A lot happened in Alaska during the month of August. Here’s the run down on how we read the headlines.
BP and Hilcorp Agreed to Terms on Alaska Assets
The news that broke the internet in Alaska last week was a press release from BP. They announced that they were selling all of their remaining Alaska assets to Hilcorp for a total price of $5.6 billion.
Hilcorp will pick up 26% of Prudhoe Bay, 32% of Point Thomson, the remaining 50% of Milne Point and Liberty, and some exploration leases in ANWR. They will also take a 49% ownership in the Trans-Alaska Pipeline System and BP’s interest in other associated pipelines.
This completes BP’s multi-year process of divesting of Alaska assets, including a 2012 sale of Badami, a 2014 sale of smaller assets to Hilcorp, the sale of their Anchorage headquarters building in 2016, and a 2018 asset swap with ConocoPhillips.
There are a few interesting things we can infer from this most recent sale.
Inferences About BP
First, the sales price indicates that BP does not believe that all of the future net cash flows from these assets is worth more than $5.6 billion today. This says a lot about how they view the trillions of cubic feet of stranded natural gas on the North Slope.
It also says a lot about how they view the risks and rewards of deploying their resources in Alaska. The fact that these are the assets that they sold (in order to increase shale opportunities) indicates that the Alaska assets were viewed as the least valuable among their global portfolio.
This quote says it all “we have other opportunities, both in the US and around the world, that are more closely aligned with our long-term strategy and more competitive for our investment.”
Implications of Hilcorp Ownership
Hilcorp would not have made the purchase unless they felt differently than BP. They must view the future cash flows from these assets as being sufficiently more valuable than the purchase price to justify the expense. The reason for this is two-fold.
First, Hilcorp has a lower overhead cost than BP. This means that they can get the same amount of oil out of the ground at a lower cost. Given our net tax system, the State of Alaska will receive 35 cents for every dollar that those costs are reduced.
Second, Hilcorp likely sees more resource potential than BP did. This is because Hilcorp specializes in getting more oil out of mature reservoirs. By increasing enhanced oil recovery efforts, tertiary recovery methods, and workover activities, we will see more oil production.
And, because marginally economic projects do not have to compete with a litany of global opportunities, some of the prospects within Prudhoe Bay that have not received the green light in the past may come off the shelf (if they can get the other working interest owners to agree).
And remember, the State receives 12.5% of every barrel of additional production, plus increased production taxes on that incremental oil. That’s good news for Alaska.
Of course, reducing costs means less employees. So, we should expect to see some of those BP employees move out of Alaska – as Hilcorp will probably not need them all. This means that we may notice a few hundred less oil industry jobs in Alaska once all the dust settles (relative to BP keeping the assets).
But, if we do see increased investment activity, we will see additional work for Alaskans and Alaska based businesses. This should offset those job loses from efficiency gains. So, don’t go banging that recession drum quite yet.
Contrary to some buzz in Twitter land, it’s doubtful that this asset transfer results in less State revenues at the end of the day.
The gains from cost savings and incremental oil will likely more than make up for the corporate income tax issue (Hilcorp reportedly falls outside of the levy due to their structure as an LLC). Plus, I’m sure that a law change went to drafting within hours of the sale announcement.
While we are finally seeing some acknowledgement of how generous BP was to Alaska non-profits, I’m confident that Hilcorp will be a terrific corporate citizen.
All in all, this transition is probably a win for everyone.
Alaska’s Unemployment Rate Sets a New Record Low
The Department of Labor released the July jobs numbers on August 19th. While many speculated that the budget fight between the Governor and Legislature would paralyze the labor market, the first month of the fiscal year showed continued strength in the face of uncertainty.
The data show another increase in total jobs last month, led by the oil and construction industries (as expected). This marks the 10th consecutive month of job growth in Alaska and that growth looks poised to continue.
As a result, the unemployment rate ticked down again in July. It is now at the lowest level in Alaska’s recorded history. Although still higher than the L48, that’s normal.
The Permanent Fund Earned $3.8 Billion Last Year
According to a press release issued by the Alaska Permanent Fund Corporation on August 5th, the Fund earned a 6.32% rate of return in FY19, ending the year with a balance of $66.3 billion. That earnings total is right on track with what we expected.
Anyone that uses that return percentage to plug into a spreadsheet should be careful. The $3.8 billion of earnings applied to the beginning year balance of $64.9 billion works out to a simple annual return of only 5.8%.
The difference comes from the fact that money flows in and out of the fund over the course of the year, that there is a lag in the equity market reported returns, and from some technical accounting factors.
POMV and PFD Calculations
Having the FY19 final return numbers allows us to complete the calculation for the POMV and PFD formulas. We now know that the POMV limit (the maximum authorized draw from the Permanent Fund to pay PFDs and support general fund spending) for the next budget cycle is set at $3,095,932,000.
We also know that the October 2019 PFD transfer would have worked out to $1.89 billion. Taking away the appropriations from those funds, adjusting for the rollover balance, and dividing that money between an estimate of eligible Alaskans works out to a PFD of $2,949 each (the official number is probably a little lower, assuming more people applied this year expecting a bigger payout).
Your PFD in October will be about $1,600
The actual transfer authorized by the legislature was less than that. It ended up being $1.07 billion at the end of the day. After paying administrative costs and associated appropriations, that works out to around $1,608 per person.
We will see what the official number is when the Department of Revenue makes an announcement next month.
Set Your FY20 Investment Return Targets Lower
While the Alaska Permanent Fund Corporation hasn’t released its updated projections just yet, FY20 started out a bit rough. The stock market is down a little over 3% on the fiscal year so far.
Based on general trends and the Fund’s portfolio, they are probably down about $500 million so far this year. Even with normal returns for the next 10 months, it might be hard to reach even a 5% total return.
And, with the US/China trade war escalating, and subpar economic data around the globe being released, the threat of a global recession is looming large on the trading floor. Fear that a recession is coming is at the highest level since 2008.
Sputtering economies don’t tend to have growing corporate values. So, if you believe the analysts, it may be prudent to set your sights a little lower this year and hope the Corporation outperforms.
Oil Prices Are Lower Than Last Year
Those recession fears are weighing down the oil market as well.
With OPEC holding back over 1 million barrels of oil a day, plus nearly 3 million barrels per day of disrupted supply due to oil sanctions, it is surprising that prices are not higher.
What is more surprising is that disruption events that would have historically sent prices soaring (tanker attacks in the Straight of Hormuz for example) barely registered on the trading screens. In theory, these events occurring at a time of supply disruption should have sent prices to historic heights.
Yet, the bears are running the market rights now. Concern about trade wars are dominating fears of physical ones. And, data showing non-existent oil demand growth last year (outside of China), and slowing economic growth around the world, only feeds the appetite for bad news.
Alaska oil averaged $61.14 per barrel in August, bringing the fiscal year to date average to $63.51. For comparison, oil prices were averaging $75 per barrel at this time last year.
However, the August Short-Term Energy Outlook continues to show balanced markets and a stable price forecast through the fiscal year. But, there is still a great deal of uncertainty in the market.
Given the current market conditions, we are on pace to see a FY20 average of $62 +/- $11 per barrel. And, there’s currently a 68% chance that the annual average price for the fiscal year turns out lower than was planned on during the budget preparation.
But, there is room for the bulls to run. In fact, any validation of an upcoming cease-fire in the trade war could start a stampede. So I wouldn’t get married to any forecasts just yet. As always, appreciate how much we can’t really know.
But for now, all news swimming against the stream of recession woes seems to jump straight into gnashing teeth. And, for those reasons, the current oil price outlook is grizzly.
North Slope Production is on Track for a 1% Increase in FY20
AOGCC data shows that this July’s summer maintenance cycle was less disruptive than last year.
Most notably in the much higher production from the Colville River Unit. Over all, July 2019 production was 58,263 barrels per day higher than last year. This adds up to 1.8 million barrels of oil.
However, TAPS throughput data for August indicates that the pattern won’t hold. We only saw 390,222 barrels per day move through the pipeline this August. That suggests a production level of just under 400,000 barrels per day. Production last August was 454,603 barrels per day.
Looking forward through the fiscal year, some rate additions at GMT and Milne Point should offset most of the natural decline in the larger fields. The result should be a slight uptick in total North Slope production.
All told, here is how FY20 looks to be shaping up:
Oh, it’s also worth noting that the Willow prospect advanced to the next stage in the Federal permitting process. The Draft Environmental Impact Statement is out for public comment. Of course, we are still a few years away from that oil entering the pipeline (if it gets sanctioned).
FY20 Revenues Remain on Track, but are Uncertain
The FY20 budget was passed using a revenue assumption of $2.3 billion. That assumption was based on an oil price of $66 and oil production of 193.8 million barrels of oil.
Given the constantly changing state of information, it now appears that FY20 UGF revenues should land somewhere between $1.8 and $3.4 billion (with 90% confidence). The average of simulated results brings in $2.4 billion of unrestricted general funds to the State treasury.
This estimate accounts for a lower price forecast and a lower production forecast for FY20 (given where the numbers have come in so far). But, a lease sale in ANWR is scheduled to bring in a little more revenue than was in the forecast last spring. Whether or not that actually happens is yet to be seen.
Generally speaking, revenues should still come in about where expected. But, the opportunities for upside surprises are diminishing while downside risks remain in place. It’s a good idea to keep watching as more information trickles in.