Fitch: Alaska Revises FY2015 Oil Price Forecast; Increases Budget Gap; No Immediate Rating Impact

Yesterday's substantial reduction in Alaska's FY2015 price forecast for crude oil produced on its Alaska North Slope (ANS), from $105 per barrel to $76.31 per barrel, offset by a modest expected increase in oil production, has lowered the state's revenue forecast for the current fiscal year (CFY) by almost $2 billion. The revised forecast increases the state's earlier anticipated revenue shortfall to almost $3.4 billion (57% of unrestricted General Fund expenditures) that Fitch expects to be covered by a draw from the state's vast financial reserves. In enacting the FY2015 budget the state expected to utilize almost $1.4 billion from its Statutory Budget Reserve Fund (SBRF) to support appropriations; that projected application has now more than doubled.

The state also lowered its price forecast for FY2016 from $107.69 to $66 per barrel while estimating higher production from forecast investments on the North Slope and the Cook Inlet. These revisions lowered its revenue forecast for that year by a net $2.5 billion. Through the life of the forecast period, to 2023, the state's price expectations have been reduced, which if proven correct, will result in financial reserves being depleted faster than the state's earlier expectations, in Fitch's opinion, despite Fitch's expectation that the state will take balancing actions. The key considerations for the state's credit quality will be if price expectations remain subdued and to what extent recent developments influence the state's decisions on applying its reserves to operating costs. For local governments in the state, the impact is less direct and much more gradual, driven by changes in property tax revenues that are not directly linked to oil prices. Nevertheless, a sustained period of very low oil prices would put pressure on some municipalities through reductions in long-term oil industry investment, assessed valuations and employment.

Alaska's 'AAA' GO rating reflects the state's maintenance of very substantial reserve balances and conservative financial management practices to offset significant revenue volatility linked to oil production from the North Slope and global petroleum price trends. For many years, the state has witnessed a gradual decline in production at its oil fields; however, tax revenues to the state have largely continued to increase as a factor of increased prices for ANS crude oil. While the revised forecast projects increases in production in FYs 2016 and 2017, the state continues to forecast production declines over the long term. A recent change in its oil tax policy, enacted in the More Alaska Production Act (MAPA) of 2013 at a time of significantly higher oil prices, sought to spur production by removing the progressive surcharge tied to the value of oil, lowering effective tax rates for new oil developments, and providing greater incentives for capital investments.

Alaska plans to close the newly identified gap by applying funds from its Constitutional Budget Reserve Fund (CBRF) and the SBRF, both of which require only a simple legislative majority to access when the state's budget is in a deficit. Combined, those funds had a balance of $14.7 billion as of Nov. 30, 2014, equal to 250% of unrestricted general fund spending, providing ample flexibility to the state in meeting the current revenue challenge.

The state has robust multi-year forecasting practices and has long expected that ongoing declines in production would result in a gradual decline in oil tax revenue in forecast years. In turn, the state has prudently set aside much of its past revenue windfalls in the CBRF and SBRF. The state has intended to apply these funds to ease potential expenditure reductions until the new tax structure incentivized new production. However, the ability to tap these funds' for operating expenditures was premised on sustained higher per barrel prices, and the current low crude oil price is expected to disrupt those articulated plans, in Fitch's opinion.

The state maintains additional, large reserves beyond the CBRF and SBRF that provide multiple times coverage of its outstanding debt obligations. Over $1 billion has been set aside for pre-funding school formula payments that does not require a vote of the legislature to access. Also accessible by a majority legislative vote is the realized earnings reserve of the $51.2 billion Alaska Permanent Fund (as of Dec. 9, 2014), measuring almost $4.4 billion (as of Oct. 31, 2014). Fitch expects the state to prudently manage draws from its various reserves as warranted, in addition to realigning its discretionary expenditures to achieve budgetary balance. Access to the Permanent Fund corpus itself would require an amendment to the state's constitution, a path the state has never pursued even during past multi-year periods of low petroleum prices.

A very high 88% of the state's unrestricted general fund revenue was derived directly from petroleum-related activity in FY2014. In contrast, local governments in Alaska are highly dependent on property taxes that are not directly linked to energy prices. Rather, property taxes levied on energy extraction are based on the depreciated value of the capital stock. As a result, Fitch expects any financial impact from lower oil prices on local government credits to be much more gradual and only if the lower prices are sustained. A sustained, multi-year decline in oil prices and energy industry investment could pressure tax bases, financial performance, economic indicators and ratings.

Over the near- to medium-term, local governments' exposure to falling oil prices is primarily through their reliance on state aid. Alaska municipalities receive state support for major expenses such as education and infrastructure. Local government financial performance could weaken if state policymakers chose to address state budget shortfalls through cuts in aid to local governments. Fitch believes Fitch-rated issuers have the financial and expenditure flexibility to adjust to changes in state aid; however, an unanticipated failure to adjust budgets and tax rates to restore structural budget balance would be negative for credit quality.

For more information, see Fitch's press release 'Fitch Rates Alaska's $31MM COPS 'AA+'; Affirms Outstanding GOs at 'AAA' dated Aug. 11, 2014, available at www.fitchratings.com.

Additional information is available at 'www.fitchratings.com'.

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