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Eye on the Prize: Petroleum

Scott Goldsmith

Scott Goldsmith

The Alaska economy has always been dependent on its abundant natural resources of wildlife, fish, timber and minerals, but none has transformed Alaska like petroleum since we became a state. Research done at the University of Alaska’s Institute of Social and Economic Research funded by Northrim Bank has estimated that two-thirds of the job growth since 1960 is attributable to petroleum and that half of today’s jobs and income can be traced back to petroleum.

But the path forward is not clear. Although by standard measures the economy is strong, the decline in petroleum production represented in the “Prudhoe Curve” looks like a dark cloud on the horizon. Fortunately petroleum has the potential to continue to sustain the economy for decades to come, but only if Alaska can rise to the challenge.

 

Today’s Economy

The economy is not only bigger today because of petroleum; it bears little resemblance to the Alaska of 1960. Alaskans today take home paychecks that are above the national average, enjoy a low tax burden, and collect a Permanent Fund dividend check each year. Job opportunities are readily available for young Alaskans.

The cost of living in urban areas mirrors that of the rest of the U.S. The expanded availability of consumer goods and services eliminates the need for trips Outside for shopping and health care.

Generous government spending has resulted in high quality public services like education and health care delivery across the state and new roads, harbors and other infrastructure to support the Alaska life style and economic development.

The economy is more diversified and less dependent on federal spending or the seasonal fishing and tourist industries.

There is no better indicator of the quality of the economy than the fact that young Alaskans and senior citizens are both voting with their feet to stay in Alaska. In fact, the senior population is growing at a faster rate than any other state, both because retirees are choosing to stay and new seniors are moving in.

Unfortunately many Alaskans underestimate the role that petroleum has played. Unlike tourism or commercial fishing, most petroleum exploration, development and production takes place in the remote northern part of the state, far from the population centers, so we just do not see it. This is particularly the case in the rural parts of Alaska where no one can point to a neighbor who works in the oil patch or can see the headquarters building of an oil company.

But a large part of the impact of petroleum on the economy has come from the $170 billion (2012 $) the state has collected in royalties and taxes from petroleum production. This has gone out to every part of the state from Ketchikan to Barrow, fueling private and public jobs and income not readily identifiable as dependent on petroleum.

 

Understanding Petroleum’s Role

Furthermore most Alaskans have no memory of what Alaska was like before petroleum, so it is difficult to see the difference it has made in the economic life of the Prudhoe Bay generation.

It is important that Alaskans understand the role of petroleum in this transformation because the continued prosperity of the economy depends upon the future of petroleum in the state. Our other natural resource industries will certainly make a contribution, but just as they have accounted for only a small share of our growth since Alaska became a state, they can only play a supporting role in the future.

The last several years have been particularly good for the Alaska economy. After two decades of uninterrupted growth we have weathered the national recession with only a one year pause. Job growth has returned strong and the unemployment rate is below the national average. Growth is projected to continue for the next several years.

But this rosy picture is a distraction from the reality of the continuing fall in oil production from its peak of 2 million barrels a day in 1989 to only about 600 thousand barrels today. It was easy to ignore the slide in production when the oil price and oil patch employment were both growing and when federal dollars were pouring into the state thanks to Ted Stevens and military spending growth.

But the federal dollars are drying up and the “Prudhoe Curve” has reached the point where the viability of the pipeline has come into question. The production decline can no longer be ignored. If the petroleum industry withers away, much of the prosperity Alaska has enjoyed and come to expect will disappear with it.

A number of strategies have been proposed to compensate for the decline in oil production represented by the “Prudhoe Curve” and all of them have a contribution to make. These strategies include the commercialization of the vast natural gas resources on the North Slope, economic diversification, value added processing of our natural resources, and investment in transportation and energy related infrastructure.

However, none are likely to generate the wealth and jobs we have gotten from oil for the simple reason that the Alaska economy remains small, remote and relatively high cost. Production of North Slope oil has been able to overcome all of those disadvantages because of the phenomenal size of the oil fields. Prudhoe Bay was the largest field discovered in North America and at its peak, North Slope production was exceeded only by six countries. Even 20 years later Prudhoe Bay has more proved reserves than any other field in the U.S.

Fortunately petroleum has the potential to continue to drive the economy for generations to come and to become a truly renewable resource. The production decline reflected in the “Prudhoe Curve” only shows conventional production on state land, which indeed is driven by depletion of the giant fields discovered years ago.

What that curve does not show is the potential for squeezing more oil out of these fields and their smaller neighbors using new technologies, nor does it show the potential unconventional production from heavy oil and shale oil deposits, or the potential production from federal lands—particularly on the Outer Continental Shelf.

 

Realizing Opportunities

Converting the potential of these resources into reality will require hard work on two fronts. First the state will have to develop a better working relationship with the oil industry because that is where the resources of capital and know-how reside that can get those resources to market. And it is also the industry that has the ability to take the risks necessary to make that happen.

The state has always been concerned with tax policy for getting its “fair share” of the value of production and somewhat less so with maintaining incentives to attract new investment. Although tax policy is important, the time has come to consider alternative methods of partnering with the industry that produce better alignment between the interests of the state and those of the industry.

For example, the experiences of other oil rich regimes with co-investment need to be examined to see if they could be applicable in Alaska. As the “owner state,” a more proactive role in the management of our resources might be warranted.

Second, because much of the remaining reserve base is on federal lands, the state has less direct control. It has to make the case that these reserves can be developed and produced efficiently and in an environmentally sound way, and that it is in the best interests of the entire nation.

Realization of the opportunities represented by these reserves could result in production, jobs and business opportunities coming from the oil patch comparable to those from Prudhoe Bay during the last 40 years. But because of the high costs associated with production of unconventional reserves and the inability of the state to tax or share in the royalties from OCS production, this “Post Prudhoe” generation will not produce revenues for the state on a similar scale.

But we can still pay for the public services we have come to expect and those that the “Post Prudhoe” petroleum generation will require because we are fortunate to have the legacy of the Prudhoe Bay generation to rely upon. That legacy is in the form of $60 billion in savings accumulated from past production deposited into the Permanent Fund as well as the Constitutional and Statutory Budget Reserves.

And we are also fortunate because although most of the easy to reach conventional North Slope oil has been produced, the remaining reserves have a market value almost as high as the oil already produced because the price of oil today is so much higher than in the past. Careful stewardship of those revenues yet to be collected could more than double the size of this legacy.

But doing so will require more discipline than we have shown since the oil price boom started in 2005, driving oil revenues to record high levels and allowing us to quickly forget the previous years when we were rapidly drawing down the Constitutional Budget Reserve. Rethinking how we manage our petroleum wealth to generate the maximum sustainable yield would provide guidance for sustaining our petroleum wealth for all future generations of Alaskans.

Petroleum has brought prosperity to Alaska and sustained the economy for more than a generation. If we keep our eye on the prize it can continue to do so for future generations of Alaskans as well.

Scott Goldsmith is Emeritus Professor of Economics in the Institute of Social and Economic Research (ISER) at the University of Alaska Anchorage.

This article first appeared in the October 2012 print edition of Alaska Business Monthly magazine.

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