A Pipe Dream Goes Bust

In 1979, when world oil prices shot up to $40 per barrel, the state of Alaska found itself rich beyond its wildest dreams. Through royalties, severance, and income taxes, Alaska collected approximately 30 percent of the gross value of production at the "wellhead"-the price of delivered oil minus transportation charges. Reported wellhead prices on decontrolled oil reached $28 per barrel, and the state of Alaska began collecting revenues that rivaled the richest Middle Eastern oil producers.

The oil companies that controlled Alaska's North Slope production used a number of accounting maneuvers to avoid paying taxes and royalties, including selling oil to affiliates at prices below market, and deducting inflated tanker and pipeline tariffs. But in spite of their efforts, the state government receipts from oil taxes and royalties were $3.7 billion in 1981 and $3.9 billion in 1982. With a population of roughly 450,000, this amounted to about $8600 per capita, or more than $34,000 for a family of four.

Experts on oil markets were forecasting increases in the price of oil of two percent annually, after adjusting for inflation, and planners talked of oil reaching $60 or more per barrel in the coming decades. As the magnitude of the windfall began to be realized, the debate over what to do with the money intensified. On the one hand, an odd coalition of fiscal conservatives, environmentalists, and other activists argued that the state should place the major share of the revenues into an investment account in order to limit current spending and build up a nest egg for when oil production declined. A powerful collection of merchants, contractors, and labor unions, on the other hand, opposed the nest egg idea and wanted the state government to spend billions on capital improvements, roads, dams and subsidies to different constituencies.

The proponents of spending oil revenues rapidly were far more successful than those who wanted to put aside the money for the future, but the state did establish a special "Permanent Fund," that would guarantee some savings from the oil boom. Earnings from the Fund were to benefit the state, but the principle could not be touched.

In four years the government set up a dazzling array of programs to provide low interest loans to miners, fish processors, hotel developers, and scores of other groups. Home buyers-but not renters-were eligible to receive interest subsidies of $6,000 or more per year. Plans were launched to build a $15 billion hydroelectric project near Anchorage. Local property taxes were cut. The individual income tax was eliminated, and the state began providing annual cash dividends to residents-$1,000 per person in the first year of the program. Convention centers, swimming pools, and other capital projects were sprinkled throughout the state by legislators eager to capture some of the windfall for local constituents.

The bureaucracy swelled, both in numbers of employees, and in salaries. Combined state and local government employees grew from 36,000 to 46,000 between 1980 and 1984, an increase of nearly 28 percent. About 18 percent of the state's work force is now directly employed by state or local governments, and thousands more are employed in private organizations that are partly or wholly funded by state grants and contracts. By 1985, one out of every eight state employees was paid more than $50,000 a year in base pay, which does not include overtime, pensions, or other fringe benefits.

In spite of all the money that was spent, by 1986 the state was able to allocate more than $7 billion to the "Permanent Fund."

The explosion of the state budget produced mixed results. Rural areas of the state secured millions of dollars to improve schools, housing, roads, and utilities. Social services, higher education, parks, and other programs were expanded, but programs for the poor received only marginal increases. Costs rose due to inflationary state spending policies; and firms that received no state subsidies found themselves competing against firms that did.

There was also enormous waste-programs were poorly conceived and managed, and patronage, fraud and corruption siphoned off millions. The state legislature became the primary target of oil companies that wanted to control development and taxation decisions, and private groups who wanted patronage, funding or subsidies of one type or another. Campaign spending exploded.

In the last four months the spending spree has ground to a halt. The drop in oil prices, from $28 to around $12, has stunned the state of Alaska. The economics of North Slope oil production, where transportation costs run from $6 to $10 per barrel, have radically changed. The wellhead price of Prudhoe Bay deliveries to the Gulf Coast have dropped from $19 to little more than $4 in one year. If world oil markets stabilize at current prices, state government oil revenues will fall by nearly $2 billion in fiscal year 1987.

For a state that receives from 80 to 90 percent of its funding from the oil industry, the revenue decline is a disaster. If prices don't increase substantially, the state will have to cut its budget by at least 50 percent over the next two years, and perhaps more. An across-the-board decrease of just 25 percent would result in the loss of more than 11,000 state and local government jobs. A study by the University of Alaska predicts a decline in the state's total work force of approximately 25 percent over the next five years. Thousands of uncompleted capital projects will have to be abandoned, and the state will have a difficult time providing even rudimentary services to its population. Law firms are beginning to gear up for bankruptcy work, and local bankers are close to panic. The state's credit rating, AAA just a few years ago, is disappearing.

Democratic Governor Sheffield, who is facing a tough re-election campaign after narrowly escaping impeachment for favoritism in state contracting, is trying to ignore the problem. His proposed budget for next fiscal year calls for the layoff of 400 to 500 state employees, and a mere $125 million reduction in a budget of about $3 billion. Elis solution to the fiscal crisis is to finance the deficit next year out . of $850 million in cash reserves, and hope for higher oil prices. The state budget is based on an increase in the world price of oil to around $19. There is only modest debate among Alaskans over the Governor's rosy predictions on oil prices. According to one state official, the revenue forecasts for next year are high because it `would be too traumatic" to consider larger budget cuts.

Even with this price increase, the state may face draconian budget reductions the following year, as the $850 million in cash reserves will be spent. If prices don't rebound, the state will be bankrupt in a matter of months, and the government and the economy will be thrown into chaos.

Meanwhile, the oil industry is now asking the state government to lower royalty obligations from 20 to 12.5 percent on production from the Milne Point field, and eliminate work commitments on other leases. The state has also settled an eight-year-old dispute over pipeline tariffs by accepting about $150 million in refunds, rather than continuing to litigate over an estimated $3.5 billion.

Surprisingly, the legislature has resisted attempts to dip into the state's Permanent Fund to pay budget deficits, and recently passed legislation that would protect more than $1 billion in Permanent Fund assets from future appropriations. If oil prices stay low and North Slope production begins its expected decline within the next three years, the income from the Permanent Fund will soon become the largest source of revenue for the state. If Alaska had invested a greater share of its oil revenues in the Permanent Fund, it would have been better able to offset the current crisis. This is a lesson that may be important in the future should Alaska ever enjoy a similar bonanza.

James Love was a resident of Alaska for 15 years and is currently at the Woodrow Wilson School in Princeton, New Jersey.