About thirty years ago, WC had the pleasure of working for Dr. Mike Rice, Dean of the School of Management, University of Alaska Fairbanks. Mike Rice’s special interest was commodity prices, and in particular the forecasting of commodity prices. His dissertation demonstrated the best tool for forecasting commodity prices was the Drunkard’s Walk.
For those who skipped statistics – or sensibly slept through it – the Drunkard’s Walk is a random process. From the point at which you are at, take a random step in any direction. Repeat, again and again. As you might imagine, the path drawn is pretty, er… random. And it is called the Drunkard’s Walk.
What Mike Rice did was demonstrate that commodity prices were best predicted by a random behavior, that they were inherently unpredictable. Rice thought it was amusing that the State of Alaska’s economy was driven by a commodity price – the price per barrel of crude petroleum – which was random. Pretty clearly, any effort to forecast into the future was equally random. As this chart shows:
Remember more than 90% of Alaska’s unrestricted revenue is from oil taxes, calculated as
Oil Produced x Crude Oil Price x Effective Tax Rate = Tax Revenue
A decline in price of $10 a barrel translates into a shrinkage in state revenue of about $100 million. Imagine trying to balance a state budget when, over just a few months, at random intervals, the price of crude oil and go up or down $40-$50 a barrel. In comparison to price, volume is relatively stable: slow decline over decades. Commodity prices stubbornly remain random.
It can’t be done.
So prior legislatures and governors, who had far more common sense than the current crop, in 1990 created the Constitutional Budget Reserve. It currently has a balance of about $12.17 billion; certainly the Legislature could have done a better job putting money into the CBR, but there it is.
Captain Zero recently forced through a reduction in the effective tax rate, promising us that any shortfall would be made up in volume. The idea, as WC and others have shown at length, is very seriously flawed. Now, as the random walk of oil prices turns down, all three factors in the revenue equation are down, resulting in a serious revenue shortfall. Oil produced remains in the slow, steady decline since the early 1980s. Crude oil prices are down. And Captain Zero’s idiot tax cut completes the suite.
So, mostly because of the decline in oil prices, we are dipping into the CBR. And the shrill squawking has already begun: “Oh dear oh dear oh dear. At this rate we’ll burn through the CBR in just six years.”
Folks, it’s random. It’s just as likely crude oil prices will go up in 2014-2015. You can’t plan on them going up or down. Remember, random. True, Captain Zero’s Big Oil giveaway magnifies the effect of the random price changes, but at lower prices the impact is slight. This is exactly what the CBR is for; you can’t piss and moan about the future because, like it or not, it’s random. You certainly can’t draw any conclusions from current behavior as to the future.
Captain Zero is already trying to panic the voters and the Legislature into massive budget cuts. It’s the same technique he used for his idiot tax cut.
Maybe they’ll learn. Maybe they understand it’s living with the Drunkard’s Walk. But probably not.