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FRBSF

WEEKLY LETTER

August 8, 1986

Oil and Alaska's Economy
The recent plunge in oil prices has focussed
considerable attention on the problems faced by
.. oil producing regions.lndeed,some economists
have argued that these problems are likely to be
so severe that at the national level they could
outweigh the benefits of lower oil prices. In the
western United States, sustained lower oil prices
could have particularly serious consequences for
Alaska's economy.
Although the oil industry itself accounts for only
four percent of Alaska's jobs, state spending of
oil~generated revenue has provided an important
impetus for Alaska's rapid economic growth. In
1985,84 percent of the state's revenue was oil~
related, and that oil money allowed the state to
spend at a per capita pace five times the
national average.
Nevertheless, Alaska is in better shape fiscally
than are most other oil-producing states. Currently, its "rainy day fund" has an accumulated
balance of $436 million, while the principal of
Alaska's "Permanent Fund" investment in the
future now stands at $7.7 billion. In addition,
extremely generous spending and revenue policies during recent years leave ample room for
changes in the state's fiscal policies. Finally,
most of the other industries that generate outside
income for Alaska, including tourism, fishing,
forestry, and metal mining, benefit both from
lower oil prices and from the infrastructure
development that the oil boom made possible.

the early 1970s there was a flurry of economic
activity associated with developing the Prudhoe
Bay oil field - the largest ever discovered in
North America - and building the trans-Alaska
pipeline. In 1979, shortly after oil began flowing
through the pipeline, Alaska surpassed Louisiana
to become the second largest oil producing
state. By 1985, Alaska produced 20 percent of
all
oil, secolldonly to Texas' 27 percent.
Alaska reaped enormous revenues from the oil
boom, primarily through severance tax (on the
wellhead value of oil), royalty, and corporate
income tax collections. As a result, state appropriations blossomed, rising from $173 mi Ilion to
$3.7 billion between fiscal years 1969-70 and
1984-85. By 1985, the state's population was
about 74 percent higher than it had been in
1970, and employment had grown by 131 percent.

u.s.

The huge infusion of funds into Alaska's economy allowed spending on a great variety of programs. Large construction projects improved
Alaska's infrastructure. In addition to the
federally financed trans-Alaska pipeline, major
building projects included highways and dams.
Loan programs were instituted, including widely
available subsidized home mortgage loans.
Local governments also benefited from the
state's largess. For example, the state began supporting schools in some isolated towns from
which children previously had been sent away
to attend boarding schools in one of Alaska's
few major cities.

The boom years
Oil was first discovered in Alaska at the turn of
the century, and small-scale production began
shortly afterward in the Gulf of Alaska. Oil
became more important to Alaska's economy
when large deposits were discovered and
exploited in the Kenai Peninsula and Cook Inlet
during the 1950s and 1960s. But the oil boom
began in earnest with the discovery of the Prudhoe Bay oil field in 1968.

Because Alaska had enough money to support a
wide variety of programs, state and local governments grew significantly. In 1976, they provided
17 percent of the state's wage and salary
employment, substantially more than the
national average, but that proportion had grown
to 22 percent by 1985. In contrast, state and
local government employment comprise only 14
percent of the national total.

In 1970 only 303,000 people lived in Alaska,
and total employment was only 99,000. During

Not all of the oil money was spent, however.
The state also set aside large amounts of savings.

FRBSF
These savings were placed in a "Permanent
Fund", to be invested towards the state's post-oil
future, and a "rainy day fund," to cushion
against sudden revenue decreases.
Indeed, by 1980, the state coffers were so awash
in funds that political pressure for fiscal changes
became overwhelming. As a result, the state
income fax Was abolished, and dividends from
the Permanent Fund were distributed annually to
each resident. Each Alaska resident received a
$400 dividend check from the state government
in 1985, and the dividend payment is expected
to increase to $530 this year.
During the oil-based boom in construction and
government activity, other parts of the state's
economy also were growing, albeit less spectacularly. Fishing and tourism, for eX(imple,
grew substantially during the oil boom years.
Moreover, growth in these export industries nurtured further growth in the service infrastructure.
While jobs in trade, services, and finance comprised only 37 percent of Alaska's jobs in 1976,
they were 44 percent of the total in 1985. This
trend is similar to but more pronounced than the
national increase (from 45 to 51 percent) in the
share of such jobs in total employment during
the same period.
Impact of lower oil prices

The spectacular growth Alaska experienced during the 1970s and early 1980s is now threatened
by a less robust market for oil. Some evidence
already indicates that a slowdown has begun,
although the drop in oil prices is unlikely to
depress Alaska's economy to the extent that the
Prudhoe Bay discovery and higher oil prices in
the 1970s boosted it.
Employment growth has slowed from the frenetic pace of over 5 percent annually that was
established between 1976 and 1985, but
employment still grew by 2.3 percent between
June 1985 and June 1986. During the first six
months of 1986, Alaska saw a marked slowdown in construction activity, with the value of
nonresidential construction awards (year-to-date
through June) 19.3 percent below their year-earlier level, and residential construction permits
down a whopping 54.8 percent.
The decline in the oil price to its current level of
about $10 per barrel should have little immedi-

ate impact on oil production. Industry observers
estimate that pumping, piping, and shipping an
additional barrel of oil from Prudhoe Bay to the
"Iower 48" currently costs between $8 and $12.
Halting pumping operations is very expensive,
and therefore is unlikely tooccur unless the
price of oil falls well below $8 per barrel.
However, exploration in Alaska is now at a virtual standstill. If oil prices remain relatively low,
drilling activity would likely slow down during
the coming months.
The direct effect on the state's economy of a
slowdown in oil activity over the next few
months would be relatively small. Alaska's oil
industry is extremely capital-intensive, and consequently accounts for less than 4 percent of
Alaska's wage and salary employment. Some
manufacturers also depend on oil activity, but
they provide an even smaller proportion of the
state's employment, probably much less than 1
percent.
Nevertheless, the overall effects of lower oil
prices on Alaska's economy could be substantial. Alaska's state and local governments have
been a major economic stimulus during the past
several years, providing a large proportion of the
state's new jobs, primarily with oil money. Afrequently cited rule of thumb holds that each $1
drop in the price of oil causes the state government tolose $150 million in revenue. Using this
rule of thumb, if the price of oil settles at around
$15 (a decline of about $10 from last December), the state stands to lose some $1.5 billion in
revenue annually. That represents a decrease in
general fund unrestricted revenue of about 46
percent from its 1985 level. These calculations
do not even account for the secondary effects of
the decline in oil industry activity. Conse, quently, if over a period of years pumping
activity slows down from its present level in
response to lower prices, the state would lose
even more revenue.
Savings accounts and the latitude for fiscal
changes allowed by its previous generosity
provide Alaska with substantial flexibility. Consequently, state spending should fall by less than
the drop in oil revenues, at least for the next few
years.
The state could supplement appropriations with
Permanent Fund earnings (rather than distribut-

ing dividends to Alaska residents) and the rainy
day fund. Even without dipping into Permanent
Fund principal, these two changes would add
$660 million and $465 million respectively to
the state treasury, for a total contribution of $1.1
billion. In addition, Alaska, which currently is
the only state in the
that has neither a sales
tax nor an income tax, could expand its use of
tax instruments. For example, imposing a state
income tax at a 3 percent average rate - the
rate that existed before the income tax was abolished - would add about $260 million to the
state treasury. These three changes together
wouldprovide$l,4 billion, enough to compensate for most of the revenue shortfall due to
lower oil prices.

u.s.

However, revenue augmentation will probably
be combined with spending cuts to compensate
for the revenue shortfall. If major spending cuts
are required, they will hurt Alaska's economy.
Scott Goldsmith of the University of Alaska has
calculated that for every $100 million decrease
in state spending, Alaska would lose 2,000 jobs.
These calculations suggestthat a $1.5 billion
reduction in annual state spending would cause
Alaska to lose as many as 30,000 jobs, or 13
percent of its employment base.

The good news
Nevertheless, such large spending cuts would
not destroy Alaska's economy. One reason is
that Alaska's per capita state spending would
remain more than twice as high as the national
average.
Moreover, Alaska's growth, even during the
boom years, can be traced to sources unrelated
to oil as well as to oil-related sources. This distinction shows that Alaska has a small, but positive, underlying growth trend beyond the
stimulus provided by oil money. Using Goldsmith's estimates of employment effects cited
above, oil industry and government stimulus
from oil-generated revenues are responsible for
job growth of about 40 percent during the oil
boom years between 1976 and 1985. Total job
growth, however, was 52 percent during this
same period. Moreover, part of Alaska's population is relatively mobile, so any reduction in
economic activity would tend to cause outmigration, and consequently would cause a
smaller increase in the unemployment rate than

would be true in states where population is less
mobile.
Key basic sectors that should continue to grow
despite adverse developments in the oil market
include tourism and fishing. Improved access by
both air and sea has boosted tourist travel, so
that in 1985 visitors brought almost $750 million into the state. The visitor industry grew an
estimated 3.5 percent last year, and most expect
even stronger growth this. summer. Fishing and
fish processing are also growth industries in
Alaska, with fishing alone generating some $1
billion in income annually. The market for
Alaska's fish products is improving, partly
because of an increased taste for fish in the
"lower 48" and partly because the depreciation
of the dollar against the yen improves Alaska's
competitiveness on the Japanese market. The
improved yen-dollar relationship also should aid
Alaska's timber industry which, like its counterpart in the Northwest, has experienced several
lean years.
Finally, during the oil years, Alaska made substantial investments in its infrastructure. The
transportation facilities, as well as the trade and
financial infrastructure established during those
years, provide a more solid basis for growth in
other important industries than had existed previously.

Summary
If oil prices stay near their current level for the
next several years, Alaska will have to make
major adjustments to a new, more austere economic environment. The oil boom years appear
to be over, but oil production will continue to
provide a boost to Alaska's economy. Savings
accumulated during the boom years provide a
cushion that allows Alaska a few years to adjust
to new realities. Moreover, infrastructure investments, and the increased importance of the service and trade sectors encouraged by the oil
boom, provide a more solid basis for future
growth unrelated to oil than existed previously.
Alaska faces a series of difficult policy decisions
and an end to the exuberant days of the oil
boom, but its long-run future, buoyed by a
wealth and variety of natural resources, remains
bright.

Carolyn Sherwood-Call

Opinions expressed in this newsletter do not necessarily reflect the views of the management of the Federal Reserve Bank of San
Francisco, or of the Board of Governors of the Federal Reserve System.
Editorial comments may be addressed to the editor (Gregory Tong) or to the author •.•. Free copies of Federal Reserve publications
can be obtained from the Public Information Department, Federal Reserve Bank of San Francisco, P.O. Box 7702, San Francisco
94120. Phone (415) 974-224&.

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BANKING DATA-TWELFTH FEDERAL RESERVE DISTRICT
(Dollar amounts in millions)
Selected Assets and Liabilities
Large Commercial Banks
Loans, Leases and Investments 1 2
Loans and Leases 1 6
Commercial and Industrial
Real estate
Loans to Individuals
Leases
U.S. Treasury and Agency Securities 2
Other Securities 2
Total Deposits
Demand Deposits
Demand Deposits Adjusted 3
Other Transaction Balances4
Total Non-Transaction Balances 6
Money Market Deposit
Accounts-Total
Time Deposits in Amounts of
$100,000 or more
Other liabilities for Borrowed MoneyS
Two Week Averages
of Daily Figures
Reserve Position, All Reporting Banks
Excess Reserves (+ )/Deficiency (-)
Borrowings
Net free reserves (+ )/Net borrowed( -)

Amount
Outstanding

Change
from

7/16/86
200,784
183,097
51,267
66,964
39,262
5,492
10,352
7,334
207,310
53,849
36,159
16,494
136,967

7/9/86
21
88
- 343
238
5
- 80
- 61
- 8
928
1,041
- 559
135
22

47,146

59

35,124
24,773

Change from 7/1 7/85
Dollar
Percent 7

-

-

-

132
2,555

-

7,619
8,355
541
3,203
3,987
89
1,213
475
9,625
6,957
4,798
2,661
8

-lOA

2,318

5.1

2,508
536

Period ended

Period ended

7/14/86

6/30/86

6
23
17

123
80
43

Includes loss reserves, unearned income, excludes interbank loans
Excludes trading account securities
Excludes U.S. government and depository institution deposits and cash items
ATS, NOW, Super NOW and savings accounts with telephone transfers
s Includes borrowing via FRB, TI&L notes, Fed Funds, RPs and other sources
6 Includes items not shown separately
7 Annualized percent change
1
2
3
4

-

3.9
4.7
1.0
5.0
11.3
1.6
6.9
4.8
14.8
15.2
19.2
0.0

-

6.6
2.2