Drop in oil and gas prices leads to negative rating watch for Alaska

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While the nation grapples with economic distress wrought by COVID-19, Alaska and other oil-dependent states, are wrestling with the economic impact caused by the drop in oil and gas prices.

Fitch Ratings placed AA-minus-rated Alaska on rating watch negative March 27 saying the watch “reflects the severe financial and economic stress the state is expected to undergo as a result of the recent plunge in crude oil prices, compounded by the negative impact the coronavirus pandemic is expected to have on the state’s important fishing and tourism industries.”

An oil production facility on Alaska's North Slope. Collapsing oil prices have put a huge dent in the state's economy and budget.

“We think their flexibility and resiliency is heading down a negative path,” said Fitch analyst Marcy Block in an interview.

The watch affects $670 million in general obligation debt, $1.1 billion in Alaska Municipal Bond Bank Authority resolution bonds and $215 million in state appropriation bonds, Block said.

A sustained period of low oil prices is likely to create negative credit pressures for eight oil producing states including Alaska, Louisiana, Montana, New Mexico, North Dakota, Oklahoma, Texas and Wyoming, according to a March 11 S&P Global Ratings report.

“While shock declines in commodity prices are not new, the timing of this latest rout has the potential to upend recent fiscal and economic improvement,” S&P analysts wrote.

Alaska, the state most reliant on oil-related revenue, has depended on reserves to balance its budget since fiscal 2015, S&P analysts wrote. Equity market volatility and low oil prices, with already deep expenditure cuts, may limit the state’s fiscal flexibility, analysts wrote.

S&P “has long held that the outsized budget reserves of oil-producing states have provided an effective fiscal cushion during a transition to lower oil prices,” analysts wrote. “Over the past five years, a changing economic outlook and a wide range of fiscal adjustments resulted in an easing of the negative pressure facing state credit quality. However, a fiscal shock to these states, so soon after their economic recovery, is likely to create a challenging budgetary environment.”

A combination of volatility related to the current coronavirus epidemic, shrinking demand for oil, and conflict between OPEC and Russia that kept global production high despite lower demand caused prices to plunge to a low of $23.91 per barrel of crude oil on March 18, Fitch Ratings analysts wrote.

This price level is far below estimates in the state’s forecast used to enact the current budget, they wrote.

With many car-centric states closed for business and fewer planes flying, the situation is likely to worsen, Block said.

The state’s operations rely on revenue from earnings of its Permanent Fund, which saw its value decline from $66.3 billion as of July 1, 2019 to $56.5 billion as of March 23, an almost 15% decline, according to Fitch.

The Alaska Legislature recessed Tuesday after finishing work on the $4.54 billion fiscal year 2021 operating and capital budget, the fiscal year 2020 supplemental budget, and extending the Public Health Emergency Disaster Declaration for COVID-19.

Alaska Gov. Mike Dunleavy lauded the speed in which the Legislature approved the budget, but said he "feels the Legislature missed the mark by not including a cash infusion that many leading economists believe should be implemented as quickly as possible."

“Thousands of Alaskans are out of work through no fault of their own, due to the government pausing most economic activity to slow the spread of the disease,” Dunleavy said. “It would appear lawmakers missed the opportunity to create a cash infusion from the earnings reserve account into the hands of Alaskans, like hairdressers and restaurant workers, that could have happened in as little as two weeks. I am quite frankly puzzled why they would not do that.”

Since taking office in 2018, the governor has battled with the Legislature over reductions to dividend checks Alaskans receive from its Permanent Fund. The fund created by voters in 1976 was described as a "world class sovereign wealth fund," by Terry Smith, president of Commonwealth North, during an online debate Wednesday orchestrated by the public policy group.

The Legislature's budget delivers a $1,000 Permanent Fund dividend check in October to eligible Alaskans.

The Senate had included a second dividend in its budget to help Alaskans struggling with the economic impacts of COVID-19. That second $1,000 dividend was removed by a special committee formed to resolve differences between the House and Senate budgets.

While the budget has passed through the Legislature, there is no guarantee it will be signed into law in its current form. The governor has the power to veto the entire budget or individual spending items.

Legislative Finance Division Director Pat Pitney told members of Common Wealth North during a Friday morning video conference that the State of Alaska is now facing significant annual deficits even before Permanent Fund dividends are paid.

Fitch will be “examining in detail the potential impact of the market decline on the viability of the Permanent Fund Earnings Reserve over the short to immediate term,” analysts wrote. “Any valuation losses in the PFER from the current financial market turbulence would be compounded by potential state action to appropriate additional sums to residents as a means of economic stimulus.”

The rating watch negative is expected to be resolved following Fitch’s analysis of the state’s Spring 2020 revenue forecast, which is usually released in April, and will consider state actions to address the anticipated economic and revenue weaknesses. Though the Department of Revenue typically publishes an update to its fall forecast in late March or early April, department heads said they were delaying publishing new numbers given the market volatility.

The rating agency had already downgraded the state’s underlying rating in September to AA-minus. The state holds an Aa3 rating from Moody’s Investors Service and AA rating from S&P Global Ratings.

Moody’s revised the state’s outlook to negative in July citing the risk of deterioration of financial metrics or governance practices, particularly if political paralysis impedes policymakers from agreeing on effective approaches to the state’s key credit challenges.

S&P downgraded the state each year from 2015 to 2018 with the rating falling a notch each time to the current AA. Before the fall, the state had a triple-A rating from S&P in August 2015.

It’s too soon to say whether the negative outlook could result in a one-notch downgrade or a multi-notch downgrade for the state, Block said. While most of the country has been experiencing the longest economic recovery in recent history, Alaska has spent most of the past several years in a recession.

“It is on rating watch negative,” Block said. “We see the trends as being negative. We will be looking for any stabilizing factors in the budget once it is enacted.”

The state made headlines during last summer’s budget process when Dunleavy proposed steep cuts to the university system in order to close a budget gap. Dunleavy and the Legislature walked back the severity of the proposed cuts following an outcry from university leaders.

“It took them several rounds to get a final budget last year,” Block said. “The size of the cut was just shy of 11%, after negotiations ended. Right now, the process they are going through is for 2021, and the 2020 supplemental budget.”

Expenditures were down 5%, but Fitch doesn’t know what the final supplemental budget for 2020 will be, she said.

On the upside, the Alaska Senate budget for 2021 included a pretty low estimated cost of oil at $40 per barrel, she said. S&P said most of the oil producing states estimated oil prices of $50 per barrel for fiscal 2020 in their enacted budgets.

Alaska North Slope crude was selling for $26.73 per barrel as of March 25, according to Department of Revenue figures.

Oil and gas prices are critically important for Alaska, Block said.

Thus far, the state has not recognized in long-range plans that gas and oil prices are down and could be down for some time, she said.

State lawmakers need to put in some sort of reoccurring action that balances the budget, and avoid bringing reserves down to a level that they won’t have the cushion needed for future downturns, Block said.

Correction: Fitch Ratings placed Alaska on rating watch negative. The action was reported incorrectly in the original version of the story.

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