JUNEAU, Alaska - Alaska's deputy commissioner of revenue Ross Kinney sits in his small, sparsely decorated office peering at his Bloomberg terminal.
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From the 11th floor he can gaze down into the Gastineau Channel, a broad and picturesque passage lined by steep, pine-covered cliffs. Three cruise ships are moored there, and their passengers are pouring out to rummage through dozens of gift shops dotting the capital city's streets.
But the prospect of Alaska's plucking tourist dollars is lost on Kinney, at least for the moment. "Oil is up 10 cents a barrel," he notes with pleasure. "A 10-cent change in the price of oil makes a lot of difference here."
The moment is emblematic. Kinney, the equivalent of state treasurer and a 26-year veteran of Alaskan public finance, is proud of his state's diversifying economy, and how the state's natural beauty attracted more than one million tourists last year. Tourism employment, while lower on the pay scale, is a fast-growing sector.
But oil - that's Alaska's cash cow.
In fact, severance taxes and royalties on oil production last year accounted for 85% of the revenue that flowed into the state's general fund. Oil has made Alaska so cash-rich that for years the state has proudly clung to a pay-as-you-go policy for infrastructure and aid to local governments.
That dependence on oil hasn't always made life easy for Alaskans. There have been wide, uncontrollable swings in state revenues, and in the late 1980s, when oil prices plummeted to below $10 per barrel, Alaska plunged into its worst recession since statehood in 1959. And now officials and residents are uneasily pondering a future after the oil dries up.
State lawmakers are starting to figure out how to fund government in the new Alaska, and some of the options - such as spending huge cash reserves - aren't popular. So, the idea of issuing a lot more bonds is becoming a lot less heretical.
"I would anticipate that for the foreseeable future, debt will probably come into play in the state of Alaska in a much bigger way than it has for the last 10 years," Kinney says. "At the same time, it's going to be used judiciously. The reason is that we just are not going to have the cash resources available. We are going to have to finance like others do across the country."
Under the Tundra, Oil
In 1968, oil was discovered in North Slope Borough, a vast territory above the Arctic Circle. Oil companies spent $8 billion to build the 800- mile Trans Alaska Pipeline that delivers crude from the oil fields to ice- free shipping ports to the south such as Valdez.
With the petroleum came cash - so much that in 1980, the state repealed its income tax and reimbursed all residents who paid it the year. The state imposed a severance tax on oil produced, while local communities in North Slope charged a property tax on oil rigs and other equipment.
When drilling reached its peak during the first half of the 1980s, the state went on a spending spree. One example was the $70 million spent on a failed attempt to create barley and dairy farming industries.
Then there was the Alaska Renewable Resources Corp., created by the state after the oil started flowing to coax new industries along. By the time the program was canceled in 1984, the corporation had amassed $28 million in non-performing loans, including one to a would-be developer of dog-powered washing machines, according to a 1996 economic diversification study.
At the same time, lots more money was spent quietly and well on everyday needs such as roads and schools.
But Alaskans always have been aware of a disturbing reality: someday the oil would run out. Experts traced the Prudhoe Bay curve, named after the largest field in North Slope, to track the life expectancy of the oil fields. Alaska is on the downward slope of that bell curve, and the bond market knows that.
One result has been that local issuers such as North Slope Borough have compressed debt maturities down to an average of 10 years. Also, Wall Street assesses what is commonly known as the "Alaska penalty" of as much as 10 basis points compared with similarly rated bonds from other states.
The curve originally predicted oil would run dry about now, but new technology in finding and extracting petroleum has pushed the curve's end out to 2015 - and officials expect it to be pushed out even further. That has helped slow the decrease in oil production considerably, but it's still in decline.
Since Alaska's oil fields came on line 20 years ago, prices have fluctuated from as low as $4 per barrel to a high of $30 during the Gulf War. Each dollar per barrel amounts to about $100 million of revenues for the state, according to Standard & Poor's.
The Ultimate Cushion
In 1990, the Legislature created the constitutional budget reserve to combat the instability caused by the volatility in oil prices; ironically, if unsurprisingly, it's funded from oil money. The state is required to appropriate 25% of oil revenues into the budget reserve, and withdraws from it when lean years in the industry creates budget shortfall. The reserve had nearly $3.5 billion as of June 30.
Last year, Alaska had expected a $400 million budget gap, but a spike in oil prices and spending cuts produced an operating surplus of $214 million.
An even more notable instrument that grew out of the state's windfall is the Alaska Permanent Fund Corp. Created in 1976, today it's a $25 billion portfolio of stocks and bonds designed as the ultimate cushion for when petroleum is no longer the state's breadwinner. Also capitalized by oil-tax revenues and managed as a public corporation, the fund returns an annual dividend to all eligible Alaskan residents.
Last week, it set a new growth record for the fifth year in a row, with dividend checks now four times higher than they were in 1993. Beginning next week, some 564,000 Alaskans will begin to receive their $1,540 checks thanks to the $2.6 billion the fund earned on its $25 billion principal.
"The stock market has been good to us in recent years," says Department of Revenue Commissioner Wilson Condon, speaking with considerable understatement.
In fact, growth in the Permanent Fund has been so phenomenal that last year, for the first time in its history, investment income surpassed revenues from oil.
"We took a non-renewable resource in the form of oil and turned it into a financial asset that generates a renewable income stream on an annual basis," says Kinney, who is considered a skilled negotiator and one of the most influential debt officers in the state.
"But we have to go in and look at what we want to do to diversify our revenue sources if we want to justify the issuance of debt farther out into the future, to give rating agencies, insurers, and bondholders a level of comfort that we still deserve a very high bond rating based on our ability to pay."
Kinney, who oversees the investment of most state funds along with debt and cash management, will be called upon to help solve the state's future funding dilemma.
He represents the Department of Revenue as a board member on the Alaska Housing Finance Corp., the Alaska Industrial Development and Export Authority, the Alaska Municipal Bond Bank, the Alaska Student Loan Corp., and the Alaska State Bond Committee.
In the past, Alaska limited its debt both because oil money made it easy not to borrow, and because volatility in petroleum prices made it prudent. In fact, the state hasn't issued general obligation bonds since 1984, and will pay off that loan next year. The state has relied on project revenue bonds and lease-backed certificates of participation when forced to borrow.
In January, for example, Alaska will sell $179 million of airport revenue bonds to pay for an expansion of Anchorage International Airport, the largest single public works project in the state's history. Merrill Lynch & Co. is running the books on that deal, on which institutional and Alaska retail buyers get first crack.
But the political will has not surfaced in the state yet to leverage the Permanent Fund for bonds, to pass a large GO authorization to pay for much-needed infrastructure, or to create a state income or sales tax to back debt.
GOs must be approved at the polls, and few Alaska politicians are willing to attach their name to the tax increase needed. As for the Permanent Fund, annual dividend checks are so wildly popular with Alaskans that lawmakers are reluctant to even discuss ending the program or spending part of the principal.
Even so, the sheer number of dollars amassed from the petroleum boom make bankers sanguine about Alaskans' options as they come to grips with borrowing.
"Alaska generally has diversified somewhat, although it still relies upon oil. But they have a small population. If you took the Permanent Fund and divided it by the number of people, you could buy everyone a home," says one New York City-based underwriter.
"They have amassed quite a sizable chunk of wealth to finance many things that they want," he continued. "And I think that's always going to be an interesting discussion up there about if they should use only the interest of the Permanent Fund and should they ever use the capital and for what. I don't see a negative story here at all about the long-term prospects of the state."
Tapping For-Profit Agencies
In the meantime, the state has devised a way to enlist the Alaska Housing Finance Corp., the most prolific and best-known Alaskan issuer, to pick up some of a $1.4 billion infrastructure tab.
The AHFC is a profit-making public corporation that returns a $50 million annual dividend to the state's general fund - a gift that was quickly devised a few years back after some lawmakers began discussing the possibility of liquidating the corporation and spending its money. The AHFC earns a profit from the spread between its borrowing and lending rates.
Now, the Legislature wants the AHFC to issue $200 million of its own GO debt backed by the $50 million it would have given to the state. That way Alaska can avoid ruffling taxpayers' feathers by issuing its own state- obligated debt. The corporation is allowed to issue GOs that are payable from its unrestricted assets.
"AHFC isn't the solution to the state's problem," says its executive director, Dan Fauske. "It's a piece of the solution. But the state of Alaska - in order to service a variety of things, not only deferred maintenance but new construction for schools, harbors, and whatever - is going to have to come up with some type of financing plan, whether it be the issuance of debt or cash flows."
Another well-known issuer is the Alaska Industrial Development and Export Authority. It, too, provides a dividend to the state's coffers that began several years ago to pacify lawmakers looking for a quick infusion of cash. Like the AHFC, AIDEA makes a profit from its loan portfolio, as well as from the business operations it owns.
While the AIDEA has no immediate plans to sell debt to help pay for deferred maintenance, its borrowing has been used to diversify the economy and create jobs.
"Having just one economic engine is not very good. When that one gets sick or goes away, we are left with nothing," says AIDEA executive director Randy Simmons. "There are a number of different entities that deal one way or another with economic development in Alaska, and they may be private and they may be government. We are just one of the tools in the toolbox."
Last year, for example, the AIDEA issued $71 million of tax-exempt conduit revenue bonds to help finance a portion of the Fort Knox gold mine near Fairbanks in central Alaska, and $23 million of conduit electric revenue bonds to pay for the Goat Lake hydroelectric plant near Skagway in the southeast part of the state.
In March 1997, the agency engineered its largest bond sale ever. It issued a $150 million mix of new-money and refunding bonds, largely to pay for construction of a 52-mile road leading to the Red Dog zinc mine, the world's largest.
The authority is considering another, $80 million bond sale for the Red Dog operation to dredge an AIDEA-owned port that services the mine. Currently, larger cargo ships have to wait in deep water until zinc is loaded onto smaller vessels and ferried out to them.
A deep-channel harbor would allow cargo ships to load zinc directly from the dock. The AIDEA is awaiting environmental impact and feasibility reports on the project. Meantime, some of its officials have concerns about the financing.
"We are about a $1.3 billion corporation," Simmons says, "and we have concerns that if we were to finance this on our credit, we would have $300 million invested in this one project - and we think that is a little bit too much concentration."
Next Up, Natural Gas?
Looking to the future, Alaska is endowed with the largest natural gas reserves of any state - an estimated 35 trillion cubic feet of it buried under the frozen North Slope. Until now, the main use for the gas has been a secondary one: it's injected back into North Slope fields to build pressure and force petroleum out from the rock.
Cognizant that the days of big oil are numbered, officials see the natural gas reserves as a powerful new source of revenue. But first, companies interested in tapping gas pockets will need to build a new Alaskan pipeline.
Currently, state officials estimate the pipeline would cost $15 billion, too much for the private sector to absorb. For that reason, the administration of Gov. Tony Knowles mobilized a task force to suggest ways of reducing the overall cost by altering state and federal tax laws.
Officials so far have avoided being pinned down on whether any state bonding would be used to help pay for the project. But if municipal debt is needed, it is the AIDEA that would most likely be called upon.
While Alaska lawmakers have much to debate in the coming years, this much is certain: Something must be done to stabilize the state budget at the same time spending on infrastructure grows.
"We are extremely fortunate in that we have a big tool box and lots of tools," Kinney says, repeating what seems to be a favored metaphor among Alaska's hands-on officials.
"We all agree in the state that there is a financial situation where reoccurring revenues aren't meeting reoccurring expenditures, and we've got to do something about it. We all agree on what tools are out there to deal with this. What we haven't agreed upon is how much of each tool or which tool we are going to use, and in which order."
