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We Build Alaska

Brad Keithley’s Chart of the Week: Alaska is leaving future generations with even less than a bare cupboard; that needs to change

As we read through it, a recent thought piece in The Economist struck us hard. The piece, entitled “Oil’s endgame could be highly disruptive,” was the leader for a “Special Report” on the future of the oil industry in the March 16, 2024, edition.

While there have been a number of commentaries over the past several years looking at the potential demise of oil, as it usually does generally, The Economist looked at the issue dispassionately, focusing on the economics. Here is some of what it said:

Governments everywhere are designing policies to reduce the demand for oil and boost alternative sources of energy, as they seek to fight climate change. … this shift will grant some producers more market power. The biggest, least carbon-intensive and cheapest reserves of petroleum by far are found in Saudi Arabia and its immediate opec neighbours in the Persian Gulf. As the market for oil shrinks, their share of production will soar. Depending on the pace of the energy transition, this cabal could command a market share of half or even two-thirds of global output by 2050, according to bp, an oil firm, compared with less than 40% today.

Meanwhile, other oil powers will be left behind. … Because governments in many producing countries are often unduly reliant on commodity revenues, the failure [to adjust] could lead to debt crises, bankruptcies and a decade of lost development.

For the unlucky producers … the priority must be to diversify while oil prices are relatively high and demand still strong. … Governments, too, must seek to ensure that economies can diversify away from oil, by setting business-friendly rules and spending on things like infrastructure and education, to allow private enterprise to thrive. … The supply-led oil shocks of the past half-century were a frequent source of geopolitical tumult. Unless the coming transition is approached with more foresight, the next-half century will be no less fraught.

While Alaska is fortunate to have two new major projects – Conoco’s Willow and Phase I of Santos’ Pikka – fully sanctioned and under development as we enter this transition period, we need to recognize that they may very well be among the last we see. As the transition gains speed, the industry’s contraction toward the Middle East forecast by The Economist may leave Alaska without any major follow-on projects to succeed them as our legacy fields continue to decline.

And that transition could be fast. Throughout its analysis, The Economist continually focuses on the contraction occurring by 2050. That is only 26 years from now, or, to put it in stark perspective, it is only about the same time period looking forward as, looking backward, it is from now to 2000. That was midway through Tony Knowles’s second term as governor, something that, in all fairness, seems just a blink of an eye ago.

Of course, Alaska will face huge issues as that transition occurs. But our immediate thought as we read through the report was not what those issues might be and how they should be addressed. That is something that those future generations who have to face those issues head-on will be best positioned to determine.

Rather, our immediate thought went to in what fiscal shape we – this generation – are leaving the state for those future generations.

The answer, at present, is not a very good one.

The current generation of Alaskans has benefited greatly from a veritable mountain of liquid state savings that stood at nearly $17.6 billion only a decade ago. This chart, taken from a presentation by the Department of Revenue before the Senate Finance Committee earlier this year, shows the extent.

Over the seven years between 2007 and 2014, the state increased its fiscal reserves, combined between the Constitutional Budget Reserve (CBR) and Statutory Budget Reserve (SBR), from $2.55 billion to $17.6 billion, an astonishing compound annual rate of growth of 32%. In the seven years following that to 2021, however, the state spent all but $1.1 billion of it covering its excess bills, a drop over that period of $16.5 billion, or at an even faster compound depletion rate of 33%.

Largely through cuts in the Permanent Fund Dividend (PFD) – the “most regressive tax ever” that falls hardest on middle and lower-income Alaska families – by the end of Fiscal Year (FY) 2023, the state had increased savings slightly to $3.06 billion. However, that’s only roughly $500 million more in nominal terms than where the build started initially in 2007, and it is significantly less than where it started in inflation-adjusted terms. The remaining net of roughly $14.5 billion remains spent.

The result is that while, at least up to this point, those in the current generation have been able to ride through challenging times somewhat unscathed from a fiscal perspective, from this point forward, future generations are being left to face likely even greater challenges without anywhere near the same fiscal shock absorber in place. While this generation was left by the previous one with a fully stocked fiscal cupboard, so far, this generation is leaving the next with a bare one.

Of course, as some will quickly point out, under Art. 9, Section 17(d), the state has a constitutional obligation to pay back a portion of the amount it has drawn from the combined savings over the last decade. But that obligation only relates to a portion of the amount. The state’s most recent Comprehensive Fiscal Report (for FY22) estimates it at only $11.2 billion as of that date. And, most importantly, the Alaska Constitution provides no timeline for the payback. On its current course this generation is already on track to leave the bulk, if not all, of the obligation to the very same future generations that will need available cash instead.

But it’s worse than that. Not only is the cupboard not stocked, as the handover occurs between generations, but it also has a couple of large holes in the bottom that will need attention.

The first relates to the unfunded share of the currently accrued liabilities for the state’s two largest defined benefits programs: the Public Employees Retirement System (PERS) and the Teachers Retirement System (TRS). The following is from a presentation earlier this year by the Department of Administration before the Senate Finance Committee, showing the most recent calculation of the level of unfunded liabilities under the PERS and TRS programs.

The slide shows that, as of the end of FY23, PERS was only 67% funded (actuarial value), with an unfunded liability of $5.56 billion, and while somewhat better off, TRS was still only 77% funded, with an unfunded liability of an additional $1.87 billion.

A second slide included in the presentation analyzes the issue from a different perspective, showing the projected level of additional contributions required to address the state’s share of the unfunded liabilities over the next 15 years.

The chart shows the amounts steadily rising from a combined $182 million annually in FY25 to a combined $380 million annually in FY39 (a compound growth rate of 5.5%, or roughly double the currently anticipated rate of future inflation) at a time when the state’s fiscal clock will be already ticking closer and closer to 2050.

The second hole in the bottom of the cupboard this generation currently is on track to leave for the next deals with deferred maintenance, the estimated cost to restore government-owned property, plant, and equipment to an acceptable condition after maintenance has been delayed.

In presentations to the Senate Finance Committee in early 2023, the Office of Management and Budget (OMB) and the University of Alaska (UA) provided estimates of the amount of the current backlog of deferred maintenance separately for the state as a whole, other than for UA and for UA.

Here was the estimate by OMB for the state as a whole other than for UA:

Here was the estimate provided by UA (the red line represents the amount of the UA backlog, read against the right-hand scale):

Based on those presentations, the total estimated deferred maintenance backlog for the state as a whole as of the end of FY23 appears to be around $2.25 billion.

The combined amount of $9.89 billion in unfunded liabilities plus deferred maintenance might not seem as daunting if the state was also passing on the $17.6 billion in savings it had at its peak or even the $11.2 billion it currently owes to the CBR.

But it’s not. It is passing on the liabilities plus an unsatisfied IOU to the CBR that, on the current track, future generations will have to pay back to themselves.

When asked how to prepare Alaska for the coming transition best, some are certain to propose spending even more currently on “infrastructure” and in other areas that they will claim are related. To us, however, that’s just a continuation of the “take the money and run” approach that has gotten the state into its current situation.

Instead, to us, the best way this generation can help those coming after deal with the coming transition is by restoring the fiscal shock absorber that this generation has used so much to make its own life easier over the past decade.

Future generations will know best what they need to do to address the issues that the transition may bring. To us, the last thing they will need is to be hamstrung by additional infrastructure and kit built before those needs become clear. That likely will just generate more deferred maintenance and other expenses that put them farther behind.

Instead, to us, the best way this generation can help future generations prepare for the coming transition is by repaying the CBR and reducing the current fiscal holes of unfunded pension liabilities, deferred maintenance, and any others we may have overlooked.

Just as this generation has realized for itself, future generations will need cash in the bank to help work themselves through the fiscal challenges they are facing ahead.

We have previously discussed how this generation can start repaying the CBR. In future columns, we will discuss alternatives for addressing the other fiscal holes.

Some will resist, wanting to continue to ride the “no tax,” savings, and deferred liabilities-financed spending spree this generation has been on as long as it can last. But now that we can see clearly where this is headed, this generation owes it to future generations to do much better going forward. We should live up to the admonition from Sir Robert Baden-Powell, the founder of the Boy Scouts, to leave this world a little better than we found it, or if not that, at least clean up after ourselves and put it back to where it was before we go.

Brad Keithley is the Managing Director of Alaskans for Sustainable Budgets, a project focused on developing and advocating for economically robust and durable state fiscal policies. You can follow the work of the project on its website, at @AK4SB on Twitter, on its Facebook page or by subscribing to its weekly podcast on Substack.

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