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State takes conservative view in forecast Future revenues depend on the vagaries of future oil prices, future oil production and future expenditure by oil companies Alan Bailey Petroleum News
With around 90 percent of the State of Alaska’s unrestricted income originating from oil-related revenues of one form or another, predicting those revenues and thus enabling the formulation of a state budget is a difficult but essential exercise.
And, given the unknowns and uncertainties in the various parameters that impact revenue levels, the state administration is taking a conservative approach to its revenue forecasting, trying to ensure that budgets are based on realistic levels of state income and not on over-optimistic expectations, Angela Rodell, commissioner of the Alaska Department of Revenue, told the Alaska Senate Finance Committee on Jan. 23.
Forecast revenue drop That conservative approach has resulted in an anticipated drop in the state’s unrestricted revenues to $4.9 billion for the 2014 financial year from $6.9 billion 2013 and $9.4 billion in 2012. The bulk of that predicted revenue fall comes from forecast drops in oil production tax and royalties. However, the Department of Revenue thinks that in subsequent years the unrestricted revenues will remain relatively stable.
“That is forecasted to stay right around the $4.9 billion, $5 billion mark throughout the next 10 years,” Rodell said.
Unrestricted revenues, money that goes into the state’s general fund without legal restrictions over its eventual use, predominantly comes from oil production taxes and royalties on oil production. Other smaller, oil-related tax components — oil related property tax and corporate income tax — are relatively stable, Rodell said.
Two key parameters that determine production taxes and royalties are the level of oil production and the market price of the oil. Also critically important are tax deductible oil industry costs, primarily expenditures associated with oil lease development and operation, and the cost of transporting oil to market.
Production forecast Having in the past tended to take an overly optimistic view of future oil production rates, the state has been refining its production forecasting approach, Rodell said. The forecasting method involves distinguishing between oil from currently producing wells, and “new oil,” oil that is under development or under evaluation, she explained.
And the bulk of the production forecast consists of future projections for currently producing oil, she said.
Rodell also noted that current production from the Prudhoe Bay field now constitutes a smaller proportion of total production that had been the case in the past, with fields such as Kuparuk and Alpine now becoming more prominent in the overall production profile.
Conservative view Using as a starting point a decline curve derived from historic decline rates for producing fields, the state has determined possible future production trends encompassing a range of possibilities, with assumptions of no new oil development at the bottom end of the range, and with top end of the range including new development plans provided by the oil companies, without considering the risks of these developments not happening. The forecast used for estimating future revenues lies between these two extremes, Rodell said. Actual average North Slope oil production rate in 2013 was 531,000 barrels per day: The state forecast shows this dropping to 508,000 barrels per day in 2014 and continuing to decline thereafter.
While rating agencies and external investors have been complementary about this relatively conservative forecast, the forecast also allows great upside potential, given the possibilities for future oil development on the horizon but not yet certain, she said.
The forecast does not take into account new development that the state hopes will take place as a consequence of recent reform of the Alaska oil production tax. Asked when the state expects production to level off, as the impact of tax reform kicks in, Rodell said that she was unable to say when or if that might happen. The tax impacts on development are beyond the timeframe of the current revenue forecast, she said.
And the state does not have any forecast for other resources, such as heavy oil and shale oil that the companies are working on and may develop in the future.
“A lot of that is to do with what our role is … and that is to always give you a prudent forecast that you can use for budgeting purposes,” Rodell said.
Increased lease expenditure However, the state is seeing a tremendous increase in lease activity, including new development drilling and announcements by the oil companies of development plans, Rodell said. That activity ramp up might lead to some stabilization in production in 2017 or 2018, she said.
“We see a lot of activity. We hear a lot of things from the companies. And so I am very optimistic … that we will be coming back with very different production forecasts in the future,” Rodell said.
Meantime, the activity increase, while welcome in terms of future oil production, is increasing lease expenditures and, thus, reducing the state’s tax revenues, she said. The oil transportation cost per barrel, another tax deductible oil company expense, is also increasing as the operational costs of pipeline transportation, for example, are spread over fewer barrels of oil as oil throughput declines.
Oil prices The Department of Revenue addresses the tricky question of forecasting oil prices by holding a day-long meeting of appropriate people from state agencies, academia and the private sector, with expert speakers presenting information on world oil markets, commodity markets and market modeling.
“We asked those participants to forecast real North Slope prices and then we converted those using a 2.5 percent inflation assumption,” Rodell said.
Prices have stabilized in a range between $100 and $120 per barrel in the past 18 months or so, Rodell said. The state anticipates prices continuing in this range and assumes an average price of $105.68 in 2014, with the price dropping slightly in 2015 before climbing to $110.38 in 2017. The state is developing a new oil-price model that takes into account spare supply capacity and tries to allow for price sensitivity in the oil market, Rodell said. The idea is to reduce the error rates in the forecasts, she said.
Given the impacts of long-term inflation, the state thinks that prices may rise to a level as high as $133 by 2022, although there is much more confidence in the prediction of prices over the next couple of years than predictions for those later years, Rodell said.
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