In an analysis of the fiscal situation in Alaska, Standard & Poor’s wrote that in order to keep its credit rating, Alaska must reduce the budget deficit given the low price of oil.
“Although the rapid decline in oil prices exacerbates Alaska’s existing fiscal budget deficit, whether it will weaken the state’s credit quality will depend on the state’s budgetary response,” the credit rating service wrote. In most other cases, a $3.5 billion, equal to 57 percent of general fund expenditures, would “likely result in immediate negative rating consequences.” However, S&P is not changing its ratings yet because of the state’s large budget reserves, as well as the ability of the state to tap into the Permanent Fund earnings reserve balance, and the constitution budget reserve.
A decline in Alaska’s credit rating could cost the state hundreds of millions of dollars.
Here’s S&P’s analysis in full:
Alaska has built up layers of budgetary reserves that allow it to absorb one or two years of large operating deficits — just outside of our outlook time horizon –at its current rating level. But in order for it to avert credit quality deterioration, we believe the state must make material progress in reducing the deficit in its fiscal 2016 budget.
Although the rapid decline in oil prices exacerbates Alaska’s existing fiscal budget deficit, whether it will weaken the state’s credit quality will depend on the state’s budgetary response. For fiscal 2015, the state assumed oil prices would average $105.06 per barrel, giving rise to about 495,900 barrels per day of production on Alaska’s North Slope. Based on more recent price and production information, the state has revised its estimates to $76 per barrel and 509,500 barrels per day for fiscal 2015. The state’s assumptions regarding oil prices and production are integral to its budget condition because oil-related revenues made up 88% of its estimated revenue for the 2014 fiscal year and 79% of fiscal 2015. At enactment, the state’s budgeted general fund expenditures for fiscal 2015 exceeded its unrestricted revenues by $1.4 billion. Weaker oil prices and production resulted in an updated budget gap of $3.5 billion, equal to 57% of general fund expenditures. For most states, an operating deficit of this magnitude would likely result in immediate negative rating consequences. In Alaska’s case, however, extraordinarily large budget reserves effectively buy the state time to deal with its structural misalignment.
Even before the recent plunge in oil prices, the state’s unrestricted revenue structural deficit wasn’t sustainable indefinitely. But whereas its baseline fiscal forecast previously showed total budget reserves equal to 140% of expenditures after 10 years, now they would be depleted by 2023. However, we would likely begin taking rating action well in advance of that. In fact, the state’s ability to enact a budget for fiscal 2016 that makes material progress toward reducing the fiscal gap will be important to the future direction of its credit quality. Nevertheless, we are not changing the rating or outlook at this time because even with the large shortfall that has emerged, the state projects that fiscal 2015 will end with total budget reserves of $9.6 billion, or 157% of expenditures. In addition, the state’s permanent fund earnings reserve balance, which can be drawn upon with a majority vote of the legislature, is expected to have a balance of $4.66 billion at fiscal year end, bringing the state’s total reserves available for operations to 233% of expenditures. Finally, Alaska’s practice of prefunding major expenditures serves as another type of fiscal reserve. For instance, the fiscal 2015 budget prefunds the $1.2 billion fiscal 2016 education budget. Were the state to discontinue its prefunding activities, it would immediately generate a like amount of budgetary savings on a one-time basis.
The state’s large reserve balances also generate considerable annual revenue. Although the revenue from investment earnings is considered restricted, it could be made available for appropriation. In fiscal 2014, the state’s constitutional budget reserve (CBRF) returned approximately $1 billion in revenue that — with a three-fourths vote of the legislature — could be appropriated. Likewise, the state’s permanent fund generated $7.9 billion in investment revenue that could be appropriated with a majority vote of the legislature. And because most of the revenue is saved rather than spent, the state’s net asset position can increase even when there is a deficit of unrestricted revenue in the general fund. In fiscal 2014, for example, the state’s government wide net asset position increased to $82.1 billion in fiscal 2014, from $76 billion the prior year, despite a $1.9 billion unrestricted revenue shortfall relative to appropriations.
Projections for fiscal 2015 indicated reduced investment earnings of $270 million in the CBRF and $3.3 billion from the permanent fund. These amounts, if the legislature voted to make them available for appropriation, would approximately cover the revised budget gap estimate of $3.5 billion.
Under Standard & Poor’s policies, only a Rating Committee can determine a Credit Rating Action (including a Credit Rating change, affirmation or withdrawal, Rating Outlook change, or CreditWatch action). This commentary and its subject matter have not been the subject of Rating Committee action and should not be interpreted as a change to, or affirmation of, a Credit Rating or Rating Outlook.
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