A Crude Surprise for Fossil-Fuel States

A Crude Surprise for Fossil-Fuel States
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One of the most significant political and economic stories of 2014 was the decline in crude-oil prices, which has continued apace in 2015. Entering the first full week of trading after the holiday season, the two major oil benchmarks, Brent and West Texas Intermediate, had both hit lows not seen since the aftermath of the 2008 financial crisis. Weak global oil demand and a supply glut due in part to record-breaking domestic drilling in the United States has effectively halved the price of crude oil in six months.

The ripple effects of this price collapse have reverberated worldwide, with some countries, such as India, taking advantage of lower import bills to roll back subsidies and price controls on fuel. For producing countries, forecasts for the year 2015 have taken a more dire turn. Venezuelan president Nicolas Maduro has undertaken a series of visits to China and member nations of the Organization of Petroleum Exporting Countries designed, according to the BBC, to secure financial assistance and a promise of production cuts in order to stop the collapse of his country's economy.

Yet it is not only overseas that these revenue shortfalls are having a tremendous effect on government budgets. While Americans typically revel in lower prices at the pump, the United States is a major producer as well, so the effects of the drilling boom are not uniformly positive.

The fiscal health of Alaska, for example, is tied to the success of the oil-and-gas industry in a way that will be hazardous to the state's long-term growth prospects if crude-oil prices do not recover substantially. Its predicament is a lesson for governments everywhere that assume their fiscal policy can be supported forever by success in energy markets.

Alaska has no personal income tax, and no statewide sales tax. To fund its operations, the state relies on tax revenue collected on the extraction of its vast natural resources, some of which is paid directly to state residents as a dividend. In the 2013 fiscal year, a jaw-dropping 79 percent of its revenue came from the oil-and-gas production tax; the next-highest source was 13 percent from the corporate income tax.

This set-up works smoothly when prices are historically high and stable, as they have been for most of the past decade. This set-up is problematic, however, when the world oil market turns against you, as it has for Alaska. Like North Dakota and Texas, it is a victim of current market realities. North Slope crude prices have declined alongside Brent and West Texas Intermediate, and this has blown a hole in the state's budget, imperiling state-funded infrastructure projects and threatening an increase in a variety of state fees. The year-on-year change is astounding: Comparing third-quarter collection from 2013 to 2014 yields a 74 percent reduction, according a report from the Rockefeller Institute of Government, which regularly monitors state tax collections.

Alaska is not entirely without options, however. Its Permanent Fund, from which it distributes an annual dividend to non-felonious Alaskan residents, still has a sizable reserve, but tapping it to plug a hole in the budget (to say nothing of imposing additional taxes) may not be politically popular. Likewise, adding oil-revenue streams is possible, but problematic. As McKenzie Funk wrote in the New York Times, the last frontier, oil exploration in the Arctic, faces significant technical challenges before full-scale drilling can begin. A low-price environment, as Funk points out, only compounds these difficulties, as companies are unlikely to recoup their investment on an acceptable timeframe, if at all.

The simple lesson, then, is not to construct your state budget as if it were the business plan of the company town's general store.

There is a wider lesson, though, too. Namely, that volatility may soon become an even bigger and more consistent problem for global energy markets than it was during price swings of the 1970s and 1980s, as it will result not only from traditional ebbs and flows in supply and demand, but also from the energy transitions that will be part and parcel of any concerted response to climate change. Low global demand now is driven in large part by lethargic economic activity. In the future, an increasing proportion of low demand will be driven by measures like those California is taking to de-carbonize its economy, including reining in its notorious car culture.

In this respect, Alaska, North Dakota, and Texas are merely bellwethers, extreme examples of how energy booms can quickly become busts and the financial damage that busts leave in their wake. Crude prices could of course rebound in the short term and ameliorate a lot of these difficulties. But the stark economic realities at play here for states dependent on fossil fuel development will be a long-term challenge.

Neil Bhatiya is a policy associate at the Century Foundation, a nonpartisan progressive think tank.

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