Brad Keithley’s chart of the week: Is the State (Governor + Legislature) leaving money on the table?

Last month we wrote a column entitled “How much would ‘government take’ from oil need to increase to balance the budget.” In that column we wrote this:

For example, if, to pick a number, the effect of raising the average take level over the next decade from the currently projected 17% to 22% was a corresponding reduction in production of 5% from currently projected levels, that would still be a very good deal for state revenues.

Yes, the state would lose the revenues from roughly 25 thousand barrels a day of production, but the increased revenue it made on the remaining 500 thousand barrels would still produce a significant net gain. And that gain certainly would reduce the amount of revenue the state needs to take from other sources (e.g., PFD cuts) to close its deficits.

On the other hand, if the effect on investment of raising the average take by that amount was a reduction in production of 50% from currently projected levels, pursuing that course would be a bad deal for state revenues. The increased revenues on the remaining 250-ish thousand barrels wouldn’t be enough to make up for the reduction in revenues from the production which is lost.

Between the two examples is a “revenue maximizing” point – what those who work in the area refer to as a “sweet spot.” But finding it requires a lot of information, making some assumptions about decline curves and some dedicated work. To be honest, over the past ten years we’ve not been aware of any governors, group of legislators – or for that matter, voters – who have demonstrated the interest and patience required to pursue calculating it and, more importantly, applying it in practice.

The response of some, essentially, was “Come on, don’t leave us hanging. Go ahead and calculate the ‘revenue maximizing point.’”

We can’t. An essential component of that calculation is a solid estimate of the causal decline curve – the rate at which overall production would decline (for competitive and other reasons) in response to increasing the level of government take. We don’t have the information needed to develop one.

But since that column we’ve thought more about how we can, at least, put some additional meat on the bone.

Let’s start with what the Department of Revenue (DOR) already has told us. In its most recent Fiscal Model (dated April 2022), DOR includes two options related to oil taxes. The first is, essentially, to close the Hilcorp Loophole we discussed in our previous column; the second is to “Reduce Current $8.00 per Barrel Tax Credit by $3.00.”

Clicking on the first option raises, on average between FY24 (once past the transition year) and FY31, a bit over $95 million per year in Unrestricted General Funds (“UGF”); clicking on the second raises, on average, a bit over $425 million per year. Using the baseline assumptions in the Fiscal Model, combined they raise around $525 million – a bit over half a billion – per year.

Now – and here’s the interesting part – clicking on those options doesn’t impact the base level of “Traditional UGF Revenue” included in the Fiscal Model for any of those years. While the calculation isn’t transparent, that seems to imply, at least according to the Fiscal Model, there is no production loss as a result of taking either action; the model appears to treat the options essentially as found money that, by not retrieving, the state – the Dunleavy administration and Legislature combined – is leaving on the table for the producers to scoop up instead.

Of course, at this point someone in DOR is quickly saying to those calling to ask, “Well, it doesn’t mean that,” and it probably doesn’t. Like us, they probably don’t have a causal decline curve laying around on the desk and just let it ride.

But let’s assume for the moment that someone did have the information necessary to develop a causal decline curve and it said that the combination of those two steps would result in an annual 1% incremental decline in production levels from those included in the Spring 2022 Revenue Forecast. That is, as a result of taking those steps Alaska would lose an incremental 1% of production from the forecasted production level in year one after enactment, in year two, 2%, in year three, 3% and so on.

Even with the resulting production decline, that would be a very good deal for Alaskans. As we show on the following chart, the gain from increasing the level of “government take” on the remaining production would significantly outweigh the impact of the reduction in production levels.

The lines at the top are the levels of production projected in the Spring Forecast (blue) and that resulting from a 1% incremental net annual decline from that Forecast (red). The bars on the bottom are the net annual gain (or if negative, loss) in revenue from increasing the level of government take by implementing the two options included in the Fiscal Model, even if they result in the lower volumes shown in red.

The chart assumes the two options are made effective from FY25 to FY31. Combined, they essentially increase the average level of government take for UGF from oil by three percentage points, from 16% to 19%. The total net gain over the period is $2.6 billion; the average net gain is $370 million/year.

As we said in the earlier column, in order to fully close the projected deficits from FY25 to FY31, the level of government take for UGF would need to average 22%, roughly double the increase resulting from the two options included in the Fiscal Model.

But that’s if there’s no impact on production levels. For the sake of this discussion, let’s assume doubling the increase in government take triples the causal decline curve from 1% to 3%. Here’s the impact:

Even though the decline rate triples, the overall benefit to the state from increasing the level of government take on the remaining volumes is even greater than the case above. Over the period the total net gain is $3.5 billion; the average net gain is $500 million/year. Not enough to close the budget deficit at the reduced production levels, but still much better than the situation the state otherwise is facing without the increase.

The takeaway is that even if increasing the current level of government take on oil results in a decrease in production (as long as it is not too steep), there is a net benefit to the state – potentially, a significant net benefit.

To show that there is an upper boundary, however – and to emphasize the importance of the decline curve – let’s assume that instead of tripling the causal decline curve, doubling the increase in government take from the two options included in the Fiscal Model septuples (multiplies by seven) the curve, from 1% to 7% per year. Here’s that impact:

While the early years of the increase show a positive impact, over the full period the total net gain is a mere $20 million, and the average annual net gain is essentially zero. As importantly, by the end of the period the revenue impact is negative and in steep decline, suggesting a challenging future as the surpluses of the early periods are more than offset by continuing losses.

But recall that, in order to produce that result we had to assume that doubling the increases included in DOR’s Fiscal Model – which on its face appears to show no production impact – results in incremental production losses of 7% per year. That’s a steep – and we think unlikely – impact. At lower levels, the impact on revenues remains significantly positive.

Of course, even at higher overall revenue levels we would expect some to object nonetheless, arguing that while increased government take produces more revenues for the state, there still would be adverse impacts on the private sector through marginal reductions in drilling and related activities.

But that reveals a dirty little secret about Alaska oil – that some seek to use state tax policy to create private benefits for themselves and others in the industry.

Currently, middle and lower income Alaska families largely are providing the revenues, through cuts in Permanent Fund Dividends (PFDs), which could be raised instead through increased taxes on oil. The argument implies that those PFD cuts should continue so that a small subset related to the oil industry can continue to benefit from some incremental drilling activity.

Stripped of the spin some would attempt, that’s essentially an argument for a government subsidy: government should forgo additional net revenue so that a few in the private sector can continue to benefit instead. To put it more bluntly, the argument is that middle and lower income Alaska families should continue to pay more for government (in the form of PFD cuts) so that some related to the oil industry continue to rake in private income for themselves.

That might make some sense if those benefiting at least somewhat offset the lost revenue through incremental contributions (taxes) on the benefit they receive, but they don’t. Those making the argument want all the benefits without contributing toward the cost.

We would expect still others to object by claiming that all we are trying to do is fund increased government spending.

We aren’t. In the current context – where PFD cuts are being used to fund government – we would expect the increased revenues to be used dollar-for-dollar to substitute for PFD cuts, if not fully restoring the PFD, at least moving it closer to its statutory level.

But even if not, disagreeing with the potential use of the revenues is no basis for opposing their pursuit.

Alaska North Slope (ANS) oil is a state asset. In our view, government officials have a near (if not actual) fiduciary obligation to maximize its value. Article 8, Section 2 of the Alaska Constitution essentially says the same thing: “The legislature shall provide for the utilization, development, and conservation of all natural resources belonging to the State … for the maximum benefit of its people.”

Objections to how the resulting revenues might be used if realized is no excuse for leaving them on the table – i.e., in the hands of the producers. What happens to the revenues is a separate question that can be debated once the full value is recovered.

As we said earlier in this column, however, without a solid estimate of the causal decline curve triggered by increases in government take levels, all of this discussion is based on assumptions.

If appointed Revenue Commissioner, the first action we would take would be to assign a team to use the information available to the Departments of Revenue and Natural Resources, combined, to develop one. We hope whoever is appointed the next Revenue Commissioner does exactly that.

And as guardians of Alaska’s assets, we believe it’s legislators’ responsibility – Republicans, Democrats and Independents alike – to press the administration until it does.

Let’s find out if – as DOR’s Fiscal Model appears to suggest – Alaska really is leaving money on the table (or as some would put it, wasting state assets) and if, as we suspect it is, let’s go get it.

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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1 year ago

What if the tax credit was decreased by $4/barrel? $5?, . . . . No tax credit?

Brad Keithley
1 year ago
Reply to  Martin

The point we make in the column is it depends on the causal decline curve whether that’s a good deal for Alaskans.

1 year ago
Reply to  Brad Keithley

Point taken, but why select a $3 tax credit reduction vs. another amount, like all of it? Would that not also affect your decline curve?