scott goldsmith: what is a sustainable draw from the permanent fund?
TRANSCRIPT
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WHAT IS A SUSTAINABLE DRAW
FROM THE PERMANENT FUND?
Commonwealth North
Fiscal Policy Study Group
January 31, 2017
Scott Goldsmith
Institute of Social and Economic Research
University of Alaska Anchorage
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Inevitable and Prolonged Tug of War
No Income
Tax!
No Sales Tax!
No Dividend
Cuts!
No More Budget Cuts!
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Proposals for Use of PF Earnings
ACCESS TOTAL EARNINGS OF PF--POMV (Constitutional Endowment)– Fold Earnings Reserve into PF Corpus
– Draw 4.5% - 5% of PF value from PF Corpus
– Divide draw between UGF and PF Dividend
IMMEDIATE PLUG--SB114 (Statutory POMV)– Draw 5% of PF value from PF Earnings Reserve for UGF
– Pay PF Dividend from 75% of Royalties (with a floor)
STABILIZE REVENUE STREAM—GOVERNOR WALKER PROPOSAL (Statutory Sovereign Wealth Fund)– Dump SB21 revenues and additional 25% of Royalties into PF Corpus
– Draw % of PF value or $3.2 Billion from PF Earnings Reserve for UGF (inflation adjusted amount that sustains PF value)
CREMO PLAN (Constitutional Endowment)– Similar to POMV except ALL petroleum revenue deposited into PF
– Pay PF Dividend from 50% of Royalties
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Which Draw Mechanism Produces
the Best Sustainability Tradeoff?
• Do we care about the future?
• What do we think the future will look like as petroleum production continues to fall?
A flow of income from current financial assets and the projected future petroleum revenue stream which, if adopted now, could be maintained consistently long into the future--adjusted for inflation and population growth.
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Hypothetical Investment Rate of Return
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
6.0%
7.0%
8.0%
Nominal Rate of Return
Real Rate of Return (RRR)
Inflation
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One RRR Estimate
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RRR : Actual History
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Investment Nominal Rate of Return:
Where Should It Go?
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
6.0%
7.0%
8.0%
Inflation
Proofing
PopulationAdjustment
Depletion
Allowance
Sustainable
Draw
NominalReturn
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Nonspendable Fund Balance Assigned Balance: (Earnings Reserve)
Contributions Unrealized Gain
$40.7 + $5.3=$46.0 + $9.0 = $55
Current Practice: Inflation Proof Contributions
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2017 Partial vs. Full
Inflation Proofing
CONTRIBUTIONS2.3 % x $41 billion = $941 Million
TOTAL FUND (POMV)2.3 % x $55 Billion = $1.27 Billion
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Nonspendable Fund Balance Assigned Balance
Contributions Unrealized Gain
$40.7 + $5.3=$46.0 + $9.0 = $55
Inflation Proofing: Who Needs It?
Value of Contributions increases if Unrealized Gain counted
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Unrealized Gains Accumulate in
Nonspendable Fund Balance
(Slow Turnover of Portfolio)
Statutory / Accounting Return = 50% Under spend today
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Unrealized Gains Cashed out from
Nonspendable Fund Balance
(Fast Turnover of Portfolio)
Statutory / Accounting Return = 88% Over spend today
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Unrealized Gains Cashed out from
Nonspendable Fund Balance
(In Between Turnover Rate of Portfolio)
Statutory / Accounting Return = 66%
Just Right spend today
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Investment Nominal Rate of Return:
Where Should It Go?
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
6.0%
7.0%
8.0%
Inflation
Proofing
PopulationAdjustment
Depletion
Allowance
Sustainable
Draw
NominalReturn
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Will Need for Public Services Grow With
Population?
Other measures of the cost of government?
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Alaska Population Growth
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Investment Nominal Rate of Return:
Where Should It Go?
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
6.0%
7.0%
8.0%
Inflation
Proofing
PopulationAdjustment
Depletion
Allowance
Sustainable
Draw
NominalReturn
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Why a Depletion Allowance?
To Sustain the Total
Endowment from Petroleum
Reserves?
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Sustaining the Endowment:
Transformation from Petroleum in
the Ground to Money in the Bank
PETROLEUMIN THE GROUND
MONEY IN THE BANK
STYLIZED HISTORY << >> FUTURE
Sustainable Deposit Rate depends on How Much Petroleum Revenue Remains to be Collected in the Future
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Historical Depletion Allowance
Is this the right amount?
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My Estimate:
“Owner State” Endowment
* Estimated Net Present Value of Future Petroleum Revenue
TOTAL (FY 2018) $98 Billion
In the Bank $57 Billion
In the Ground* $41 Billion
Known Conventional Oil $25 Billion
Other Oil $5 Billion
Gas $11 Billion
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Assumptions:Optimally Manage What We Can Control
Known Conventional Oil Production Decline @ 4%Oil Price tracks ADOR, then 3.5% growth
New Conventional OilNPRAHeavy OilShale Oil
Gas Commercialization in 2026 Gas Revenues to State $1.00/mcf
Real Rate of Return on Investments 5.0%
Population Growth Rate .5%
Inflation Rate 2.25%
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How Much Can We Spend Today
from the Endowment?
NEST EGG (FY 2018) $98 Billion
Multiply: MSY Take Rate 4.5% (5%-.5%)
Equals: MSY Take $4.4 Billion
Current Petroleum Revenues (fluctuates yearly) ?
Investment Income (endowment draw minus current petroleum revenues)
$4.4 Billion - ?
Minus: PF Dividend $ 1.4 Billion
Equals: Endowment Draw for UGF $ 3 Billion
Plus: Non-Petroleum GF Revenues $ .5 Billion
Equals: UGF MSY $ 3.5 Billion
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Sources for UGF Spend
Transition of UGF Spend down to $3.76 Billion in 2021 before resuming growth
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Sources for UGF Spend: Random Oil Price
Use of investment income fluctuates yearly.
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Financial Draw is Residual
to Hit Sustainable Spend Target
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Wrap Up
• Sustainability should be based on ENTIRE Endowment
• Sustainable draw depends on size of ENTIRE Endowment
• Fixed draw rate from financial asset does not account for• Depletion of petroleum asset• Variation in petroleum revenue from price
fluctuations
• POMV with doubling of Royalty Deposit into PF would provide an approximate solution
• Implementation of limit on spending from Endowment based on Sustainability Analysis would be best solution (but politically challenging)
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Good News Scenario?
Known Conventional Oil Production Decline @ 4%Oil Price exceeds ADOR Forecast
New Conventional OilNPRAHeavy OilShale Oil
Gas Commercialization in 2026 Gas Revenues to State $1.00/mcf
Real Rate of Return on Investments 5.25%
Population Growth Rate .5%
Inflation Rate 2.25%
Nest Egg $103 Billion
MSY $4.9 Billion
GF MSY $4.0 Billion
$4.0 billion UGF can grow with inflation & population
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Best News Scenario?
Known Conventional Oil Production Decline @ 4%Oil Price exceeds ADOR Forecast
New Conventional OilNPRAHeavy OilShale Oil
Gas Commercialization in 2026 Gas Revenues to State $1.00/mcf
Real Rate of Return on Investments 5.25%
Population Growth Rate 0%
Inflation Rate 2.25%
Nest Egg $103 Billion
MSY $5.5 Billion
GF MSY $4.5 Billion
$4.5 billion UGF can grow with inflation
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Bad News Scenario?
Known Conventional Oil Production Decline @ 4%Oil Price tracks ADOR Forecast, then 3% growth
New Conventional OilNPRAHeavy OilShale Oil
No Gas
Real Rate of Return on Investments 4.5%
Population Growth Rate 0%
Inflation Rate 2.25%
Nest Egg $86 Billion
MSY $3.9 Billion
GF MSY $2.9 Billion
$900 per capita tax allows UGF to grow from $3.76 billion starting in 2021
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Worst News Scenario?
Known Conventional Oil Production Decline @ 4%Oil Price tracks ADOR Forecast, then 3% growth
No New Conventional OilNo NPRANo Heavy OilNo Shale Oil
No Gas
Real Rate of Return on Investments 4.5%
Population Growth Rate .5%
Inflation Rate 2.25%
Nest Egg $81 Billion
MSY $3.2 Billion
GF MSY $2.3 Billion
$1,750 per capita tax allows UGF to grow from $3.76 billion starting in 2021
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Alternatives Moving Forward:
Cost / Benefit Analysis
Tradeoff for one year is less revenue ($600 million) against a stronger economy.
Which do you prefer?
BASE CASE BAD NEWS
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WHAT IS A SUSTAINABLE DRAW
FROM THE PERMANENT FUND?
Commonwealth North
Fiscal Policy Study Group
January 31, 2017
Scott Goldsmith
Institute of Social and Economic Research
University of Alaska Anchorage