The implications of plummeting gas and oil prices for Alaska’s economy

Driving through gas stations around Fairbanks lately might surprise some residents. Gas prices are noticeably lower than they usually are.

Why?

As the effects of COVID-19 continue to develop, the reduced cost of gasoline for consumers is a byproduct of the efforts made to respond to the virus. Understanding the reduction in gasoline prices, however, requires an understanding of the economics of oil, the price of which is also falling.

“I see oil prices as essentially falling as a result of two things,” says Mouhcine Guettabi, Associate Professor of Economics at the University of Alaska Anchorage’s Institute of Social and Economic Research, “tension between Russia and Saudi Arabia, and the falling demand due to COVID-19 and the potential looming recession [and] depression, depending on how long this thing lasts.”

Guettabi refers to the clash between Russia and Saudi Arabia over oil production. Due to falling oil costs, the two oil-producing nations had agreed to limit production in order to drive up prices. However, due to geological restraints on their oil wells, as well as economic considerations, Russia continued to produce a larger amount of oil than they had initially agreed.

This pushed Saudi Arabia, as well as other oil producers in the OPEC+ cartel to a forced standoff: either Russia would limit its supplies of oil, or the cartel would crumble, and countries would be free to produce as much oil as they desired, predicted to lead to ever lowering oil prices.

Although declines in oil prices are not unprecedented, Guettabi says that the current situation is unlike others experienced over the past two decades. “There is a massive question mark regarding what happens to the world economy. I am hard-pressed to think about a circumstance where economic activity worldwide was frozen for an extended period time. That’s why it’s really hard to say this reminds me of the great recession or of previous episodes of turmoil in the Middle East, or in other parts of the world.”

With oil barrel prices currently hovering around the $20 mark, he predicts that Alaska faces significant looming budget consequences.

“The Department of Revenue produces forecasts for oil prices and oil revenues,” Guettabi says. The most recent forecast produced by the department predicts a $20 drop in oil barrel prices over the next decade. “That means that the revenues the state was getting from oil are going to decline by $500 million in fiscal year 2021.” As revenues continue to drop over the next decade, Guettabi predicts that Alaska will bear a one billion-dollar debt.

Although the Department of Revenue reports that in 2018, 80% of Alaska’s revenue came from oil, and projections for the next decade put it at much the same figures, oil is not the state’s only source of income.

“Alaska has a large savings account that has about $65 billion,” Guettabi says, referring to Alaska’s Permanent Fund. “It was initially capitalized from oil revenues and is now widely invested in the stock market, in real estate, and in private equity.”

An amount of the fund based on the 5-year average of its returns, known as the Permanent Fund Dividend, is distributed annually to Alaskans.

“Three years ago, Senate Bill 26 was passed in Alaska, which mandated, or allowed, the government to take out a percentage of market value from the fund in order to help pay for government services because of the falling oil price,” Guettabi explains.

S.B. 26 allowed the government to claim 5.25% of the fund’s market value for government spending. “And even with that, it still has a deficit,” Guettabi says. Additionally, the permanent fund creates revenue by investing in stocks, which have also been impacted by the COVID-19 pandemic.

“Really, [Alaska’s] two biggest forms of revenue are the draw from the permanent fund…and oil,” Guettabi explains.

Falling oil prices have created another issue with immediate implications for the state.

“We really don’t know, as of yet, the extent to which the decline in prices is going to affect the pending sale of BP assets to Hilcorp,” Guettabi remarks.

Last week, reports emerged about Hilcorp struggling to raise capital to take over BP’s Alaska assets. The Regulatory Commission of Alaska has slotted a May 4 deadline for Hilcorp to provide details of its ability to meet the capital requirements. According to its website, BP expected to produce an average of 74,000 barrels of oil per day in 2019, accounting for some 20% of Alaska’s total oil production.

Although there is a distinction between state revenues generated by oil and the state’s gross domestic product, Guettabi says that impacts to the Alaskan oil industry will “reverberate” throughout the state. “There is no industry that contributes as much, or can potentially replace, the amount of revenue that goes to government [from the oil industry],” Guettabi says.

“From the private sector standpoint, it’s not untrue that Alaska’s industrial structure is fairly diversified. It is also absolutely true that the oil industry plays a massive role within it,” he continues. “So, if we see a two or three thousand job reduction in the oil industry, that’s going to have a cascading effect throughout the rest of the economy.”

Guettabi notes that besides oil, the tourism industry in Alaska is going to experience similar losses due to COVID-19. “We were expecting about a billion and a half in spending from tourists, we were expecting record visitor numbers.”

He raises similar questions about the fishing industry: whether or not commercial fishing can be done safely, and whether there will be demand from Asia.

All of these questions have yet to be answered as the effects of COVID-19 continue to ripple across the world, and Alaskans find themselves in a position of declining revenue for the state. The falling price of oil, at a time of low demand and high supplies, has prompted gas retailers to incentivize Alaskans to purchase.

As to the questions about the future of Alaska’s economy, only time will tell. For now, perhaps it’s best to just enjoy cheap gas.