oil to
existing fields or will bring new fields into
production.
•Must have senior management approval and be allocated
funds in the company's budget.
•These volumes are risk-adjusted for commercial
uncertainty.
•Volumes from Contingent Resources:
•Oil from projects that are likely to occur in the
future, but have not met the requirements of the
previous category.
•Oil reserves must be known and recovery is
technically possible with current technology.
•These volumes are more strongly risk-adjusted due to
the commercial uncertainty and other risks.
•DR + UDR + CR = Unrisked Investment Case
Mr. Tichotsky referred to slide 12, "North Slope Production
Forecast," that graphed the volumes of the reserves
according to its classification. He reported that volumes
from developed reserves were forecast with a high degree of
certainty. The reserves from undeveloped reserves and
contingent sources were forecast with "relative certainty
and included in the production forecast. He elaborated that
the "upside potential volume" from undeveloped reserves
reported in a company's production plan offered the
department much less certainty and was not included in the
production forecast.
Mr. Tichotsky continued to slide 12, "Production Forecast,"
which contained a graph of forecasted production from 2015
through 2024. He indicated that the revenue forecast was
based on a specific price in 2015 and 2016. The department
historically "over forecasted" future production volumes.
Previously, the departments "risking methodology" included
the "unrisked investment case" which contributed to over
forecasting future production. The reasons DOR over
forecasted the unrisked investment case was twofold. One
reason pertained to timing; projects were in progress, but
the commencement of production was unknown. The other
reason was that the predicted amount of production from the
project was overestimated. However, the unrisked investment
case line on the graph illustrated a "very realistic
potential of oil that could come online, given the right
investment climate." He added that the "low investment
case" included on the graph portrayed production forecasted
relying on currently producing reserves and no new
investment.
Senator Dunleavy queried whether the state was currently
"in a low investment scenario."
Mr. Tichotsky believed that it was too early to know. He
opined that Alaska could market itself as a safe investment
in a low price climate. Because the lead time to production
was long, and volumes were large by the time production
commenced prices would be higher. He defined his scenario
as "compelling."
Mr. Tichotsky continued that the current production
forecast portrayed the "range of possibilities" and
provided "goalposts" for future market scenarios.
9:49:08 AM
Senator Dunleavy asked whether the department contacted
with a production engineer and wondered what happened to
the individual if the projections were "wildly off the
mark."
Mr. Tichotsky responded that recent one and two year
predictions were accurate. He pointed out that the
difficulty was with definitive forecasts over a ten year
horizon. He felt that the ideal long-term prediction
included a range of production volumes. Forecasting beyond
a two-year horizon was problematic. He voiced that DOR was
satisfied with its short-term forecasting.
Senator Dunleavy assumed that a DOR expert did not
anticipate the current steep decline in oil prices.
Mr. Tichotsky reiterated that the production forecast was
based on the information provided by the oil companies;
their production plans and investments and believed the
current forecast was satisfactory.
Mr. Tichotsky identified slide 7:
DEPT. OF REVENUE INVESTMENT CASES
•Unrisked Investment Case:
•This is a technical forecast provided by a DOR
consulting petroleum engineering service.
•It is based upon the expectations and best estimates
of oil companies.
•It includes forecasts from the production from
developed, undeveloped oil reserves and contingent
resources
•Adjusted Expected Investment Case:
•This is the official revenue forecast.
•Unrisked investment case adjusted for risks and
uncertainties.
•It is used for forecasting revenue beyond two years.
•All developed reserves remain un-risked, but less
certain projects are weighted over time.
•Low Investment Case:
•This includes forecasts strictly from projects and
wells that are already developed. This is risk
weighted only at the technical level.
•If no new projects came to fruition, this is what we
would expect the future to look like.
Mr. Tichotsky examined slide 14, "Alaska North Slope Crude
West Coast Price." He articulated that the graph depicted
the inaccuracy of the forecasted mid-term average price of
over $100. The price hovered at $47. However, prices were
typically volatile and the current low was not as steep as
a drop that occurred as recently as 2009.
Co-Chair MacKinnon referred to slide 14, and wondered what
the notated "95 percent confidence level" meant.
Mr. Tichotsky related that the confidence level was not
contained in the slide and referred to chapter 4, page 29
of the Revenue Sources Book.
Vice-Chair Micciche clarified that the inclusion of the
confidence level reference on the slide was a mistake and
did not refer to the data on slide 14.
Mt. Tichotsky affirmed but further clarified that in the
Revenue Sources Book the reference to the confidence level
related to the actual price relative to the mean. He
continued to slide 15, "Alaska North Slope Crude West Coast
and West Texas Intermediate Prices," which graphed the
price relationship between Alaska North Slope Crude (ANS)
and West Texas Intermediate (WTI). He observed that the
volatility in the price of oil was more of the norm rather
than the stable price environment of the last few years.
Co-Chair MacKinnon asked why the price of Brent oil was not
included in the comparison on slide 15.
Mr. Tichotsky responded that Alaska North Slope crude (ANS)
was traded on the West Coast market. He elucidated that
historically, ANS accounted for a large share of the crude
oil refined in California and Washington. ANS crude was
currently more like Brent crude which traded on the global
market by water tanker. West Texas Intermediate represented
U.S. sourced (U.S. midlands) crude at depressed prices
because the oil was suppressed from global markets. He
elaborated that the amount of crude had significantly
decreased and was substituted with crude from various
countries, i.e., Ecuador or Russia. Currently, ANS was part
of a global market called "water born crudes." The West
Texas Intermediate market represented the U.S. midlands,
which was "bottlenecked" and not able to get its oil to the
global markets resulting in lower prices. Traditionally,
the state "benchmarked" off of the price of the WTI but
since entering the global water born market, "… the state
no longer took the WTI benchmark at a coefficient and
imputed" the price of ANS based off of WTI.
Co-Chair McKinnon asked that if Brent oil was graphed on
the chart would the price be similar to ANS.
Mr. Tichotsky answered that in general the two crude
markers were very similar.
Co-Chair MacKinnon wondered why the graph depicted WTI
instead of Brent oil.
Mr. Tichotsky specified that the WTI benchmark was familiar
and regularly reported in the news media. The department
would provide a graph that included the Brent oil
benchmark.
10:00:58 AM
Co-Chair MacKinnon wondered whether DOR changed its
modeling.
Mr. Tichotsky replied that until 5 years ago DOR forecasted
WTI prices and converted them to ANS using a coefficient.
However, the practice was halted when the WTI benchmark
became "disaligned" with ANS. He furthered that Brent oil,
being a European marker, was not an appropriate benchmark
either. The department forecasted the ANS price
exclusively.
Senator Bishop commented on slide 15. He shared that the
bottleneck on WTI was being mitigated by an "export
pipeline at Cushing" [Wyoming] to Port Arthur [Texas]. In
addition, he noted significant west coast capital
investments expanding railroad lines to the Cherry Point
terminal [near Blaine, Washington]. He felt the
transportation changes, in addition to Bakken oil [North
Dakota] was exerting pressure on ANS prices.
Mr. Tichotsky responded that the opening up of Cushing was
raising the price of WTI up to the global price without
affecting the global price. He commented that transporting
crude was costly, inefficient and limited to rail capacity.
Tanker and pipeline transport of crude oil was more
efficient. Railed Bakken oil was not competing with ANS;
global water born crudes were. He communicated that Alaskan
crude also had the option of being exported to other
markets. He hypothesized that if the Cherry Point refinery
price dropped too low, the proper incentives would fall
into place for the option to sell to Asian markets existed.
He cautioned that the issues were complex and "not as
simple as it seemed at face value."
Vice-Chair Micciche asked whether there "was any value to
Alaska" supporting import tariffs on exported oil coming
into the west coast market." He mentioned that tariffs were
applied to Alaskan oil exported to other countries.
Mr. Tichotsky responded that tariff "mechanisms can produce
monetary value in the short term. He believed that over
time markets set the "most efficient" price and the state
would fare better to "develop to the market price" rather
than impose tariffs.
Mr. Tichotsky directed attention to slide 16;
"Key Oil Price Drivers,"
•Supply & Demand
•There are two main factors to monitor.
•Global spare capacity, since it is both a reflection
of supply and demand. In other words, the Organization
of Petroleum Exporting Countries (OPEC) spare capacity
(flipping a switch) is key.
•Cost of developing new oil supply.
•Current Events
•Weak global demand
•Saudi trades market share for lower prices
Co-Chair MacKinnon asked Commissioner Hoffbeck whether he
believed that The President's response to the Keystone
Pipeline Project would affect ANS supply and demand.
Commissioner Hoffbeck replied that he did not believe it
would affect ANS supply, but that moving the product more
efficiently would affect demand. He felt that the
President's actions of keeping the pipeline "bottled up"
actually benefited the ANS price.
Co-Chair MacKinnon further queried whether "what the
President was doing was helping keep prices depressed for
America."
Mr. Tichotsky stated that when attempting to forecast price
the most useful tool was to understand the potential for
high and low price extremes and other complex factors. It
was impossible to pinpoint the global oil price on one
particular factor.
Co-Chair MacKinnon referred to the Keystone Oil Pipeline,
and wondered whether completion would affect "Alaska's
viability for production" or "create less incentive in
Alaska." She judged that the Keystone Pipeline would not
affect ANS. She believed that ANS was a "resource for all
of America." She stated that, "Saudi Arabia was controlling
the market right now" and wondered whether Keystone
affected Alaska.
Mr. Tichotsky responded that the Keystone Pipeline "was not
directly related to the west coast market." He delineated
that the Keystone Pipeline affected the WTI price by
exporting North American midland crude to the market. He
delineated that Alaska production did not control the price
and was sold into the west coast market, which was not
affected by the Keystone Pipeline. He noted that Ecuadorian
and East Siberian crude competed more directly with ANS.
Co-Chair Kelly handed the gavel over to Co-Chair MacKinnon.
10:11:17 AM
AT EASE
10:13:44 AM
RECONVENED
10:14:09 AM
AT EASE
10:14:46 AM
RECONVENED
Mr. Tichotsky referred to slide 17:
"Price Forecast Methodology"
Price Forecasting Session
•Held a day long oil price forecasting session on
October 7, 2014.
•Speakers provided insight into oil markets,
probability and analysis, modeling, and financial
aspects of commodity markets.
•37 participants from state government, academia and
the private sector.
•DOR, DNR, DOL, OMB, University, Legislative Finance
and outside participants.
•Participants were asked to forecast P10, median, and
P90 real ANS prices for the West Coast.
•Real prices were converted to nominal using a 2.25%
inflation assumption.
•Official forecast is based on probabilistic outcomes
from Price Forecast Session and DOR price model.
Mr. Tichotsky noted that representatives from the oil
industry did not participate in the forecasting session due
to anti-trust issues. He detailed that the department
sought a "P10" probability (probability of 10 percent) in
forecasting the low price and a "P90" probability when
establishing the price for ANS and West Coast Crude.
Senator Dunleavy wondered who participated in the oil
forecasting session since representatives from the oil
industry did not attend.
Mr. Tichotsky replied that the participants represented
experts and analysts who studied the oil industry, experts
from DOR, and analysts from other departments that had
developed expertise in oil and gas markets.
Senator Dunleavy wondered what the actual composition of
the participants were.
Mr. Tichotsky replied that the group was comprised of
Alaskan's who had the expertise, interest, and
qualifications to analyze the global markets and possessed
a strong knowledge of markets or the energy industry. The
day was spent listening to the experts. He stated that the
method was called a "modified Delphi process."
Senator Dunleavy asked how the individuals were selected.
Mr. Tichotsky responded that anyone with appropriate
knowledge or expertise of the energy industry from state
government, the private sector, or the university, may
participate. Journalists were prohibited from attending the
forecasting session.
Vice-Chair Micciche believed that commodity markets
typically had little effect from inflation. He wondered why
the department utilized a 2.25 percent inflation
assumption.
Mr. Tichotsky reminded the committee that oil is a U.S.
dollar dominated market. He pointed out that when analyzing
the "future nominal price of oil" an assumption on
inflation is mandatory and not unreasonable to factor in.
The department consistently utilized the inflation rate
provided by its contracted investment company, Callan
Associates. He indicated that the inflation assumption was
"especially critical in how it affected the price forecast
in the outer years." A forecasted price of $137/bbl. in
2025 amounted to $100 in real dollars because inflation
caught up to the price over time. He reiterated that DOR
believed that the long-term price of oil would eventually
recover to approximately $90bbl. to $100bbl. in real
dollars.
Mr. Tichotsky referred to slide 18:
"Fall 2014 ANS Revenue Forecast Prices"
Official forecast is one value within a range of
possible outcomes.
• Probabilities as of early December 2014
• FY 2015 & FY 2016 are from an internal DOR
probabilistic pricing model.
• FY 2017 and beyond are from the Fall 2014 price
forecast session held on October 7, 2014.
Mr. Tichotsky elaborated that the department used a
"probabilistic pricing model" that factored in the
"reversion to the mean;" "the likelihood that the price of
oil will revert to the current price of oil." Another
factor of the model analyzed "the chaos in the system," and
whether the current price of oil is a "jump event." He
defined a jump event as something out of the norm. He
judged that the current price of $50/bbl. of oil was a jump
event.
Mr. Tichotsky examined slide 19, "'What if the oil price is
…'" for the last half of FY 2015." He related that what
mattered was the average price of oil over a fiscal year.
The slide depicted the actual and estimated monthly price
of oil over FY 2015. He noted that prices were much higher
from July until October of 2014. If the price of oil
continued in the $50/bbl. range through June of 2015 the
lowest price for the fiscal year would be $68/bbl. The
average forecasted price in December 2014 for FY 2015 was
$77/bbl.
10:27:14 AM
Vice-Chair Micciche clarified that the nominal inflation
adjustment in the forecasted price "accounted for the
eventual purchasing power of the U.S. dollar versus the
value of the commodity."
Mr. Tichotsky responded that the inflation adjustment
represented the potential rate of real inflation to the
U.S. economy. He informed the committee that the department
issued a revenue forecast in nominal dollars and the
legislature budgeted in nominal dollars.
Senator Hoffman stated that the state's bond rating was
downgraded as the price of oil dropped below $50/bbl. He
asked whether the state's bond rating will rebound or be
further downgraded through 2025.
Commissioner Hoffbeck reported that the state's bond rating
was not downgraded. Moody's [bond rating agency] placed the
state on a "negative watch" but the state retained a Triple
A bond rating. The bond rating could be affected by how the
state reacted to the fiscal environment when budgeting
regarding: the size of government, continued savings, and
generating new sources of revenue.
Senator Hoffman wondered which factors were most important
to the rating agencies.
Commissioner Hoffbeck responded that the rating agencies
were most focused on the state expanding its revenue base.
Senator Olson asked whether Commissioner Hoffbeck was
advocating for a state income tax and if the administration
would be in favor of one.
Commissioner Hoffbeck replied that he was not advocating
for a state income tax and did not believe that the state's
policies should be dictated by rating agencies. He added
that Alaska was the most financially solid state in the
country.
Senator Olson asked whether the bond rating would change
significantly if the state instituted a state income tax.
Commissioner Hoffbeck answered in the negative.
Senator Bishop commented that he felt it was very important
for the state to maintain its Triple A bond rating.
Co-Chair MacKinnon wondered how a potential bond downgrade
would impact the state and whether the administration was
analyzing a bond downgrade scenario.
Commissioner Hoffbeck responded that DOR and the governor
was scheduled to meet with the rating agencies: Moody's,
Standard and Poor's, and Fitch on February 2 and February
3, 2015. He noted that the current oil markets do not
affect the price of borrowing because debt was inexpensive,
but that might not be the case in five or six years. He
maintained that the state needed to protect its Triple A
bond rating.
Co-Chair MacKinnon wondered what experts the new
administration retained in order to be prepared for meeting
with the bond rating agencies. She suggested that
inexperience within the governor's transition team when
conversing with the rating agencies coupled with the
precipitous decline in oil prices possibly contributed to
the bond rating downgrade discussion.
Commissioner Hoffbeck replied that he believed the price of
oil was the biggest driver of Moody's negative watch
announcement. He had confidence in the team assembled to
meet with the rating agencies. Every member had prior
experience presenting to the rating agencies. He felt that
the team was solid and the discussion would be robust.
Mr. Tichotsky interjected that he had worked as a credit
rating analyst with Fitch, and had experience with the
North Slope Borough. He thought that the team had expertise
on both the treasury and the tax side of the credit rating
issue. He surmised that forecasting revenue was useful not
only for budgeting purposes, but for the credit agencies to
understand how the state predicted its future revenue.
Co-Chair Kelly returned to the room.
Mr. Tichotsky referred to slide 20, "Historical ANS West
Coast FY OIL PRICE BANDS: ANNUAL AVERAGE AND OFFICIAL
FY2014 FORECAST" and articulated that the slide depicted
the actual price of oil averaged over a year, as well as
the highest and lowest "spot prices" from 2010 through
2014. He remarked that in 2013 and 2014 the price of oil
remained the same, and was an almost statistically
impossible occurrence. He observed that the forecasted
price (ranging from 2015 through 2025) depicted within a
range of high and low possibilities represented the
department's preferred method of forecasting the price of
oil. He understood the need for a specific number.
In response to a question by Senator Hoffman, Mr. Tichotsky
restated that slide 20 represented actual prices from 2010
through 2014.
10:39:25 AM
Mr. Tichotsky referred to slide 22, titled, "General Fund
Unrestricted Oil Revenues." The chart depicted the total
revenue broken down by revenue type with actual 2014 and
2015 prices and the forecasted price for 2016. He conveyed
that the net royalty was a "very important component to
revenue" and remained "relatively" stable with low oil
prices. He noted that the non-petroleum revenue (other
sources of economic activity) was approximately $500
million.
Commissioner Hoffbeck added that production taxes were
emphasized when discussing the value of Alaskan oil but
additionally, the Net Royalty component generated
substantial revenue.
Vice-Chair Micciche queried what assumptions the department
was making with regard to oil and gas property taxes.
Commissioner Hoffbeck replied that the value was tied to
the asset itself and not to the value of oil and was
relatively stable. He qualified that property taxes were a
cost-based model, and declined slightly over time due to
physical deterioration; calculated by replacement costs
minus depreciation.
10:43:27 AM
AT EASE
10:44:33 AM
RECONVENED
Co-Chair MacKinnon referred to the proposed natural gas
pipeline and the property tax valuation in relation to
municipalities. She remarked that some local communities
were "sensitive" to the valuation. As the valuation
increased the state received less and the municipalities
received more. She related that the previous administration
engaged in negotiations with municipalities to find a
resolution to the expensive property tax litigation brought
to the state by communities. She requested clarification on
how the current administration planned to address the
issue.
Commissioner Hoffbeck replied that legally, he could only
speak to the issue in generalities and reported that there
were two separate issues. One issue related to the
litigation regarding the existing trans-Alaska pipeline and
the other issue questioned how to move forward on the
gasline. Mediation over the trans-Alaska pipeline
litigation was scheduled to meet in February. The state,
municipalities, and the pipeline owners would attempt to
reach a long-term resolution on the value of a trans-Alaska
pipeline and the associated taxes.
Co-Chair MacKinnon queried whether the commissioner recused
himself from the litigation since he had litigated in the
past on behalf of municipalities and was strongly in favor
of the municipalities' position.
Commissioner Hoffbeck clarified that in 2006 he was the
primary witness for the state in his role as the state
assessor. In a subsequent trial, he was the expert witness
for the municipalities. He reasoned that "he should be able
to come up with the same answer on either side of the table
if he was really being honest about what" he did. He stated
that his testimony was not dramatically different for both
trials. He continued that he was the Finance Director for
the North Slope Borough and was a consultant for the
borough and the City of Valdez during property tax
litigation. He made a request to the attorney general's
office to review the issue and decide whether he should
recuse himself.
Co-Chair MacKinnon asked whether the attorney general
designee would make the decision in light of his
involvement in the issue on behalf of the municipalities.
Commissioner Hoffbeck replied in the negative and added
that another attorney was assigned to the issue.
Commissioner Hoffbeck continued that in relation to the
gasline he met with the municipal advisory group to discuss
"alternate ways of valuing the pipeline to make it more
stable and responsive to the economics of the project." He
noted that another meeting was scheduled to specifically
discuss the AKLNG project.
Co-Chair MacKinnon asked whether the meeting was a
"confidential meeting," and if he could share the items
under discussion.
Commissioner Hoffbeck answered that the group favored
discussing the PILT (payment in lieu of taxes) proposal.
Vice-Chair Micciche wondered if the negotiations with
municipalities over PILT were successful whether there was
"potential" that the PILT model might be used on the trans-
Alaska pipeline negotiations in the future.
Commissioner Hoffbeck stated that it was a possibility, but
municipalities were resistant to "tie the gasline issues
into existing assets and that it would be a difficult
discussion."
Vice-Chair Micciche thought that the issue divided Alaskans
for many years and that the PILT model was worthy of
consideration to resolve differences in the future.
Senator Hoffman asked about slide 22, "General Fund
Unrestricted Oil Revenues," and wondered whether the actual
revenues depicted were based on audits. He requested an
update on the department's progress of "audited taxes."
Commissioner Hoffbeck reported that the audit review
process began as soon as DOR received a return and that DOR
was approximately five and one half years behind in a six
year statute of limitations on several audits. The backlog
was largely created due to the implementation of a new tax
management system and took a vast amount of staff time. He
related that he had spoken with the Tax Division director
who assured the commissioner that the department would not
miss any audit deadlines and would catch-up within the next
few years.
Mr. Tichotsky referred to slide 23, titled, "General Fund
Unrestricted Revenues Non-Petroleum." The chart depicted
the total non-petroleum revenue broken down by revenue type
with actual 2014 and 2015 prices and the forecasted price
for 2016.
Co-Chair MacKinnon asked about the drop in investment
returns income between the actual reported amounts of $130
million in 2014 to a forecasted $30 million in 2015. She
wondered whether the figure represented the expected draw
on the states reserve accounts to balance the budget and if
the states rate of return on investments was predicted to
be lower than last year.
Mr. Tichotsky explained that the forecast for investment
returns was based on the average returns predicted by
Callan. Investment returns were "volatile" and average
predictions were not reliable in the short-term.
10:56:44 AM
Commissioner Hoffbeck interjected that he agreed with Co-
Chair MacKinnon's assumptions. The reserve draw and the
fact that currently, there was very little return on short-
term investment factored into the lower forecast. He
indicated that the major returns from the Permanent Fund
were not reflected in the forecast.
Co-Chair MacKinnon asked if DOR was currently attempting to
"move fixed assets into cash to meet the projected $3.4
billion revenue shortfall." She reminded the committee that
the $3.4 billion shortfall was only for the remainder of FY
2015.
Commissioner Hoffbeck answered in the affirmative.
Co-Chair MacKinnon believed that the future budget [FY
2016] was also projected to have a $3.4 billion shortfall.
Commissioner Hoffbeck replied in the affirmative.
Co-Chair MacKinnon asked how the administration was
prepared to meet the shortfall without proposing additional
revenue sources.
Commissioner Hoffbeck referenced a presentation by Pat
Pitney, Director, Office of Management and Budget that
demonstrated the shortfall could be met for "a couple" of
years from the state's savings accounts. Additional revenue
was needed in the future.
Co-Chair MacKinnon referred to slide 23 and queried whether
DOR was preparing for a cash draw. She thought that as the
state spent down its savings the state could not sell its
investments without taking "incredible losses." She
wondered how the department was strategizing on how to draw
on "more fixed" assets to meet the projected $3.4 billion
shortfall from savings. She believed that at current oil
prices the shortfall might amount to approximately $7
billion.
Commissioner Hoffbeck voiced that the assets were moved to
liquid assets as needed in a timely and programmatic way
looking into the future. He expounded that very little of
the assets were invested in longer term investments in
recognition of its future need so no loss was incurred but
by moving the assets into more liquid assets the amount of
returns were "dramatically reduced" as short-term
investments.
Co-Chair MacKinnon announced the "urgency" of the topic at
hand. She requested an accounting of the state's cash flow
and where the department was drawing the reserves from.
Commissioner Hoffbeck agreed to provide the committee with
the information.
Senator Hoffman referred to a presentation by the Director
of the Legislative Finance Division (LFD) that urged
discussions regarding generating additional revenues in
order to pass enacting legislation in the short-term. He
asked whether the department engaged in discussions about
how to generate potential revenue.
Commissioner Hoffbeck answered in the affirmative, and
shared that the governor was willing to engage in the
discussion.
Mr. Tichotsky turned to slide 24, titled, "Total Revenue
Forecast - FY 2015 and FY 2016." The chart reported the
2014 actual and FY 2015 and FY 2016 forecasted total
revenue and revenue broken down by revenue type. He shared
that in FY 2014 the state generated the second highest
overall total state revenues. He offered that the state was
well positioned in terms of wealth relative to other
states.
Mr. Tichotsky referred to slide 25, "FY 2016 General Fund
Unrestricted Revenue, With Price Sensitivity," and observed
that the graph demonstrated that in a lower price
environment the decline revenue curve tended to flatten out
and did not decline as greatly as revenues increased over
$80/bbl. He cited the charts on page 83 of the Revenue
Source Book and recommended that the committee refer to the
charts when inquiring what the state's revenue would be at
a particular price and production combination.
Mr. Tichotsky moved to slide 27, "Comparison - Fall 2014
vs. Spring 2014 Forecasts. He noted that the charts
highlighted the amount the forecasted figures had been
adjusted from the spring 2014 to the fall 2015 forecasts.
The forecasted price changed approximately 27 percent
(declined) for the current period and production numbers
increased [2.7 percent], which did not alter the effect of
low prices; a decrease of half of the projected revenue in
the current fiscal year. The slide depicted a similar
scenario in FY 2016.
In response to a question by, Co-Chair MacKinnon Mr.
Tichotsky restated that production estimates increased in
FY 2016.
Mr. Tichotsky identified slide 28, "Contributors of Change
in FY 2015 Revenue Forecast." He remarked that one
contributor of change in the revenue forecast was
production.
11:07:56 AM
Vice-Chair Micciche referred to the departments projected
revenue of $2.8 billion based on $66.03/bbl. in FY 2016
($2.2 billion in petroleum revenues and $5.7 billion in
non-petroleum revenues). He noted that the range of prices
forecasted was a low of approximately $40/bbl. to a high of
$85/bbl. and wondered how DOR responded when the price of
oil was in the bottom of the range.
Mr. Tichotsky responded that in terms of revenue
forecasting the difference was $1.6 billion to $1.8 billion
in revenue per year as opposed to $2.5 billion at $80/bbl.
The revenue difference in the low ranges was not as great
until prices rose to the higher end of the spectrum.
Mr. Tichotsky referred to slide 29, "Contributors of Change
in FY 2016 Revenue Forecast," and explained that the chart
depicted a considerably lower price than the forecasted
spring price and a production increase of 30 thousand
barrels per day.
Mr. Tichotsky moved to slide 31, "North Slope Operating
Expenditure Forecast Change," and detailed that the graph
depicted an increase in operating expenditure based on the
increase in investments over the previous spring forecast.
He reverted attention to slide 30, North Slope Capital
Expenditure Forecast change," and indicated that the
department was "overly optimistic" when forecasting the
timing of receiving capital expenditures. The expenditures
were anticipated to be greater than expected in spring
2014.
Commissioner Hoffbeck explained slide 32, "Net Tax Credits
Versus Production Tax," noting that the data had created
some controversy. He discussed that the light green bar on
the bar graph depicted production tax before any credits.
The darker green bar portrayed production tax after credits
used against tax liability. He communicated that not all
credits were considered costs. The difference between the
two bars indicated the cost of credits per barrel. He
observed that the 20 percent per barrel capital credits
under Alaska's Clear and Equitable Share (ACES) and its
replacement in SB 21 (SB 21 Oil and Gas Production Tax,
June 2013) were essential parts of the tax system, and were
accounted for before revenues. The differences between the
light green and dark green bar also represented the per
barrel allowances that were considered in the tax rate for
the companies that were actually producing and had a tax
liability. The dark green bar denoted approximately $500
million in FY 2015, which was the amount of tax the
producers were paying this fiscal year. The red bar (the
production tax net of refundable credits) which dipped
below the zero line in negative numbers, represented
credits that encouraged production namely, exploration and
new field development. The activity did not immediately
create a revenue stream and qualified as refundable
credits. He emphasized that the producers were paying
production taxes but the negative total (production tax net
of refundable credits) indicated by the red bar [in FY
2016] represented the state's investment in the future to
bring more production online. He judged that the issue was
not a "systemic problem" with the credits but indicated a
cash flow problem due to low oil prices. He surmised that
credits that spur investment in the future at times when
revenue was low were "painful" but remained crucial
investments for the future.
Co-Chair MacKinnon referenced an editorial written by
Governor Walker titled, "The Hard Truth about Alaska's Oil
Revenue." She perceived that the editorial attributed the
problem to the "big three" oil producers in the state [BP,
ConocoPhillips, and Exxon]. She clarified that an array of
oil producers paying taxes operated in the state and that
the three largest producers paid net positive taxes to the
state. She elaborated that the negative net number was
generated by producers who had zero tax liability. Under
the state's new tax regime a small producer's zero tax
liability could be purchased by the state. The negative
number represented credits to smaller producers to
"incentivize production." She asked the commissioner
whether he agreed with her assessment.
Commissioner Hoffbeck concurred with her statements.
Co-Chair MacKinnon continued that oil taxes accounted for
88 percent of Alaska's revenues. She referred to the
"Indirect Expenditure Report" sanctioned by the legislature
in 2014 and compiled by the Legislative Finance Division
with the help of DOR. She noted that the report showed
substantial reductions in [non-petroleum] revenue
authorized by the legislature in collaboration with the tax
paying entities and were established as far back as 1969.
She asked the commissioner to name the top five to ten tax
credits in order to determine those particular credits
value to the state.
Commissioner Hoffbeck was unable to provide the information
without review but agreed that the state's tax credits
needed to be re-examined to ensure they were achieving the
original goals. He would provide the information at a later
date.
Co-Chair MacKinnon noted that other types of tax credits in
other "revenue streams" did not generate revenues and
exemplified the Film Tax credit. She stated her support for
the film industry in Alaska and noted the benefit the
credit provided those employed in the industry. However,
she believed that tax credits and the resulting ceded
revenue needed to be re-examined in the face of multi-
billion dollar revenue shortfalls. She suggested that the
legislature develop a method for DOR to assign value to tax
credits and determine whether a particular tax credit would
generate future revenue for the state.
11:20:31 AM
Commissioner Hoffbeck responded that one element embedded
in the film tax credit was a pre-credit review and approval
process, which was missing from other tax credits. He
specified that one criteria considered was whether the
credit was in the best economic interest of the state and
believed that criteria should apply to every tax credit.
Vice-Chair Micciche believed that SB 21 was specifically
designed to induce "improvements" in the long-term. He
assumed that the credits predicted in the department's oil
production forecast included "the volume from undeveloped
resources and additional accelerated developed reserves."
He asked whether the credits reflected the category of
undeveloped resources that had a high probability of
producing a net positive outcome for the state.
Mr. Tichotsky replied in the affirmative. He explained that
the forecast examined the net investment effect on
production. He restated that the greater the investment the
greater the "production signal" the investment sends.
Co-Chair MacKinnon pointed out that the Cook Inlet tax
credits had zero liability, and that the Southcentral
region directly benefitted from the credits. She delineated
that the credits incentivized development as a solution to
the "brown outs" the area had been experiencing. The
majority of the refundable credits were associated with
South-Central and the Cook Inlet region of Alaska.
Commissioner Hoffbeck indicated that the refundable credits
were actually split fifty-fifty between Cook Inlet and the
North Slope. He pointed out that significant development
was presently occurring on the North Slope. The credits
"incentivized" and enhanced the oil and gas industry in
Cook Inlet.
Vice-Chair Micciche stated that North Slope production
generated revenue for the state and Cook Inlet production
served Southcentral Alaska's energy needs and reflected
"two very different production environments." He wondered
whether the administration shared his view.
Commissioner Hoffbeck replied that the Cook Inlet credits
were intended to create a stable gas supply for South-
central Alaska and that the purpose of credits for the
North Slope was to generate revenue for the state. He added
that the Tesoro Refinery in Southcentral also benefitted
from the incentive credits.
Senator Dunleavy inquired whether the administration was
considering revising the tax regime instituted in SB 21 in
the near-term.
Commissioner Hoffbeck responded in the negative. He
believed that the new tax system needed time to develop to
determine whether it was producing the intended results.
Co-Chair Kelly did not agree with the administrations
initial response to the issue of oil tax credits. He
believed that false information was disseminated in the
press around the issue of oil tax credits and that it was
unfortunate that the citizens of Alaska had to "mistakenly"
make decisions about oil industry taxes and production
based on falsehoods. He referred to the editorial piece by
Governor Walker, and felt that it aligned with the
"nontruths" circulated about the credits and "hit" the
legislature "hard." He referred to press reporting that he
believed misrepresented the facts regarding SB 21. He
maintained that SB 21 rectified a previous tax system that
wrote "huge checks to the oil industry." He found it
"difficult to navigate" the situation while misinformation
was being circulated and believed that in regards to his
editorial the governor was misinformed. He was encouraged
that the administration had no intention to revisit SB 21
and felt that the tax overhaul already had a positive
effect on production while sending a message of "stability"
to the industry. He concluded that the legislature had
worked arduously on the issue of tax credits and believed
that the Governor was acting responsibly with a restrained
approach to SB 21.
Co-Chair MacKinnon clarified that the Cook Inlet loss carry
forward credits expired January 1, 2016.
Mr. Tichotsky referred to slide 33, "Fall 2014 Total
Revenue Forecast," and observed that the graph demonstrated
the historic variability of the state's revenue sources
(non-petroleum, petroleum, federal, and investments) but on
average more stability was predicted in the future.
Mr. Tichotsky referred to slide 34, "Unrestricted Revenue
Forecast 2015-2023," and noted that the chart depicted the
department's belief that oil prices were expected to
recover over the longer-term and that production was
expected to increase in the short to mid-term. The
production decline beginning in 2019 was due to uncertainty
by forecasting that far into the future. Deductible lease
expenditures were anticipated to increase due to the
additional production which also affected the state's
revenue. Revenues in the $2.5 billion range were expected
in the short-term. The graph included the production tax
value per taxable barrel.
11:33:46 AM
Vice-Chair Micciche agreed with the departments forecasting
methodology but expressed concern that the forecasted price
of $66.03/bbl. was 42 percent above the current price of
oil.
Mr. Tichotsky replied that the revenue forecast "is what it
is" and that "perfect knowledge" was not available. He
voiced that the revenue forecast provided a "multi-use
tool" for budgeting, planning, and the bond rating
agencies. He felt that "overall" the revenue forecast
served the users well.
Senator Dunleavy noted the forecasted "significant
production decline" and asked for clarity.
Mr. Tichotsky reiterated that the decline represented the
uncertainty in forecasting production into the longer-term.
Senator Bishop referred to the Cook Inlet credits, and
related that the credits had "eliminated a lot of fear in
Southcentral Alaska" and that similar credits could benefit
energy needs in other parts of the state.
In response to a question by Senator Hoffman, Mr. Tichotsky
replied that the asterisk on slide 34 next to general fund
unrestricted revenues was there inadvertently.
In response to a question by Co-Chair MacKinnon, Mr.
Tichotsky replied that the footnote on slide 33 that read,"
GFUR did not reflect true investment revenue forecast" was
also not relevant.
Co-Chair MacKinnon referred to the red line projecting
federal revenues of $3.1 billion on slide 33, and wondered
whether the figure included federal monies from "the
increase with Medicaid."
Mr. Tichotsky replied in the negative. He elaborated that
typically $3.1 billion of federal revenue was allocated but
approximately 20 percent to 30 percent less (approximately
$2.4 billion) was actually spent.
Vice-Chair Micciche believed that Commissioner Hoffbeck was
"extremely fair on the positive net effects of SB 21." He
calculated that the net positive to the state from the new
production tax of 35 percent base tax and sliding scale at
current prices was well over $200 million as opposed to the
previous tax regime. He wondered whether DOR had done any
calculations regarding the differences in revenue between
the previous [ACES] and new tax systems.
Commissioner Hoffbeck replied that he had not performed any
recent calculations but agreed that "a substantial uplift"
had occurred with low oil prices because of the "minimum
tax floor."
Co-Chair Kelly asked whether SB 21 "tended" to raise more
revenue with low oil prices than ACES.
Commissioner Hoffbeck responded in the affirmative and
furthered that when the minimum tax threshold was reached,
SB 21 raised "substantially more" revenue.
ADJOURNMENT
11:42:05 AM
The meeting was adjourned at 11:42 a.m.
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