On Wednesday, the Department of Revenue (DOR) published its Spring 2024 Revenue Forecast (Spring RF), which is considered a milestone by some in the annual budget process.

The Spring RF is considered a milestone in the current budget process because it updates projected revenues – in particular, those tied to oil prices and production volumes – from those included in the Fall 2023 Revenue Sources Book, on which Governor Mike Dunleavy’s (R – Alaska) original Fiscal Year (FY) 2025 budget was based. The update provides the Legislature with a more recent set of projections on which to base its decisions as it works to finalize its cut at the FY25 budget.

Just because the numbers are more recent, however, doesn’t mean they—or any similar projections—are any better for budgeting purposes. As we have explained in previous columns, we think the current overall budgeting process is fundamentally flawed because it perpetuates the use of oil price and production projections as the basis for a significant part of Alaska’s annual budget. Substituting one set of projections for another doesn’t help solve the underlying problem.

Instead, we believe the Governor and Legislature could much more effectively manage the state’s budgeting process by basing oil revenues on a rolling 10-year historical average. Doing so would both base the budget on revenues the state actually has received, rather than revenues it may or may not receive, as well as decrease the significant volatility that otherwise affects Alaska’s annual budgets as a result of the continuous gyrations in oil prices. As we said in a previous column:

In our view, this volatility largely has been at the core of many of the state’s current fiscal challenges. We believe legislators and administrations would have budgeted much more responsibly had they been dealing over time with a relatively steady and predictable revenue stream.

As we explained in another previous column, we also believe FY25 has provided the state with a unique opportunity to switch from using projected revenues to actual, historical-based revenues. The FY24 budget is based on an oil price within one dollar of the preceding, historical 10-year average oil price. Using the same 10-year historical averaging approach to calculate the FY25 budget would similarly base it within one dollar of the FY24 price, significantly reducing the year-to-year volatility that otherwise makes Alaska’s fiscal situation so challenging.

The 10-year historical average price preceding FY24 was $69; at the time of enactment, the FY24 budget was based on an oil price of $68. The 10-year historical average price preceding FY25 is $67, within $1 of the price on which the enacted FY24 budget was based. Based on DOR’s most recent price sensitivity analysis, using that price would result in traditional revenues of $2.23 billion, within 10% of those on which the FY24 budget was based.

On the other hand, the Spring RF forecasts an FY25 oil price of $78, more than 15% above the 10-year historical average price. It also projects traditional revenues of $2.79 billion, more than 12% above those on which the FY24 budget was based and more than 25% above those on which the FY25 budget would be based using the 10-year historical average price. Using a projected price to develop the budget just continues the gyrations between price spikes and lows that have proven so troublesome in the past.

The consequences of continuing to use these projected prices and volumes are clear. Rather than producing an entirely predictable and relatively stable revenue line, the approach creates a form of fiscal Russian roulette, with some cycles resulting in “windfall” revenues from higher-than-long-term price levels and others creating fiscal “crises” as projected revenues fall below long-term trends.

Using a historical average-based approach would help normalize those cycles. Revenues produced during periods of higher-than-average prices could either be used to pay back previous draws from the Constitutional Budget Reserve (CBR) or to build up additional reserves in anticipation of future lows. Draws from the CBR could supplement revenues produced during periods of lower-than-average prices.

On the other hand, using projections, this cycle, we are already seeing legislators propose various ways of spending the projected “surplus” resulting from using the higher projected price levels, both undermining the ability to use all or a portion to pay back some of the amounts previously borrowed from the CBR as well as significantly increasing the likelihood that this year’s budget will just continue to perpetuate the huge up and down swings in spending that have come to characterize Alaska fiscal policy.

However, despite the opportunity presented this year to transition smoothly to a better approach, neither the Dunleavy administration in its proposed version of the FY25 budget nor the Legislature in working on theirs has seemed interested in making any significant changes to the budgeting approach that has served Alaska so poorly over the past decades. By following the same path as their predecessors, both seem content with leaving Alaska exposed to the same unpredictable and volatile fiscal future as it has experienced in the past.

To illustrate how volatile these projections are, the charts below show the prices and production volumes projected for FY24 and the following five years in DOR’s last six forecasts—from Fall 2021 through the most recent, Spring 2024.

The first chart looks at the price projections over the past six forecasts:

Last Spring’s forecast – the basis for the Legislature’s FY24 budget – projected an FY24 price of $73/barrel, as we noted above, relatively close to the 10-year historical average. By contrast, with roughly 70% of the year in the books, it appears that the actual FY24 price will end up around $84/barrel, 15% higher. The change is being viewed as an opportunity to increase current spending rather than, as it more likely would using an averaging approach, repay past draws from the CBR or build up new balances to deal with future revenue drops.

Production levels suffer from the same problems. Here are the production levels projected over the last six forecasts:

Last Spring’s forecast – again, the basis for the Legislature’s FY24 budget – projected FY24 volumes of 496 thousand barrels per day (mbd). By contrast, with roughly 70% of the year in the books, it appears that actual FY24 volumes will end up around 468 mbd, 6% lower than that used in last year’s budgeting process.

While perhaps better than forecasting prices and production levels by throwing darts at a dartboard, we believe the state’s fiscal future would be much more predictable and stable if based on an ongoing rolling average of historical results.

This is especially true when considering the initiation of new programs or significant changes in the long-term spending levels of existing programs.

Two years ago, the Spring 22 revenue forecast projected an ongoing string of strong oil prices and solid production levels. At the time, for example, it projected average oil prices of $90 for FY24, $82 for FY25, $77 for FY26, $75 for FY27, and $74 for FY28, with average production levels of 503 mbd, 512 mbd, 510 mbd, 514 mbd, and 524 mbd, respectively, over the same period.

The current view of the world is significantly different, however. Instead of the high price strip projected in the Spring 22 revenue forecast, the current forecast projects prices of $84, $78, $74, $72, and $70, with average production levels of 468 mbd, 477 mbd, 482 mbd, 520 mbd, and 547 mbd, respectively, over the same period. Long-term spending levels that may have seemed reasonable when looking at the Spring 22 revenue forecast now put a significant strain on the budget and will lead to an even greater strain when future price levels, as they will, ultimately revert toward the long-term average.

We are significantly concerned that the same may happen this year. Adopting new programs that result in significantly increased spending levels going forward may seem reasonable based on current price and production projections, but they will play out much differently as future price and production levels turn out to be less robust than currently anticipated.

Ironically, the other part of the revenue stream used to support the state’s budget is based explicitly on historical averages. By statute, the percent-of-market-value (POMV) draw from the Permanent Fund is based explicitly on “the average value of the fund for the first five of the preceding six fiscal years, including the fiscal year just ended.”

The justification for using that approach is exactly the same as the argument for converting the oil-related portion to historical averages—to smooth out the volatility that otherwise results from using one-year, forward-looking projections in the case of Permanent Fund earnings. In short, to make that portion of the revenue stream more predictable and stable.

The same rationale should be applied to both components of the state’s revenue stream, and they should each be calculated using the same approach.

Like those in the past, this year’s Spring RF contains some significant anomalies that we will explore in greater detail in future columns. We wish we didn’t need to do that – the averaging approach would minimize the impact of anomalies occurring in any given period. But under the current approach the anomalies do matter. In fact, they often impact each year’s budget significantly more than the long-term trends. That is not a sign of a stable, long-term fiscal system; instead, it is a very strong indicator of an unstable one.

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.