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Michael McDonald

Michael McDonald

Michael is an assistant professor of finance and a frequent consultant to companies regarding capital structure decisions and investments. He holds a PhD in finance…

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Is The End In Sight For Alaska’s Oil Based Economy?

Alaska has long been one of the few U.S. states without an income tax. Thanks to its incredible bounty of natural resources, the state had more than enough cash coming in through oil company taxes and especially Prudhoe Bay production. All of that is starting to change. After a 40 year oil boom that transformed Alaska from a frozen tundra into one of the richest states in the country, the oil price crash is bringing reality back to bear.

Alaska’s problems go deeper than the current oil price collapse though. Simply put, the state is getting long in the tooth – at least as far as its productive assets go. The Prudhoe Bay Oil field, once the largest such field in North America, is starting to reach the end of its life. In 1985, the Prudhoe Bay field was pumping 2 million barrels per day – roughly a quarter of the total U.S. output. Today it is pumping 500,000 barrels a day. That’s leaving the 800 mile Trans-Alaska pipeline seriously under-utilized.

Roughly 90 percent of Alaska’s general fund revenues are tied to oil. Between the oil price collapse and the inexorable decline of oil production over time, Alaska now faces a $4B budget deficit, all while the state has slid into an oil related recession over the last year. With the State’s rainy day fund burning through $11 million per day, that energy fund will be exhausted in less than two years.

All of this is a new challenge for Alaska and its roughly three-quarters of a million residents. Alaska has traditionally lightly yoked its residents with the lowest tax burden of any state across the country. In contrast, it has also had the highest per capita spending in the country thanks to its vast swath of territory. Both facets of this social compact may have to change. The State and its new governor, Bill Walker are already looking closely at implementing a state income tax for the first time in 35 years. Walker is also looking to double the gas tax and cut corporate incentives for energy firms. Related: Oil Continues To Tumble On Brexit Fears

Against this grim backdrop, Alaska does have one very large Ace left in the hole – the $53B Alaska Permanent Fund. This fund, composed of past oil earnings for the state, is contractually untouchable by politicians. Or at least the principle is. The earnings from the fund have traditionally been paid out to Alaskan residents as a bonus for living in the state. Last year, every man, woman, and child in the state got a check for $2,072. That may change in the future as Walker is looking to take those earnings to help fund the state government.

Regardless of the political decisions made in Alaska, it’s clear that changes will need to be made going forward. Alaska is not alone in this situation. Traditional heavy weight producers like Norway and the Saudis have similar issues. The key to ensuring a prosperous future in all three cases is the same – investing the proceeds of the natural resource bounty when times are fat and revenues flow freely. Alaska needs to invest the proceeds of its past bounty while it still can to ensure a bright future for a time when oil revenues will no longer sustain the state on their own.

By Michael McDonald of Oilprice.com

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  • Martin Katchen on June 19 2016 said:
    Simply put, the Lower 48 won't allow Alaska to be a normal state. It is almost impossible for Alaska to get Congressional approval to expand it's infrastructure regardless of it's oil reserves or lack of. Congress has consistently treated Alaska as a place which got statehood by mistake and by rights should be a gigantic national park since the late 60s. Even a senior Senaor like Ted Stevens couldn't change this.
  • Bill Simpson on June 20 2016 said:
    Maybe they will rethink mining one of the largest copper deposits ever found, on their south coast. Or they can pay even higher taxes, and let the 50 years worth of copper in the ground. After all, with hundreds of millions of electric motors soon to be built for the coming electric car revolution, who needs copper, or the associated gold and silver byproducts. Just buy everything from China.
  • Matthew Biddick on June 20 2016 said:
    One of the very big problems for Alaska is that 98% of the land is owned by tribal, state, or federal entities. One of the key drivers for economic success in our (supposedly) free market economy is private property and Alaska has very little of it. Alaska has many virtually unexplored basins and they shall remain that way. Alas.

    One of these days, perhaps our state and federal governments will be forced to sell the millions upon millions of acres that they have locked up. To pay off the debt you know? I'm not talking about state and national parks either.

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