MINUTES SENATE FINANCE COMMITTEE January 20, 1999 9:01 AM TAPES SFC-99 # 1, Side A & Side B CALL TO ORDER Co-Chair Sean Parnell convened the meeting at approximately 9:01 AM. PRESENT Senator Sean Parnell, Senator John Torgerson, Senator Randy Phillips, Senator Dave Donley, Senator Loren Leman, Senator Gary Wilken, Senator Lyda Green, Senator Pete Kelly, and Senator Al Adams. Also Attending: Wilson Condon, Commissioner, Department of Revenue; Deborah Vogt, Deputy Commissioner, Department of Revenue; Ross Kinney, Deputy Commissioner, Department of Revenue; Brett Fried, Division Of Income and Excise Audit, Department of Revenue; David Teal, Director, Division of Legislative Finance; Phil Okeson, Ginger Blaisdell, Fiscal Analysts, Division of Legislative Finance; and aides to committee members and other members of the Legislature. SUMMARY INFORMATION Co-Chairs Parnell and Torgerson introduced Senate Finance Committee staff and their prospective office staff. Under other "housekeeping" duties, Senator Al Adams and Senator Dave Donley resolved differences left from the previous session. Co-Chair Sean Parnell introduced WILLIAM CONDON, Commissioner of Department of Revenue, whom in turn introduced Chuck Logsdon and Brett Fried. Mr. Condon explained to the committee how the department made its annual forecasts. He told them that it involves people from many other areas of state government, was done twice a year, a short-term forecast in April then a long- term price forecast in November He detailed the eight Department of Revenue staff involved in the process along with research staff from Department of Labor, Office of Management and Budget and the University of Alaska. The group also included an observer from Division of Legislative Finance. He explained that considerations for separation of power stipulated that the Division of Legislative Finance did not participate in decision making. Mr. Condon referred to the process as a "bottom-up" process, which looked at supply and demand, reviewing events in producing regions and all the consuming regions of the world. Then a judgement was made concerning the business as well as the politics. He then talked about how the department did a volume production forecast. He said a petroleum engineer was on contract with the department along with others from Division of Oil and Gas, Department of Natural Resources and staff from Oil and Gas Conservation Commission. The review was done on a field by field or prospect by prospect basis. It did not include undiscovered hydrocarbons. It did however make judgements about hydrocarbons that had been discovered in the likelihood of being developed. After making those judgements, the group did a detailed review of both approved and proposed plans of operation with respect to discoveries and producing areas that are being forecasted. Once the internal review was complete the group approached the North Slope operators with the forecast and the operator's approved plans of operations for review and consensus. This was the method for determining a production volume forecast. Mr. Condon then reviewed the price forecast the department had made for the current and the next fiscal years. He spoke of the FY99 forecasted price of $13.80 per barrel of oil and FY00 of $15.20. However, he stated, events from the OPEC meeting held after the forecast was made official plus other events during that time, made it clear that the judgements made in the official forecast would not be the case. Mr. Condon referred to the December, 1998 prices that fell to the eight-dollar range and said it became clear that short-term range was too optimistic. The department was no longer relying on short-term forecast. The updated forecast for FY99 was an average destination price of $11.58 and FY00 was $12.50. The revenue forecast for the remainder of this year and next year was based on the updated figures. He commented on the media focus on short-term prices in the media. He said that the importance was than while the oil prices were low today, even if oil prices rose substantially, they would not change the longer-term revenue outlook for the state that much. Mr. Condon then stated that if oil prices remained as they were today and the state continued to draw from the Constitutional Budget Reserve at the same rate, the fund would be exhausted in about four years. If prices went up to an average of $16 then the CBR would last five years, he speculated. Therefore, he concluded, anticipated production volumes and oil and gas revenue had declined to the point where the state simply can not make ends meet under the current revenue and spending practices. Senator Randy Phillips asked about projected production. Mr. Condon responded that the department anticipated daily ANS production for FY99 to be 1,180,000 barrels per day and for FY00, 1,117,000 barrels per day. He noted that the FY99 projection was just less than 100,000 barrels per day from the previous year and that FY00 production would be about 190,000 less. He attributed the decline to some delays in some of the major projects, short-term investments made in large production fields and some of the fields having less capacity as expected. Senator Randy Phillips then asked if the CBR projection was about two billion dollars by June 30. Mr. Condon said the Department of Revenue's projection was about $2.5 billion based on expected interest earnings this year. Senator Dave Donley brought up the question of withdrawals from the fund. Co-Chair Sean Parnell clarified that the figure included this year's anticipated withdrawal. Mr. Condon began showing the committee graphs on an overhead projector. He showed the history of the CBR up to the end of FY98 including settlement amounts, investment income, net loans to the General Fund showing the actual flow of funds in and out of the fund. Co-Chair Sean Parnell wanted to know if the figures showed the estimated FY03 numbers. Mr. Condon said the chart showed average oil prices and changes in the budget and then showed when the CBR fund would be exhausted. Under the Department of Revenue's forecast, the fund would be emptied in February 2003. Mr. Condon showed another graph showing the various oil prices over the last year in comparison to the forecast. Senator John Torgerson said he had seen settlement fund projections of $120 million in settlements. Mr. Condon responded the figure had been adjusted to $106 million over the next five years. Co-Chair Sean Parnell wanted to if the budget increase of two-percent every year was the Governor's proposal. Mr. Condon said the department's projections incorporated a flat budget over the next five years. Co-Chair Sean Parnell pointed out that while the fund would still expire in the next five years, with a two-percent budget increase, the deficit would be greater by hundreds of millions of dollars. Senator Randy Phillips asked for confirmation that the fund would be wiped out in about two and one-half year unless oil prices greatly recover. Mr. Condon confirmed. Senator Gary Wilken requested a copy of the overheads. CHUCK LOGSDON, Deputy Commissioner, Department of Revenue discussed the Fall Revenue Forecast based on the information presented by the commissioner. He told the committee of the division's website (www.revenue.ak.state.us), which contained information resources including daily oil prices plus division reports. He brought the committee's attention to a handout: Net Disposable General Fund Unrestricted Revenue. He explained that this information was being used for spending purposes. It was the department's estimate of unrestricted revenues. He noted some exceptions of generated income that was not included in this figure. He pointed out that in FY98 the state brought in $1.853 million and reflected the drop in oil prices. He said there was a substantial drop of about one-third of the revenues. He noted the change in previous unrestricted revenues to this stage of lower prices and said the state would have to wait several years before oil prices recover. He pointed out that December 21, 1998 saw the lowest price in ANS Westcoast history of $8.63 per barrel. The lowest average annual ANS Westcoast spot price occurred in 1998. He detailed low prices in the past and made comparisons. Senator Pete Kelly asked about the differences between FY99 and FY00 and wanted to know if that took into account an income tax. Mr. Logsdon replied that this information was based soly on current taxes and royalties. Mr. Logsdon spoke of things that affected the current budget situation: The Asian financial crisis, which had turned into a major economic crisis and in effect lowered oil consumption. He also noted the importance of the El Nino winter, which also cut down on fuel consumption. In addition, OPEC raised their production rates at the same time making a deal with Saddam Hussien allowing Iraq to produce as much oil as they needed to meet their needs, which flooded the market with an increase in oil. That is what caused prices to clash Senator Pete Kelly had questions about consumption and referred to an industry article stating that Saudi Arabia had decided to go towards the market share and squeeze independent producers out of production. He wanted to know if that assumption was true. He also said he heard that the Y2K problem was expected to be much more severe in Asia and wanted to know what affect that would have. Mr. Condon said that according to Saudi Arabian public statements, the country was suffering economically. He also said the country had other considerations with getting along with neighbors and said he anticipated they would "play ball." He spoke in further detail about the Middle East economic and political situation. The Department of Revenue had not specifically factored the Y2K situation into their forecasts. They anticipated Asia would not recover until after 2000, according to Mr. Logsdon. He continued laying out the path of the price in the market, giving historical data from the past ten years. He told the committee that the last OPEC meeting was one of the most unproductive he had ever seen and that he felt that was due to the politics involved. He spoke about the new president of Venezuela, Hugo-Chavez and his subsequent appointment of a new Oil Minister. Mr. Logsdon said that the new oil minister's statements had been more favorable with regard to reducing oil production despite his left- wing tendencies. Mr. Logsdon again said that winter temperatures have been much warmer than anticipated and that this adversely affected fuel consumption citing Department of Energy data. Mr. Logsdon moved along to the next handout: ANS Market Price, Fall 1998 vs. Spring 1998. He pointed out a big spike in the year 2001 and that he believed there would be no economic recovery in Asia until that year. He said the department believed that OPEC would muddle through and he figured that by the year 2002 prices would go up to $12.50. He felt that the world economy would remain strong during this period and that over time, OPEC would be increasing its market share. Other non-oil nations' economy would suffer from the low oil prices in the long run, according to Mr. Logsdon. Tape: SFC - 99 #1, Side B 8:50 AM Production Assumption. Mr. Condon used this handout to stress that low oil prices would have an adverse affect on oil production. Although strides were being made to run more efficiently, he stated there was no giant oil reserve to rely on. Mr. Logsdon reiterated that cooler temperatures made for better oil production. However, warmer temperatures would provide for slower production and allow the department to better judge the average production rates. He summarized various oil fields and their production. Badami was not doing as well as expected, he said. However Tarn was doing well. Mr. Logsdon spoke to the next handout: Average ANS Severance Tax Rate. The next handout was General Fund Unrestricted Revenue, Fall 1998 vs. Spring 1998. Mr. Logsdon explained that this summary chart showed an overview of the items discussed. Next handout: FY99 General Fund Unrestricted Revenue Sensitivity Matrix. This was to show relative sensitivity, according to Mr. Logsdon. Mr. Logsdon summarized his presentation by saying that the uncertainty was very high. A lot of it revolved around OPEC decisions and the Asian financial crisis. With the low oil prices, he pointed out that other state revenue sources brought in about equal amounts of income. Co-Chair Sean Parnell had a question on the FY00 price forecast of $12.50 per barrel and $11.58 for FY99 and wanted to know where those figures fell on the department's worst and best-case scenario. Mr. Logsdon called that his reference case and gave background on how they came up with those numbers. He qualified that there were some objectives that could change that market forecast. Senator Loren Leman said he recently attended the Energy Council International Conference and said that he thought the Department of Revenue projections were more optimistic then he had heard at the meeting. Others said prices would take more than five years to recover. He asked if the weather considerations the department had referred to included the whole world or just the U.S. noting that winter temperatures were warm throughout the world as well. He also wanted to know if they also considered warm summer temperatures when oil would be needed for cooling. Mr. Logsdon said they only considered US weather. He said that last summer; they didn't have a positive rise due to warm temperatures. Senator Loren Leman talked about Asian recovery and also wanted to know if the Russian economy was considered in determining the forecast. Mr. Logsdon said the expectations for the Russian economy were dismal. They did not expect demand to rise for several years. However, their oil supply rates were holding steady because of limited ability to get oil to market. Therefore, they considered the Russia situation to not be an advantage or a disability to the Alaskan economy. Senator John Torgerson said the committee in the past used a figure of about 70 million dollars premium for export of oil to Asia when the export ban was lifted. He wanted to know if exports were still being made to Asia and if Mr. Logsdon had seen any increase. He asked what could be used for a premium in today's market. Mr. Logsdon responded that unfortunately in today's market of reduced production and economic slowdown in Asia, exports had pretty much dried up over the last six months. Senator John Torgerson then wanted to know if there were any impacts on oil prices from the recent mergers of BP, Exxon and other oil companies. Mr. Logsdon had seen an e- mail suggesting conspiracy but didn't feel that would effect the state as far as pricing was concerned and that more effects would be seen in production practices. He qualified that something could come up in the future. BRETT FRIED of the Division of Income and Excise Audit, Department of Revenue gave a presentation on non-petroleum revenue sources. Handout: Non-Petroleum Revenues. Mr. Fried said he would address four largest non-petroleum tax types. These were corporation income, motor fuel, tobacco, and fisheries taxes. He referred to a handout titled, Historical and Projected Corporation Income Tax Revenues. This showed corporate income revenues since FY96 with a forecast for FY00. He told the committee of the relatively flat numbers from the general corporations. However oil corporation taxes had a greater variation with a current downward trend from FY97 to FY99. The figures went up from FY99 to the forecasted FY00 as the oil prices recover. The next handout showed tobacco revenues. He pointed out the substantial rise in income due to the change in tax fees from 25 to 75 percent. He related this tax to the school fund. Next handout: Motor Fuel Revenues. He pointed out that while the figures appeared flat, it was important to look at the breakdown between the highway, aviation and marine taxes. He related the changes in revenue amounts to some statutory changes. Aviation tax rates were changed to apply to indirect flights as well as direct flights. Motor fuel revenues dropped in part due to the repeal of the gasohol tax exemption. Marine fuel tax revenues changed due to the activation of the bunker fuel exemption. However, the main influence on the marine fuel revenues was due to the fishing industry difficulties. He showed how this correlated with the dropping prices of fish. That also affected the revenue generated by the fish tax revenues. The final tax-type he discussed was the Fish Tax revenues. He continued speaking to the effects of the fishing industry difficulties. Senator Randy Phillips wanted to know if the fishing industry was paying their way or were they being subsidized. He wanted all sources included in the determination. Mr. Condon said he would compile that information. Co-Chair Sean Parnell requested that the Department of Labor compile that information and identify all sources of revenue included. Senator Randy Phillips wanted to know the amount of the proposed motor fuel tax increase. Mr. Fried said the tax would be raised from eight cents to seventeen cents per gallon. Senator Randy Phillips then asked if that would apply to just the highway motor fuel or to aviation and marine as well. Mr. Fried answered that was just for the highway motor fuel. He stated that the forecast did not include that proposal. Senator Randy Phillips asked why the increase was not proposed for marine and aviation motor fuel as well. Senator Pete Kelly understood the motor fuel tax was increased to meet federal transportation match requirements. Senator Pete Kelly wanted to know if cigarette consumption had changed as a result of the recent cigarette tax increase and if the Department of Revenue incorporated those anticipated changes. He figured that the income generated from the tax should trend down with a decline in consumption. Mr. Fried said they had incorporated a 13 percent drop into the forecast. Senator Al Adams wanted a month-to-month cash flow projection. He referred to last year's budget front section and stated that a projection would be helpful in making budget decisions. He wanted to know if Department of Revenue had looked at ideas for shoring up unrestricted revenues such as assets the State presently had like the Alaska Railroad and the permanent fund unrestricted fund. Senator Al Adams also requested a past projection, a state forecast and a date when the supplemental would be issued. Mr. Condon said he did not know when a supplemental would be produced. Mr. Fried responded that with respect to FY99, most events that would determine the revenues had already happened. If there was a change, he hoped it would not be of a large magnitude. As for FY00, that number could be influenced to a greater extent, he answered. Senator John Torgerson requested FY00 forecasts. He was surprised that information was not included in the packet before the committee. He was told that information would be in the Fall 99 forecast report. He then referred to the repeal of the gasohol tax. He wanted to know if the exemption repeal was just for Anchorage or statewide. It was pointed out that only areas where gasohol was mandated had the exemption and that the tax had essentially been reduced from eight to two cents per gallon. Senator Loren Leman clarified that the exemption applied to noncompliance area where gasohol was required. There was further discussion on what areas of the state had the gasohol requirements. Senator Gary Wilken asked what was the horizon that WTI had traded on. He also asked what in Mr. Logsdon's experience had been the most valued indicator of future price for WTI. Mr. Logsdon said most activity was only in the future's market occurred in the in the first months of the contract. He added that most liquidity in the market was only in the first few months. He pointed out that most people used the future's market to hedge actual transactions. He further detailed his point. Senator Randy Phillips repeated his request for information on monies collected versus cost of activities for the other fuel taxes as well as the fisheries fuel tax - aviation, highway and marine. He stated that he wanted to see if the users of the facilities and services were paying for their operation through these taxes. This concluded the presentation. Senator Gary Wilken asked if a presentation from Cambridge Energy and from the US Department of Energy similar to the year before would be given this year. Co-Chair Sean Parnell said one would be given later this session during the March forecast time period, closer to the FY00 budget process. Co-Chair Sean Parnell made announcements regarding future SFC meetings. ADJOURNMENT Co-Chair Sean Parnell adjourned the meeting at approximately 10:40AM. SFC-99 (11) 01/20/99