AJOC EDITORIAL: Market slide shows risks of counting on Fund earnings
Since oil first started gushing through the Trans-Alaska Pipeline System nearly 40 years ago, the Alaska has repeatedly failed to learn the lessons from the troughs in the price cycle.
Now facing a yawning budget gap nearing $4 billion annually with crude collapsing to less than $27 per barrel as of Jan. 20, there is near-unanimous support to shift from oil income to tapping the investment earnings from the Permanent Fund to bridge the gap.
Gov. Bill Walker’s proposal to use a so-called “sovereign wealth model” using the Earnings Reserve where the Fund income flows anticipates an annual rate of return of 6.7 percent essentially in perpetuity allowing yearly draws of more than $3 billion to pay for state government.
At the beginning of the fiscal year, the value of the Permanent Fund was just more than $55 billion. As of Jan. 18, the value of the Fund was $49.2 billion.
Rosy predictions of future returns are how governments get into trouble, particularly when they are facing looming unfunded liabilities such as pension obligations — of which the state has more than $12 billion — or budget deficits.
After yet another rout on Wall Street Jan. 20 as the markets are off to their worst ever start to a year, we are now officially in a correction, which is defined as a drop of 10 percent or more from the high point in the indices.
It wasn’t that long ago, back in 2009, when the Permanent Fund lost money for the year as the Dow dropped into the 6,000 range. The markets nearly tripled since then, creating a situation where the state was earning more money from its investments than from its oil income. Now that the bulls ran for more than half a decade, the bears are roaring back.
Multiple investment firms are forecasting oil could keep dropping to less than $20 per barrel, some as low as $10 according to a Jan. 12 article in The Telegraph, as OPEC refuses to cut back production and Iran has stated it intends to start pumping 500,000 barrels per day into the market now that it has been relieved of sanctions.
While there is consensus that oil prices will keep falling, whether the United States will enter a recession is still being debated. There can be no doubt, though, that the reeling energy sector that fueled so much of the economic expansion will drag down growth.
More than 70,000 oilfield workers have been laid off — including hundreds so far here in Alaska — and more pink slips are coming. Hundreds of rigs have been idled and the ripple effects through the broader economy will be felt from everyone to contractors to homebuilders.
There is also no doubt that lower fuel prices benefit multiple sectors of the economy, but industrial output is dropping as well.
This from a Dec. 16 Reuters report: “U.S. industrial production saw its sharpest decline in more than three and a half years in November as utilities dropped sharply, a sign of weakness that could moderate fourth-quarter growth.
“Industrial output slipped 0.6 percent after a downwardly revised 0.4 percent dip in October, the Federal Reserve said on Wednesday, marking the third straight month of declines.”
Alaska’s great gasline hope for economic growth and new revenue will also face major hurdles beyond the enormous cost.
Prices in Asia have been halved since 2013, and current demand forecasts are being revised downward. Since shutting them down after the 2011 earthquake and tsunami, Japan has restarted nearly all of its nuclear reactors and is actually reselling LNG shipments; ditto for China amid its own economic growth slump.
Korea is also lowering its demand forecasts as nuclear power is still a cleaner alternative when it comes to meeting lower carbon emission commitments.
To say it’s rough out there would be the understatement of the year.
Strong leadership from the governor and legislators is critical right now, but even if the competing sides can come together with a fiscal plan they must do so knowing that the fight for Alaska’s future is far from over — and that putting our faith in investment earnings may be just as risky a bet as counting on oil prices.