HOUSE FINANCE COMMITTEE January 20, 1998 1:40 P.M. TAPE HFC 98 - 2, Side 1. TAPE HFC 98 - 2, Side 2. TAPE HFC 98 - 3, Side 1. CALL TO ORDER Co-Chair Hanley called the House Finance Committee meeting to order at 1:40 P.M. PRESENT Co-Chair Hanley Representative Kelly Co-Chair Therriault Representative Kohring Representative J. Davies Representative Martin Representative G. Davis Representative Moses Representative Foster Representative Mulder Representative Grussendorf ALSO PRESENT Dr, Charles Logsdon, Chief Petroleum Economist, Division of Oil & Gas Audit, Department of Revenue; Wilson Condon, Commissioner, Department of Revenue; Anne Louise Hittle, (testified via teleconference), Director, World Oil Product Line, Cambridge Energy Research Associates, Boston, Mass.; Representative J. Allen Kemplen; Representative Bill Williams; Representative Brian Porter; Speaker Gail Phillips; Representative Gene Kubina. SUMMARY STATE REVENUE FORECAST PRESENTATION Co-Chair Hanley called the House Finance Committee meeting to order at 1:40 P.M. He questioned if there currently exists a fundamental shift in oil prices and if so, what would that projection be. He pointed out that this analysis could cause the Legislature to make budget changes. ANNE LOUISE HITTLE, (TESTIFIED VIA TELECONFERENCE), DIRECTOR, WORLD OIL PRODUCT LINE, CAMBRIDGE ENERGY RESEARCH ASSOCIATES (CERA), BOSTON, MASS., provided background information on CERA, a consulting firm which makes independent and objective analysis on what is occurring in the world energy industry. CERA has offices based throughout the world. Ms. Hittle presented four factors, which if they occurred could place the present market at risk. Between September and October 1997, three of the four did occur. 1. A prolonged and worsening outcome to the Asian currency crisis. 2. Mild winter weather in key regions of the world. 3. A weakening of the key consuming nations economy. 4. An increase in the volume of oil Iraq is allowed to export under the Limited Oil Sales Plan with the United Nations. Ms. Hittle reiterated that unfortunately, three of the above four factors have currently unfolded in the world. The only one, which did not, was #3 creating a big dent to the oil demand. The market has factored in the possibility of a fifty percent increase in the amount of oil allowed Iraq. That would mean an additional 400 thousand barrels of oil per day coming into the market. The unfolding of these points has helped to drive the oil prices down. At the Organization of Petroleum Exporting Countries (OPEC) meeting in November, 1997, the Saudi's, Kuwait and UAE gained higher quota's receiving an increased market share from 8 million to 8.7 million barrels per day. Representative Martin questioned the impact of production from Russia, Venezuela, Columbia and Viet Nam. Ms. Hittle responded that those countries would be affected by the non-OPEC supply, a projected increase of 1.2 million barrels per day. She added, a large amount of that increase would result from Venezuela, Algeria and Gutar. The former Soviet Union (FSU) production was up in 1997 because of the political situation happening in that area. In 1998, the FSU capacity will increase by 100 thousand barrels a day, resulting from production in the Caspian Region. She believed that by the year 2002, the capacity out of the former Soviet Union would be a 600 thousand- barrel per day increase. Representative John Davies asked if the FSU numbers had been included in the non-OPEC totals. Ms. Hittle replied that in 1998, FSU would not be a big contributor to the increase in the non-OPEC production. The areas affecting that market will be the North Sea and Columbia. A large increase to production has not been factored in the "capacity" numbers. Speculation suggests that the projected North Sea production will be peaking out around the year 2002. Representative John Davies questioned the "reduction in demand" number was arrived at. Ms. Hittle noted that adjustments had been made indicating actions taken. At this time, loosing the Asian demand allowed the supply to pull ahead. The outlook for growth takes the current crisis in the Asian-Pacific area into consideration, moving downward 380 thousand barrels per day since the middle of 1997. CERA will readdress the demand outlook for that region numbers on the downhill side because of the volatility of that market. She continued, China has not been revised downward, as there are no signs of slowdown in the oil growth in that Asian market. Japan and the Asian Pacific market have been revised downward 50 thousand barrels per day with an expected growth of 100 thousand barrels per day. Ms. Hittle provided the Committee with a handout titled: The 1995-99 Oil Price Environment: ANS. (Attachment #1 - Copy on File). The outlook indicates an increase for Iraq and assumes that OPEC will total about 29 million barrels per day. OPEC could decide to take action later this year, an action that should be watched. Ms. Hittle explained that the handout indicates even with a modified good sweating, Iraq will be in and out as the currency crisis deepens. Co-Chair Hanley asked if Cambridge Energy Research Associates (CERA) provided future forecasting and if they saw a long-term fundamental shift affecting prices from last year. Ms. Hittle acknowledged that her firm has provided a projected scenario outlook into the year 2010. 1997 is a time of transition given the scenario occurring in Asia. Projected numbers indicate that in the year 2000, the picture should improve with a price moving closer to $18.50 per barrel based on the assumption that the Asian currency crisis will start to recover in 1999. There will most likely continue to be an over supply. The production outlook for 1999 is 80.6 million barrels per day. Currently, there is 78.5 million barrels per day being pumped. Present predictions indicates that sometime between the years 2002 - 2003, the market will become tighter and there will be an over-supply. Ms. Hittle summarized that CERA strongly believes in the volatility of the current market, although, higher levels could occur depending on the Iraq situation. Next year there will be a surplus amount of oil. (Tape Change, 98-2, Side 2). WILSON CONDON, COMMISSIONER, DEPARTMENT OF REVENUE, noted that the Department made their annual long term revenue forecast in November, 1997, as 75% of the State's unrestricted general fund revenue derives from oil and gas production price and volume. In November, the Department predicted an average for FY98 of $18.11 cents per barrel and in FY99, $18.22 per barrel. He added that since the November forecast, the world situation has changed which will affect projected prices. To date, there has been a $5 dollar per barrel drop from the Alaska North Slope oil (ANS) price. Based on this outlook, the Department is predicting that prices for FY98 will average out at about $16.65 per barrel. The Department does not think that today's lower prices indicate a longer-term decline in the ANS trading range. Commissioner Condon provided Committee members with Attachment #2, a list of charts pertaining to the Alaska North Slope projection. (Copy on File). He provided a brief review of Pages 1 and 2, pointing out that prices have ranged between $14.00 and $20.50 per barrel. DR. CHARLES LOGSDON, CHIEF PETROLEUM ECONOMIST, DIVISION OF OIL & GAS AUDIT, DEPARTMENT OF REVENUE, referenced Page 3, the ANS West Spot (May 1987 - Jan 1998). He pointed out that in previous years, the prices have dropped below $14.00 per barrel and that this scenario will most likely occur again, adding however, that Alaska has recovered from every slump. He provided a brief history of the crash and rise of oil prices. Dr. Logsdon acknowledged that the financial trouble in Asia could have echo effects across world economy, and would show up as a reduced demand for crude oil in those countries. Page 4 indicates how the forecast illustrates what the future market prices will be. Co-Chair Hanley understood that the spring forecast projections for last year were $18.70 per barrel. Last year's budget was based on an amount higher than $18.11. He pointed out that there has been a fundamental shift between the fall forecast and the spring forecast. Dr. Logsdon agreed and noted that in the fall, there had been 10 months of declining prices, which will show in the FY98 and the FY99 forecast numbers. Dr. Logsdon continued, Page 5 provides three scenarios for the unrestricted general fund revenues for the different oil prices. The decline results from a production decline mode. The average price from 1987 through 1997 was $17.35 per barrel. Page 6 illustrates the long-term forecast of base price in the year 2000. When compiling the fall forecast, the State reviewed a couple of long term trends. The first trend being the growth demand. There has been a tremendous rate of growth throughout the world, however, there is an additional scenario associated with that kind of a demand. Given the rapid expansion and increase in the consumption of oil also means a rapid increase pumped into the atmosphere affecting global warming. Dr. Logsdon stressed that the issue of atmospheric pollution is not going away. The other concern affecting the current price scenario is the supply. At this time, there exists a tremendous evolution in technology allowing the oil reserve base to increase dramatically. The combination of demand and supply will determine the "call" on the oil price. Page 6 provides the long run forecast provided by world entities in October 1997. In the year 2000, the expected range appears to be between $15 - $19 dollars. The Department of Energy has predicted the highest price forecast. Dr. Logsdon continued, Page 7 provides a graphed illustration of the 2005-forecasted ANS price. Prices at this time appear to have flattened out resulting from the International Energy Administration high scenario prices. He pointed out that the Department of Revenue projection was at the low end. He agreed that current events in Asia are "big" enough to change the field of play, and at this time the outcome is not clear. Dr. Logsdon noted that Page 8 illustrates the long-term oil production forecast. He stated that 1989 was at peak with a production of 2 million barrels per day. Currently, the State of Alaska is producing 1.35 million barrels per day. There is need to produce a higher amount as a result of low summer month production. Beginning in FY2000, we should be up in production to 1.355 million barrels per day after having bottomed out in FY99 at 1.3 million barrels per day. An increase has resulted from development of new fields. Page 9 illustrates the Alaska North Slope decline rates at three fields in Prudhoe Bay, Kuparuk and Endicott. Page 10 charts a rough diagram of how those changes affect decline curves. Co-Chair Hanley advised that the charts indicate that in the future there will be a decline in the oil income, stating that there will be problems keeping up with the decline. Co-Chair Therriault added that with this decline, cash flow to the treasury would decline. He emphasized that the statement "No decline after `99", refers to the production of a barrel of oil, not equating to funds in the State Treasury. He believed that there will be a problem for the future because of the declining curve. Representative J. Davies asked if the determination made on Page 10 assumed that there would be no new wells. Dr. Logsdon replied that there has been assessed oil in other places although the Page 10 indication does not include those wells. The forecast only contains wells which the Department of Revenue is comfortable guaranteeing. In response to Representative J. Davies, Dr. Logsdon stated that there would not be large shift opportunity in the State. Commissioner Condon amplified previous comments noting that in 1991 the Department modified the way in which it undertook volume forecasting. In 1999, the Department predicts that there will be a higher rate of production growth than that in 1991. Reviewing the past seven years, the production rates will most likely to be steady and will require new discoveries. (Tape Change HFC 98-3, Side 1). In response to Representative Grussendorf, Commissioner Condon explained that product prices nationwide are down as compared to crude oil prices resulting from the "squeeze" on the refiners rather than the "squeeze" to producers. Representative Martin stated that oil production is the most important key to Alaska's future. Dr. Logsdon spoke to the oil projects currently on target noting that Pt. Thompson is a long distance from the pipeline and that Endicott has declined capacity. Representative Martin suggested the need for more incentive programs. Commissioner Condon commented that the Legislature has taken measures to encourage incentives by fashioning the production tax so that it imposes a low or no tax on marginal operations. Gas development incentives on the North Slope will also be considered by the Legislature this year and that a final decision on North Star is pending. Representative Mulder asked how long the State could ride the current crisis before reevaluating. Commissioner Condon stressed that at all times it is important to be accountable, reevaluating the State's position. Dr. Logsdon noted that it takes a while before a consensus can be determined. A year could provide the necessary amount of time to ascertain adjustments in the longer term outlook. ADJOURNMENT The meeting adjourned at 3:00 P.M. H.F.C. 7 1/20/98