According to the Alaska Department of Revenue (DOR), the state will depend on oil and gas revenues to fund 92% of state spending this coming fiscal year. With increasing government costs and decreasing oil production, Alaska’s economic engine needs an overhaul.

In 2007, just weeks after successfully pushing through the largest tax increase on the oil and gas industry in the state’s history (ACES), the Palin administration proudly predicted that oil production would be 675,000 barrels per day in 2011. The actual production number turned out to be 603,000 barrels per day.

In fact, according to the optimistic projections after the tax increase was adopted, the Palin administration didn’t forecast Alaska’s daily oil production would drop to current day levels until 2022. Looks like we arrived at their projected decline destination ten years early.

The declining production numbers are increasingly worrisome once you consider the growth in government spending during that same time frame. In 2002, the state was producing over one million barrels of oil per day and general fund spending for fiscal year 2002-03 was $2.3 billion. In 2012, the state projects there will be 574,000 barrels per day produced and general fund spending will be $5.5 billion.

In short, while oil production has decreased by 40% over the last decade, the cost of education, public safety, courts, employee retirement and all other operating expenses has doubled in the last decade. This of course excludes other state expenses like the annual capital budget and shifts to the state from decreasing federal funds.

Even with record oil prices predicted to stay above $100 per barrel this year, future revenue projections show a steep decline along with production. While this isn’t a real surprise for a state that balances its budget based on a fluctuating commodity price, the question remains: how do we protect Alaska’s economic future?

Many have pinned their hopes on the sudden emergence of small independent oil companies on the North Slope. However, caution is more than warranted. While the growth of independents have made an exciting splash and given some state lawmakers an argument against modifying the existing ACES tax structure, some policy makers and industry insiders worry the benefits might not be what has been advertised.

In addition, a recent report released by oil and gas consultant Pedro Van Meurs concluded that the generous exploration tax credits that have attracted independents, were completely disconnected from the actual transition into production.

Even with the increase of independents, many of those same companies have expressed concerns about the current production taxes and their ability to eventually monetize any discoveries.

The debate over the current ACES tax structure has created a wide schism in the state legislature. Opponents of modifying the tax structure have called it a “giveaway” and argued that companies are still very profitable. Supporters of modifying the tax structure say the numbers speak for themselves.

Production has dropped by more than 140,000 barrels per day since the passage of ACES. BP has reduced its capital spending by 40% in 2011 from what it planned prior to ACES. ConocoPhillips capital investment has more than doubled elsewhere, but remain stagnant in Alaska.

But more importantly, supporters of tax reform point to current forecasts that show 50% of the state’s oil production in 2020 is expected from investments that have yet to be made.

Still opponents remain unconvinced that providing tax relief will make Alaska more competitive in the global marketplace.

In April, ConocoPhillips CEO Jim Mulva committed to the gas partial processing plant at Prudhoe Bay in exchange for ACES reform. That’s 50 new wells and 80 million barrels of new oil. It’s an investment of about $2 billion dollars. He committed to more satellite wells at Alpine.

In November at RDC, ConocoPhillips Alaska President Trond-Erik Johansen reaffirmed that commitment, and promised increased drilling activity and more satellite development at Alpine and Kuparuk, if production taxes were made more competitive.

At the same event, Claire Fitzpatrick, Chief Financial Officer, BP Exploration (Alaska) also committed to joining ConocoPhillips with development of I-Pad, along with expanding development at acreage representing more than five billion barrels of un-recovered oil.

She said BP was “poised to invest billions of dollars in new projects that will result in billions of barrels in new oil from known sources.” As for the impact of ACES, she said; “If BP had been investing in these projects over the past four years, the rate of decline over the next decade would be flat.”

And even though the producers have given specific examples of how they would take advantage of tax reform, many lawmakers are demanding more assurances from the industry.

Even the consultant Van Meurs concluded that one aspect of the current ACES tax regime that is out of whack is the punitive nature of the progressivity factor.

When oil is over $100 a barrel, the state takes two dollars to every one for the companies who are taking the risk. With the price of oil projected to be over $100 per barrel for the coming year, the high tax take from the state will continue to be a barrier for production growth without changes to ACES.

In 2007 when ACES was passed, there was a feeding frenzy in Juneau to more than double taxes on the industry. It bordered on economic suicide. Ironically, one of the pitches to lawmakers was that they needed to jack up taxes to prevent Alaskans from having to pay an income tax. However, realizing now that the decline curve projections were ten years off, the doubling oil taxes has actually pushed Alaskans closer to the day when they’ll have to reach into their own pockets, or the Permanent Fund to pay for state government.

Reasonable people can disagree on what structural changes need to be made to ACES to help stimulate new production, but a needed consensus on at least adjusting the progressivity factor should be obvious to all.

Alaska’s economic engine is in trouble. Today it’s operating on fuel from high oil prices which is masking the real risk to the state’s economic future. Given the long lead time for projects to come on line, the state needs to act sooner rather than later. Let’s hope lawmakers put aside their grandstanding and actually create a tax policy that drives investment.

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