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Providing coverage of Alaska and northern Canada's oil and gas industry
January 2015

Vol. 20, No. 1 Week of January 04, 2015

The funding challenge

How much money can the state government afford to spend on energy projects?

Alan Bailey

Petroleum News

Plummeting Alaska state revenues in response to falling oil prices are focusing minds on how to trim state costs, with much capital expenditure under threat. And, while the state sees strategic value in helping fund projects such as major hydroelectric schemes or developing a means of exporting North Slope natural gas, how much can the state government actually afford to invest in energy projects?

On Dec. 8 during Law Seminars Internationalís annual Energy Markets and Regulation in Alaska conference Gunnar Knapp, director of the University of Alaska Anchorageís Institute of Social and Economic Research, spoke about the issues surrounding state energy investments. There are three complex topics embedded in the apparently simple question of what the state can afford: the amount of money that the state has on hand; the possible mechanisms for state funding assistance; and the economic and political ramifications of making particular investment decisions, Knapp suggested.

$15 billion

At the beginning of the 2015 financial year, July 1, the state held available cash reserves of about $15 billion. But, with a project state deficit of perhaps $3 billion this year, those savings can disappear quite rapidly, Knapp said. Moreover, planned funding for state pension funds would reduce the cash savings to around $10 billion by the end of the year, he said.

The state also held savings of about $51 billion in the Alaska Permanent Fund. However, the state constitution bars the state from drawing down this fund, with access only allowed to the fundís earnings. Those earnings inflation proof the fundís principal and pay the permanent fund dividends which each Alaska resident receives annually.

Theoretically, the state could use earnings from the Permanent Fund for its own purposes, but any decision to do this would be politically very difficult. There are other sources of funding that are theoretically available but that would also prove extremely controversial - these sources include the funds used to alleviate the costs of power in rural Alaska and the education investment fund, Knapp said.

Roller-coaster revenues

At the same time, state revenues consist predominantly of oil revenues, revenues which are driven by oil prices, oil production levels, oilfield costs and state oil tax policies. Those revenues have been on something of a roller coaster ride for several years, Knapp said.

ďA critical question is whatís going to happen to oil prices going forward,Ē Knapp said. ďAlaska stands to lose billions of dollars annually if oil prices stay low.Ē

And, with a rising state population having heightened expectations for state spending, there is a dynamic of people wanting more money at a time when less money is available, he said.

A recent lively debate over state oil tax policies has led to a situation where the tax policy has been altered but is unlikely to change again in the near future. But during that debate there was little discussion of the potential impact of lower oil prices on industry investment in oil development, and hence on future oil production, Knapp said.

Consideration of these issues, and of issues such as rising oilfield costs, leads to a conclusion that state revenues may remain depressed for some time into the future, Knapp commented. Knapp pointed out that state investment earnings, much of these from the Permanent Fund, are now close to oil revenues and may go higher than oil revenues in the future.

Other approaches

But there are ways of investing in energy projects, rather than simply injecting cash from state savings and revenues. For example, the state can help finance projects through traditional-style loans. Or the state can underwrite project risks through loan guarantees, or improve project economics through tax reductions for energy developers.

All of these approaches have their benefits and disadvantages. Low interest state loans for marginal projects can put the stateís credit rating at risk, but can also provide a return for the state if a project succeeds. A loan guarantee does not require up-front money but entails financial risk. And a tax reduction reduces the future benefits to the state from a successful project.

Political factors

Set against all of these considerations are the economic and political implications of state investment in one project versus another, especially given the fact that the state is unlikely to be able to afford to assist all projects that could benefit from state help. And politics are important, given the need to convince members of the government and the electorate of the merits of particular state investments, and given the fact that people involved in the political dialogue will have different levels of knowledge about proposed projects and different priorities about what needs to be achieved.

The need for confidential deals in large complex projects such as the North Slope LNG export project can raise issues of trust in what is being negotiated, thus constraining the stateís ability to enter into deals of this type, Knapp said. And as oil prices decline there will be increased political scrutiny of state spending, he said.

In summary, Knapp suggested that under the current financial circumstances state cash payments into projects may be limited to a few hundreds of millions of dollars. However, the scale of project that the state can assist can increase significantly through the use of low interest state loans, and becomes still larger through the use of approaches such as loan guarantees. But, whatever the form of the funding, the level of state investment will strongly depend on the quality of the project economics, with the investment levels declining rapidly as project economics worsen, Knapp said.






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