HOUSE FINANCE COMMITTEE January 10, 1996 1:35 P.M. TAPE HFC 96 - 1, Side 1, #000 - end. TAPE HFC 96 - 1, Side 2, #000 - #399. CALL TO ORDER Co-Chair Mark Hanley called the House Finance Committee meeting to order at 1:35 P.M. PRESENT Co-Chair Hanley Representative Martin Co-Chair Foster Representative Mulder Representative Brown Representative Navarre Representative Grussendorf Representative Parnell Representative Kelly Representative Therriault Representative Kohring ALSO PRESENT Representative Ivan Ivan; Representative John Davies; Representative Bettye Davis; Wilson Condon, Commissioner, Department of Revenue; Dr. Charles Logsdon, Chief Petroleum Economist, Department of Revenue; Mike Greany, Director, Legislative Finance Division; Richard Pegues, Director, Administrative Services Division, Department of Law. SUMMARY DEPARTMENT OF REVENUE - FALL REVENUE FORECAST WILSON CONDON, COMMISSIONER, DEPARTMENT OF REVENUE introduced Dr. Charles Logsdon, Chief Petroleum Economist, Department of Revenue. Commissioner Condon referenced charts included in the Revenue Update Hearing packet provided to Committee members by the Department of Revenue. [Attachment #1]. Commissioner Condon provided a review of the charts in the Department's 1995 fall forecast of unrestricted general fund revenues and the State's oil production cost. The Spring 1995 revenue forecast predicted the State would receive $1.8 billion dollars in general fund unrestricted revenue, although, the closing price is anticipated to be $2.7 billion dollars. Given the difference, the State Treasury will receive $194.5 million dollars more than anticipated in unrestricted revenue. 1 Commissioner Condon summarized areas in which a divergence from the spring revenue forecast existed: Corporate income tax, miscellaneous other taxes, resource sales, investment earnings, rents, royalties and miscellaneous revenues. Representative Martin questioned the $900 million dollar Constitutional Budget Reserve (CBR) payback decreed by the court. He understood more funds should be available this year for distribution resulting from the payback. Commissioner Condon countered that the full amount had not been removed from the account, and stressed that those funds would not be available. CHARLES LOGSDON, DR., CHIEF PETROLEUM ECONOMIST, DEPARTMENT OF REVENUE, pointed the Committee members had received in their packet a FY 1996 Petroleum Revenue Update from the Department of Revenue. Dr. Logsdon referred to a series of charts which compare the FY 1996\FY 1997 revenue base case scenario. The Department of Revenue assumes that FY96 will generate $1.8 billion dollars in revenues from unrestricted general fund. The key oil providers would be Alaska North Slope Oil (ANS) at 1.49/bbl providing $16.36 per barrel. He advised that this year, production has not matched the State's expectation and that the State is currently 13 thousand barrels a day under the targeted amount. At this point, production is up. Dr. Logsdon summarized fundamental points of the world oil market which underlines the forecast. He noted that the demand for oil is strong, interjecting that as the world economy grows, so the demand for oil increases. He continued that FY97 and FY96 assume similar international oil prices, although, less oil per day will be pumped. Dr. Logsdon added, the fundamental assumptions critical to the projections were "rocky" oil prices. At the same time, the Department assumes that the embargo will not be lifted. The demand for oil has been trending globally upward with a 2% increase per year. Dr. Logsdon added that there have been concerns with the Organization of Oil Exporting Countries (OPEC) market share. The market predicts that oil prices should be coming down with increased OPEC oil production, squeezing the market shares. Current oil production forecasts do reflect that information. Dr. Logsdon emphasized that current base price predictions do support the evidence. Dr. Logsdon addressed the possibility of lifting the export ban, resulting in an additional $40 million dollar revenue. By lifting the ban, Alaska will obtain the best possible price for their oil and also a price base for rural market 2 trade. In response to a concern of Representative Martin, Dr. Logsdon stressed that Venezuela was currently a member of OPEC and in agreement to follow production quotas. He reminded members that all countries involved with OPEC want to increase production. Dr. Logsdon added that Alaska oil would always be the most desireable crude oil on the west coast, although, by lifting the ban, oil sales could then move to the Far East market. Co-Chair Hanley questioned production reductions. Commissioner Condon explained that change resulted from differing oil and gas forecast predictions. The change in the projected volume forecast resulted from an incorrect analysis of prediction methods used in the past. The double counting effect had been in place during the Fall 1994 forecast. To date, the State has not researched systems used before that date. Co-Chair Hanley provided Committee members with a comparison sheet of FY96\FY97 revenue base case scenario. [Attachment asked if that resulted from an incorrect analysis. Commissioner Condon stated that the current charts will provide more accurate information. Representative Mulder inquired if the oil pipelines could be shifted for use of natural gas. Commissioner Condon explained that to consider a shift of line use would depend on the market value of gas. He stressed that putting the gas back into the ground would maximize liquid oil production. By the year 2010, the amount of oil lost by use of the gas would be substantially lower and would then be a more reasonable investment. (Tape Change, HFC 96 - 2). Representative Mulder asked if there would be any completion of tax dispute settlements this year and what the cumulative value of those disputes would be. Commissioner Condon was not aware of any cases at this time which were close to resolution. He added that the pending amount owed to the State was $1.5 billion dollars. Representative Parnell questioned a FY 95 Supplemental request made to the Department of Law in the amount of $2 million dollars which would be paid to a law firm to cover costs for an analysis of the Department of Revenue's forecasting methodology. Commissioner Condon explained that an extremely complicated revenue forecast program had been used by the Department of Revenue for many years. An agreement was made with the Department of Law and the 3 Preston Law Firm in November 1995 to review that situation. The assistance was utilized in order to create a complete documentation of the program currently used by the Department of Revenue. Representative Parnell requested copies of correspondence between the two departments indicating that decision. Commissioner Condon was not aware of any correspondence resulting from that decision. He added that the forecasting model had been the focus of concern and attention during the State's oil and gas litigation. Co-Chair Hanley interjected that the amount had been reported as an encumbrance within the supplemental, and the surplus amount should have lapsed into the general fund. Co-Chair Hanley questioned the Department of Revenue's choice of the Department of Law to obtain modeling information and funding. Commissioner Condon advised that when a review of a revenue forecast occurs, a party that understands how the State of Alaska obtains revenue is solicited. He continued, that the Department of Law understands how the economy within Alaska works and therefore would be an appropriate choice to overview the law firm and audit chosen. Co-Chair Hanley suggested the possibility of a conflict of interest to choose a law firm that provides litigation to perform the audit and then suggest changes to the modeling procedures. RICHARD PEGUES, DIRECTOR, DIVISION OF ADMINISTRATIVE SERVICES, DEPARTMENT OF LAW, acknowledged that $100 thousand dollars had been encumbered for the above mentioned needs, adding that the $2 million encumbered dollars would be used for a block of work. He stressed that the budget request in FY96 had been reduced by $4 million dollars. Co-Chair Hanley voiced concern that $2 million had been encumbered in the FY96 Supplemental, although should have been used in FY95. He concluded that either the FY96 budget had been under funded or that the Legislature had not been adequately informed of all situations affecting the budget during the hearings. In response to a question by Representative Martin regarding the taps tariff, Dr. Logsdon referenced a chart in Attachment #1. The taps tariff recent filing represents the first result of a major attempt by Alyeska to reduce operating expenses. Lower expenses this year will affect the projected costs for future years. Dr. Logsdon concluded that inflation will also affect costs and profitability of the pipeline. Production also will affect the taps tariff by establishing a method of calculation; the anticipated costs per year would be divided 4 by the anticipated cost per barrel for shipment. The tariff would be driven by inflation and those costs would increase as a result of less barrels of oil extracted to handle the increased costs. ADJOURNMENT The meeting adjourned at 2:40 P.M. HOUSE FINANCE COMMITTEE January 10, 1996 1:35 P.M. TAPE HFC 96 - 1, Side 1, #000 - end. TAPE HFC 96 - 1, Side 2, #000 - #399. CALL TO ORDER Co-Chair Mark Hanley called the House Finance Committee meeting to order at 1:35 P.M. PRESENT Co-Chair Hanley Representative Martin Co-Chair Foster Representative Mulder Representative Brown Representative Navarre Representative Grussendorf Representative Parnell Representative Kelly Representative Therriault Representative Kohring ALSO PRESENT Representative Ivan Ivan; Representative John Davies; Representative Bettye Davis; Wilson Condon, Commissioner, Department of Revenue; Dr. Charles Logsdon, Chief Petroleum Economist, Department of Revenue; Mike Greany, Director, Legislative Finance Division; Richard Pegues, Director, Administrative Services Division, Department of Law. SUMMARY DEPARTMENT OF REVENUE - FALL REVENUE FORECAST WILSON CONDON, COMMISSIONER, DEPARTMENT OF REVENUE introduced Dr. Charles Logsdon, Chief Petroleum Economist, Department of Revenue. Commissioner Condon referenced charts included in the Revenue Update Hearing packet provided to Committee members by the Department of Revenue. [Attachment #1]. Commissioner Condon provided a review of the charts in the Department's 1995 fall forecast of unrestricted general fund 5 revenues and the State's oil production cost. The Spring 1995 revenue forecast predicted the State would receive $1.8 billion dollars in general fund unrestricted revenue, although, the closing price is anticipated to be $2.7 billion dollars. Given the difference, the State Treasury will receive $194.5 million dollars more than anticipated in unrestricted revenue. Commissioner Condon summarized areas in which a divergence from the spring revenue forecast existed: Corporate income tax, miscellaneous other taxes, resource sales, investment earnings, rents, royalties and miscellaneous revenues. Representative Martin questioned the $900 million dollar Constitutional Budget Reserve (CBR) payback decreed by the court. He understood more funds should be available this year for distribution resulting from the payback. Commissioner Condon countered that the full amount had not been removed from the account, and stressed that those funds would not be available. CHARLES LOGSDON, DR., CHIEF PETROLEUM ECONOMIST, DEPARTMENT OF REVENUE, pointed the Committee members had received in their packet a FY 1996 Petroleum Revenue Update from the Department of Revenue. Dr. Logsdon referred to a series of charts which compare the FY 1996\FY 1997 revenue base case scenario. The Department of Revenue assumes that FY96 will generate $1.8 billion dollars in revenues from unrestricted general fund. The key oil providers would be Alaska North Slope Oil (ANS) at 1.49/bbl providing $16.36 per barrel. He advised that this year, production has not matched the State's expectation and that the State is currently 13 thousand barrels a day under the targeted amount. At this point, production is up. Dr. Logsdon summarized fundamental points of the world oil market which underlines the forecast. He noted that the demand for oil is strong, interjecting that as the world economy grows, so the demand for oil increases. He continued that FY97 and FY96 assume similar international oil prices, although, less oil per day will be pumped. Dr. Logsdon added, the fundamental assumptions critical to the projections were "rocky" oil prices. At the same time, the Department assumes that the embargo will not be lifted. The demand for oil has been trending globally upward with a 2% increase per year. Dr. Logsdon added that there have been concerns with the Organization of Oil Exporting Countries (OPEC) market share. The market predicts that oil prices should be coming down with increased OPEC oil production, squeezing the market 6 shares. Current oil production forecasts do reflect that information. Dr. Logsdon emphasized that current base price predictions do support the evidence. Dr. Logsdon addressed the possibility of lifting the export ban, resulting in an additional $40 million dollar revenue. By lifting the ban, Alaska will obtain the best possible price for their oil and also a price base for rural market trade. In response to a concern of Representative Martin, Dr. Logsdon stressed that Venezuela was currently a member of OPEC and in agreement to follow production quotas. He reminded members that all countries involved with OPEC want to increase production. Dr. Logsdon added that Alaska oil would always be the most desireable crude oil on the west coast, although, by lifting the ban, oil sales could then move to the Far East market. Co-Chair Hanley questioned production reductions. Commissioner Condon explained that change resulted from differing oil and gas forecast predictions. The change in the projected volume forecast resulted from an incorrect analysis of prediction methods used in the past. The double counting effect had been in place during the Fall 1994 forecast. To date, the State has not researched systems used before that date. Co-Chair Hanley provided Committee members with a comparison sheet of FY96\FY97 revenue base case scenario. [Attachment asked if that resulted from an incorrect analysis. Commissioner Condon stated that the current charts will provide more accurate information. Representative Mulder inquired if the oil pipelines could be shifted for use of natural gas. Commissioner Condon explained that to consider a shift of line use would depend on the market value of gas. He stressed that putting the gas back into the ground would maximize liquid oil production. By the year 2010, the amount of oil lost by use of the gas would be substantially lower and would then be a more reasonable investment. (Tape Change, HFC 96 - 2). Representative Mulder asked if there would be any completion of tax dispute settlements this year and what the cumulative value of those disputes would be. Commissioner Condon was not aware of any cases at this time which were close to resolution. He added that the pending amount owed to the State was $1.5 billion dollars. 7 Representative Parnell questioned a FY 95 Supplemental request made to the Department of Law in the amount of $2 million dollars which would be paid to a law firm to cover costs for an analysis of the Department of Revenue's forecasting methodology. Commissioner Condon explained that an extremely complicated revenue forecast program had been used by the Department of Revenue for many years. An agreement was made with the Department of Law and the Preston Law Firm in November 1995 to review that situation. The assistance was utilized in order to create a complete documentation of the program currently used by the Department of Revenue. Representative Parnell requested copies of correspondence between the two departments indicating that decision. Commissioner Condon was not aware of any correspondence resulting from that decision. He added that the forecasting model had been the focus of concern and attention during the State's oil and gas litigation. Co-Chair Hanley interjected that the amount had been reported as an encumbrance within the supplemental, and the surplus amount should have lapsed into the general fund. Co-Chair Hanley questioned the Department of Revenue's choice of the Department of Law to obtain modeling information and funding. Commissioner Condon advised that when a review of a revenue forecast occurs, a party that understands how the State of Alaska obtains revenue is solicited. He continued, that the Department of Law understands how the economy within Alaska works and therefore would be an appropriate choice to overview the law firm and audit chosen. Co-Chair Hanley suggested the possibility of a conflict of interest to choose a law firm that provides litigation to perform the audit and then suggest changes to the modeling procedures. RICHARD PEGUES, DIRECTOR, DIVISION OF ADMINISTRATIVE SERVICES, DEPARTMENT OF LAW, acknowledged that $100 thousand dollars had been encumbered for the above mentioned needs, adding that the $2 million encumbered dollars would be used for a block of work. He stressed that the budget request in FY96 had been reduced by $4 million dollars. Co-Chair Hanley voiced concern that $2 million had been encumbered in the FY96 Supplemental, although should have been used in FY95. He concluded that either the FY96 budget had been under funded or that the Legislature had not been adequately informed of all situations affecting the budget during the hearings. In response to a question by Representative Martin regarding the taps tariff, Dr. Logsdon referenced a chart in Attachment #1. The taps tariff recent filing represents the 8 first result of a major attempt by Alyeska to reduce operating expenses. Lower expenses this year will affect the projected costs for future years. Dr. Logsdon concluded that inflation will also affect costs and profitability of the pipeline. Production also will affect the taps tariff by establishing a method of calculation; the anticipated costs per year would be divided by the anticipated cost per barrel for shipment. The tariff would be driven by inflation and those costs would increase as a result of less barrels of oil extracted to handle the increased costs. ADJOURNMENT The meeting adjourned at 2:40 P.M. 9