ACES, HB 21 and Reality. Or Why Tony Knowles Is Wrong

WC doesn’t like very many politicians. But WC does like former Governor Tony Knowles. And not just because he really shines in comparison to the idiots who have succeeded him. WC liked Knowles enough to contribute money to his campaigns. In fact, Candidate Knowles stayed in WC’s house a couple of times. Tony Knowles is the only politician who can make that claim.

So it’s a bit painful for WC to find himself disagreeing with Governor Knowles on the business of taxation of the oil industry. It’s even a bit embarrassing to WC to have to disagree with the distinguished Scott Goldsmith, who is not only a skilled economist, but an economist who can write and speak in very nearly plain English.

It’s also surprising to find WC agreeing with the Quitter, who apparently woke up this morning and realized that Captain Zero had knifed the signature achievement of her half-administration. But even a stopped clock is right twice a day.

Let’s start with a recap. Alaska lucked out with the discovery of the giant Prudhoe Bay oil field. It was the largest oil field ever found in North America. At peak production, in 1988-89, it produced 1.7 million barrels a day. Through 2013, it has produced about 12 billion barrels of oil. There are still an estimated 2-3 billion barrels of recoverable oil in Prudhoe using current technologies. But, absent a remarkable technological change, Prudhoe is about used up. Yes, there are other oil fields on the North Slope, but their total production is a fraction of Prudhoe’s. Alaska’s oil industry is mostly about Prudhoe. Prudhoe accounts for about 12 billion of the 16 billion barrels of oil produced in Alaska.

And while Prudhoe may have 2-3 billion barrels left, the field is in steady decline, and has been for decades now. The smaller fields, while not trivial in size, weren’t the reason the pipeline was built or the reason for the State’s relative prosperity; it is and always has been Prudhoe Bay.

So the decline in the amount of oil in the pipeline, the alarm bells that worked Captain Zero into a frenzy, is mostly a reflection of the exhaustion North America’s largest field.

And there aren’t any more Prudhoe Bay-sized reserves on the North Slope. Not in the Arctic Slope National Wildlife Refuge; not in the Chukchi or Beaufort Seas. Not in the National Petroleum Reserve. Middle-sized fields, perhaps. But the primary reason Trans-Alaska Pipeline throughput is down is the the gigantic Prudhoe Bay field is getting used up.

Which takes us to Dr. Goldsmith’s report and Governor Knowles article endorsing the report. It comes to this: there are just three variables in the calculation of the revenue Alaska gets from oil shipped through the pipeline:

1. The amount of oil in the pipeline.

2. The price of oil.

3. The State’s effective tax rate.

The only one of the three the State directly controls is the last. ACES, the tax structure SB 21 repealed, was a “progressive tax;” that is, the higher the price of oil, the higher the effective tax rate. ACES took the position that if the oil industry had a windfall because of high crude oil prices, the State should share in it. SB 21 “flattened” and lowered that tax rate. There’s no requirement that Big Oil put more oil in the pipeline as a condition to lower rates. As WC has demonstrated, the amount of oil in the pipeline is heavily dependent on Prudhoe Bay, and it’s about done. All the little fields Big Oil might find, if they had the incentive to look hard, aren’t going to add up to a significant fraction of a Prudhoe. Believing they might is wishful thinking.

And the price of oil is down. Fracking has greatly increased the amount of oil available. And from there the law of supply and demand inescapably drives the price of oil down. It will likely get worse as fracking technology makes its way into Middle East oil fields.

So the amount of oil in the pipeline isn’t likely to increase very much. The price of oil isn’t likely to go up very much. And, by flattening the tax rates and reducing them on new oil, the State has only assured itself of a fiscal crisis, not of more oil in the pipeline.

When Scott Goldsmith tells us that the State revenue picture would be much the same even under ACES, that’s true but mostly irrelevant. The State’s oil revenue is down because the world price of oil is down and Prudhoe is getting used up. The lower tax rate is the least important factor,but to the extent it weighs it reduces the third element slightly and, if oil priies were to go up again – a crisis in the Middle East, say – then the absence of ACES’ progressive rates would hurt the State badly. In particular, the rapidly depleting Constitutional Budget Reserve can’t be replenished.

Even if you assume that Dr. Goldsmith is right and in the current oil price and oil volume environment SB 21 is revenue-neutral, you have to ask what the point is of throwing away the chance of more revenue in the event of another price spike.

So, Sorry Governor Knowles, sorry Dr. Goldsmith. SB 21 is and remains an idea, unlikely to result in material quantities of oil, even less likely to produce more revenue, and therefore a bad idea.