The Friday Alaska Landmine column: Why aren’t state oil revenues growing with production, and how to fix it
Most think state revenues from oil will grow with production volumes. But the most recent Spring Revenue Forecast says they don’t. This week’s chart explains why not and how to fix it so they do.
As we discussed in an earlier column, the Department of Revenue projects in its Spring 2024 Revenue Forecast (Spring Forecast) that while oil production volumes will rise by over 36% over the eight years between Fiscal Years (FY) 2025 and 2033 (an annual compound growth rate of 4%), state unrestricted general fund (UGF) revenues from those volumes will rise over the period by only 3% in total (a yearly compound growth rate of only 0.4%), a rate less than one-tenth of the production growth.
Indeed, the Spring Forecast projects that, while production volumes will rise generally throughout the period, total petroleum revenues actually will decline in seven of the eight years, only rising slightly over the FY25 level again in the last year of the period:
What is driving the serious disconnection between growth in production and state revenues? Some historical context is helpful.
While changes in prices and production volumes sometimes make year-to-year comparisons of oil revenues difficult, using percentages makes the numbers more comparable.
For example, during the seven-year period from FY2000 to FY2006, the year before the significant changes in Alaska’s oil tax structure started taking effect, production fell by nearly 20% (from 1,040 thousand barrels per day (mbd) to 839.7 mbd), prices rose by over 265% (from $23.27/bbl to $62.12/bbl), and state unrestricted general fund (UGF) revenues from oil rose by nearly 225% (from $1.65 billion to $3.7 billion). However, on a percentage basis, the percent of state UGF take per barrel as a percent of price remained relatively constant, fluctuating over the period within a comparatively narrow range from 18.6% at the start to 19.4% at the end.
While at a different, higher level due to the significant changes to Alaska’s oil tax structure enacted in 2007 (what is referred to as the “ACES” tax structure), the same thing happened during the seven-year period between FY2007 and FY2013. Over the period, production fell by another nearly 40% (from 734.2 mbd to 531.6 mbd), prices rose by nearly another 75% (from $61.60/bbl to $107.57/bbl), and state unrestricted general fund (UGF) revenues from oil rose by over another 40% (from $4.48 billion to $6.35 billion). Despite the turbulence, however, on a percentage basis, the percent of state UGF take per barrel as a percent of price again remained comparatively constant, fluctuating in a more moderate range between 27.1% at the start and 30.4% at the end.
While the level changed again following 2013 due to the significant changes to Alaska’s oil tax structure enacted in that year (what is referred to as the “SB21” tax structure), the relative consistency on a percentage basis in the ten years since has continued. Over the period, production fell by another 10% (from 530.4 mbd to 479.4 mbd), prices fell 20% (from $107.57/bbl to $86.63/bbl), and state unrestricted general fund (UGF) revenues from oil fell by 35% (from $4.76 billion to $3.12 billion). Again, however, despite the turbulence, on a percentage basis, the percent of state UGF take per barrel as a percent of price again has remained mostly constant, fluctuating in a more moderate range from 22.9% at the start to 20.5% at the end.
Using averages, the significant changes in state UGF take levels over the three periods — owing mainly to the differences in the production tax approach applicable to each — stand out. The state UGF take during the pre-ACES period (during what is referred to as the “ELF” tax structure) averaged 17.5%, during the ACES period 31.9%, and to date, during the SB21 period has averaged 16.9%.
How does this help explain what’s happening in the period covered by the Spring Revenue Forecast? Although there has been no formal change in the oil tax structure, it is clear that the manner in which the structure applies to the evolving conditions is causing yet another significant change in the level of state UGF take from oil as a percent of price.
While prices are projected to remain relatively stable over the period, falling less than 10% between the start of the period ($78/bbl) and the end ($73/bbl), production is projected to rise by 34% (from 476.8 mbd to 640.2 mbd). Despite that, state unrestricted general fund (UGF) revenues from oil are projected to rise only slightly over the period by 3% (from $2.20 billion to $2.27 billion). While again, the percentage of state UGF take per barrel as a percentage of price remains relatively constant across the period, fluctuating in a relatively narrow range from 16.2% at the start to 13.3% at the end, the average over the period represents a significant drop from the last 10 years.
To help focus on that change, here is the averages chart, updated to reflect the projections included in the Spring Revenue Forecast for the next nine years. Despite the increase in both average production and average price in the forecast period compared to the previous ten years under SB21, the state’s average UGF take drops significantly from the previous 10-year period by 2.5%, from 16.9% to 14.4% per year.
What is driving that? To understand that, we break down the level of state UGF take from oil further into its component pieces — royalty, production taxes, and “other” (most of which is from the petroleum corporate income tax):
Compared to the prior period (FY2014–23), we see that UGF royalty as a share of price is down some, from 8% to 7.3%. That is not altogether surprising as production from federal lands — where the royalty is paid to the federal government rather than the state — becomes more significant during the period. That is more than offset, however, by the increase in “other” (again, largely the petroleum corporate income tax) over the same period, from 2.1% to 2.9%.
Balancing those two factors, it becomes clear that the entire reduction in state UGF take over the period comes from a precipitous drop in production taxes as a share of price, which falls by nearly 40%, from 6.8% over the previous period to 4.1%.
At the projected average production and price levels over the period, each 1% change in state UGF take as a share of price represents roughly $145 million per year in state UGF revenue. As a consequence, the 2.7% drop in production tax as a percent of price represents a corresponding drop in annual state revenues of nearly $400 million per year on average.
Not only would restoring production taxes as a percent of price to the previous period’s level be a positive step in offsetting the otherwise $1.2 billion in average annual UGF deficits currently projected for the period under current law, but it would also do much to put state revenues from oil on the same growth trajectory as the projected increase in production volumes.
And, although some will no doubt claim otherwise, it shouldn’t materially impact producers. All that the change would do is return the overall level of state UGF take from oil as a percent of price roughly to the same level experienced under SB21 over the last decade. The resulting overall UGF take level (roughly 17%) wouldn’t remotely approach the level under ACES (32%) and would still be less, even, than the overall level experienced during the pre-ACES period (17.5%).
As we explained in greater detail in a previous column, two components of the SB21 tax system appear to play a significant role in the projected decline in the level of state take from production tax over the upcoming period. The first is the rapidly growing number of so-called “GVR” (Gross Value Reduction) volumes, on which producers pay little in terms of production tax. The second is the significant impact of growing investment levels on effective production tax rates.
Both provisions helped reduce the effective tax levels incurred by producers under ACES to more moderate levels over the last ten years. But as we enter the next 10-year period, they now appear to be driving current tax levels significantly even further below those more moderate levels. In short, from the perspective of their impact on state revenue levels, those factors appear now to be overcorrecting for the problems that arose under ACES.
We believe the desired objective of restoring the state UGF take from production tax to previous levels — and with that, reconnecting revenue growth to production growth — can be relatively easily achieved through adjustments to those factors or other related steps.
On the other hand, if allowed to continue, the shortfalls created by continued drops in the effective production tax rate will likely be made up through additional cuts in the Permanent Fund Dividend (PFD). The failure to reverse the overcorrections will leave Alaska in the anomalous position of achieving significant oil production growth but at an ever-increasing level of take from Alaska families.
We don’t believe that’s what the proponents of SB 21 envisioned, nor, now that the effects are becoming clear, what Alaska’s current Governor and Legislature should permit. To avoid this outcome, we believe changes should be made this coming Legislature to restore UGF revenue as a percent of price produced by the production tax generally to the same average levels realized over the last ten years.
