In our last column, we examined Governor Mike Dunleavy’s (R – Alaska) proposed Fiscal Year (FY) 2025 10-year plan and expressed serious concern about both what it says about Alaska’s fiscal future and the Governor’s failure to comply with the explicit statutory requirement that he propose a response to the continuing, deep deficits it projects.

As we explained in the column, a significant part of the state’s fiscal problem is obvious from the Fall 2024 Revenue Sources Book (Fall 2024 RSB) issued by the Department of Revenue at the same time as the Governor presented his budget. Piecing together production and revenue data, the Fall 2024 RSB clearly shows that while oil production is growing by over 42% over the period and gross revenues from that production (at projected ANS West Coast price levels) by over 20%, state revenues from production tax and royalty, the two revenue sources most closely tied to that production, are dropping over the same period by over 23%. Combined with the increase in spending, that decline in the state’s traditional revenue base explains a lot about why Alaska faces such a daunting fiscal future.

This column aims to analyze that decline in greater detail to help better understand what’s behind it and lay the groundwork for fixes that we and others likely will suggest going forward. As we will explain, this is not a situation where additional volumes will help dig Alaska out of the situation, at least in the time frame covered by the Governor’s 10-year plan. Indeed, perversely, it’s the significant increase in new investment and production that the state projects that is causing the problem in the first place. Projected revenues over the period would be significantly higher if investment and production levels from new sources were lower.

As a result, for those serious about righting the state’s fiscal situation, the solution isn’t providing more “incentives.” Instead, it’s paring back what appears to be, at least in the current environment, the overly generous, multi-level incentives the state already provides.

To explain, we begin with a chart with four lines. The two solid lines at the top reflect projected production levels included in the Fall 2024 RSB. They are measured against the left-hand vertical scale. The top line, in blue, reflects the total ANS production projected in the Fall RSB. The second solid line, in red, uses the same base but deducts the production volumes projected over the period from the National Petroleum Reserve -Alaska (NPRA). Deducting the federal NPRA volumes from the total is a close, if likely not perfect, approximation of production levels from state lands.

The two dashed lines at the bottom reflect projected revenues from royalties (in red) and production tax (in blue). We use the same colors as for the production lines for a reason. The state receives royalties only from state lands; thus, both the production from state lands and royalties received from those lands are in red. For those interested, royalties from federal lands are distributed as provided by federal law. None are directed to the state’s unrestricted general fund.

The state receives production taxes, however, on production from both state and federal lands. Except for the federal and state royalty shares, production tax applies to all production within the state’s boundaries (which extend up to 3 miles offshore from the state’s shoreline) regardless of who owns the underlying land. Thus, both overall production and production taxes are in blue.

The interesting thing these lines reveal is the huge disconnect between production levels and production tax revenue levels. Generally, one would expect production tax revenues to rise as production levels rise. Indeed, that’s the theory on which “Senate Bill 21” (SB21), the state’s current production tax code, largely was sold.

But the Fall 2024 RSB projects the exact reverse. While production levels are projected to rise by an astonishing 42% over the ten-year period, from 461 thousand barrels per day (mbd) in FY24 to nearly 657 mbd in FY23, production tax levels are projected to plunge over the same period by nearly 45%, from $975 million in FY24 to $542 million in FY34.

And the latter number represents a high point. Looking midway through the period, for example, in FY30, production tax revenues are projected to fall to only $328 million, down by over 66% from FY24 levels. They only “recover” to the less-lower amount of $542 million at the end of the period.

Royalty revenues follow a different path. While they also fall slightly over the period as production levels from state lands rise, the trajectory is much more favorable for state revenues. For example, compared to the 45% plunge in production tax revenues, projected royalty revenues are expected to fall by only about 5.5%, from $1.146 billion in FY24 to $1.082 billion in FY34.

That is a dramatic and significant difference between the two. If production tax revenues had fallen only at the same rate as royalties, by FY34 state revenues still would be nearly $400 million higher than projected.

Some suggest that the projected decline in oil prices over the period is the reason for the decline in projected revenues. But that’s a very small part of the story. Projected oil prices do decline by roughly 15% over the period. But royalty revenues fall by only about 5.5%. The effect of falling oil prices on royalty revenues is more than offset by increased production volumes.

That doesn’t happen with production tax revenues, however. Compared to the 16% rise in production from state lands, overall production levels rise by 42%. Yet, while the lower rise in production levels from state lands is enough to hold royalty revenues relatively even against projected oil price declines, the even greater rise in overall production doesn’t do the same for production tax revenues. Instead, production tax revenues plunge. Something else is going on with production taxes.

To help identify the reasons, we have developed a second chart that focuses on four significant factors in calculating production taxes: operating expenses, capital expenses, the so-called “per barrel credits,” which are tied to oil price levels, and the level of Gross Value Reduction (GVR) volumes.

In preparing this chart, we use data from the Fall 2024 RSB to estimate the per-barrel operating expenses (OPEX) and capital expenditures (CAPEX) projected to be deducted from gross revenues to calculate each company’s annual production tax obligation. We express each of those as a percent of the projected price of ANS per barrel.

We also use data from the Fall 2024 RSB to estimate the impact of the so-called “Per-Taxable Barrel” tax credits available to producers under the production tax code to reduce their production tax obligations. The credits are described in the Fall 2024 RSB as part of the effort to “incentivize additional investment.” They start at $8 per barrel at a wellhead value of $80 and reduce to $0 as the wellhead value reaches $150 per barrel.

We estimate the impact by adding the projected amount of the credits back to the level of production taxes anticipated to be paid to determine projected pre-credit tax levels and then calculating the percentage by which the credits reduce them. 

Finally, we add to those a similar analysis of the projected level of so-called Gross Volume Reduction (GVR) barrels produced each year. Using data from the Fall 2024 RSB, the chart expresses the volumes qualifying for the GVR as a percent of overall ANS volumes.

We include an analysis of GVR barrels because of their significant impact on production tax levels. As explained in the Fall 2024 RSB: 

The gross value reduction (GVR) allows a company to exclude 20% or 30% of the gross value for that production from the tax calculation. …. Oil that qualifies for this GVR receives a flat $5 Per-Taxable-Barrel Credit rather than the sliding scale credit available for most other North Slope production. As a further incentive, this $5 Per-Taxable-Barrel Credit can be applied to reduce tax liability below the minimum tax floor assuming that the producer does not seek to apply any sliding scale credit. 

While the production level qualifying for the GVR “incentives” has not been significant previously, as the chart indicates, the level begins to climb rapidly in the middle of this decade and continues into the next. Because of the financial significance of the GVR incentives, the rapid increase in the portion of production qualifying for treatment as GVR volumes have a material impact on production tax levels.

Consistent with the multi-layer incentives built into the tax code, the chart reveals a number of contributors to the plunge in production tax levels over the period. The first, early in the period, is the immediate deductibility of capital expenses from gross oil revenues. Unlike other tax regimes that require the amortization of capital expenditures over a number of years, in Alaska, for purposes of production taxes, capital expenditures are deductible entirely in the year in which they are made. This is a significant benefit to the producers in terms of cash flow but is a cost to the state because it results in a spike in deductions in years in which capital expenditures are being made rather than spreading the impact of those expenditures at lower levels over a number of years.

That impact may be fairly limited in time. As the chart shows, deductible capital expenditures start to decline to more moderate levels after an intense few years early in the period. If that was the only factor at work, we could expect production tax revenues to begin to recover as deductible capital expenditures receded.

But it’s not. As the projected capital deductions begin to recede, two other factors take their place, resulting in continuing declines in production tax revenues. The first is the share of production tax revenues offset by the so-called “Per-Taxable-Barrel” credits. While always significant, the level of production tax revenue they offset climbs from 49% at the beginning of the period to 67% by the end. Put another way, production tax revenues are reduced from otherwise statutory levels over the period by roughly an additional 18% from the beginning to the end due solely to the increased impact of the Per-Taxable-Barrel credits.

The second is the rapid emergence of GVR volumes over the period. While a minimal amount of the volumes subject to production tax qualify for GVR treatment at the beginning of the period, more than a third of total production does by the end. Combined with the rise in the impact of the Per-Taxable Barrel credits, these two factors more than offset the decline in capital expenditure deductions and help explain the continued, deep plunge in production tax revenues even as the level of deductible capital expenditures declines.

The multi-layer set of incentives created under Alaska’s production tax code continually drives down tax levels even as production volumes and associated gross revenues skyrocket. Just as one seems to recede, others take its place.

It is highly disturbing that despite huge increases in production volumes and associated gross oil revenues over the period, production tax revenues are not only not climbing but, in fact, plunging. It’s not a win-win or even a win-draw; it’s a win-lose.

As we said earlier, we and others will likely offer suggestions for improving the state’s fiscal position in the coming weeks. At least from our perspective, those will include proposed modifications of the production tax code to better align production tax revenues with production volumes and associated gross oil revenues. As implied when SB21 was adopted and especially because they bear a significant share of the costs through various tax deductions, Alaskans should share significantly in the benefits as oil production volumes and associated gross oil revenues rise.

The fact they aren’t currently is a significant contributor to the state’s fiscal problems.

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.