Tuesday, August 17, 2010

Oil Deal Could Cut Long Beach Port Profits

This article by PMM Online editor Keith Higginbotham originally appeared on LBPost.com.

A Long Beach City Council and Mayor-backed contract with a major oil company that is at the heart of a November ballot proposition seeking to change the City Charter may have undercut potential Port of Long Beach oil profits by as much as $150 million over the next ten years, despite repeated objections raised by state and port officials.

While the contract will boost revenues to the nearly bankrupt Long Beach City Hall-managed Tidelands Fund, the $15 million a year loss to the port, which averages about $120 million a year in profits, could hamper future port development projects, expose the port to additional debt, and threaten the port's business competitiveness at a time when port industry competition is growing rapidly.

According to supporters, Proposition D is tacitly about minor changes to the relationship between City Hall and the city's Harbor Department, which manages the port.

However, Prop D, and the oil contract behind it, will also shift a great deal of cash from what is one of the leading economic and job creating engines in the Long Beach region to the control of the fiscally-challenged City Hall.

Through Prop D, Mayor Bob Foster and the Long Beach City Council are asking voters to approve two changes to the City Charter: a change to the formula used to calculate how much port profit the city can annually request; and, a change removing control over port-area oil properties from the port's Board of Harbor Commissioners and turning this authority over the City Council. 

The first part stipulates that the annual transfer of port profits be based on 5 percent of the port's gross earnings. Currently, the port transfer is based on 10 percent of the port's annual profits. The Charter amendment, if approved, will increase the port's annual transfer to the city by several million dollars a year, depending on port revenues.

However, at the heart of the second portion of Prop D is a contract with Occidental Petroleum Co. (Oxy) that was approved in November 2009 by the City Council.

The impetus for this new contract was a 2006 proposal from Oxy to invest in new oil production in the harbor tidelands area in exchange for a share in the profits of any new oil production generated. The profit incentive, the argument goes, would justify additional production investment, which in turn would increase oil production and the amount of oil profits going to the city.

"Without ongoing capital infusion, the oil production will decline and [the city] may not be able to withstand the next downturn in oil prices," Long Beach Oil and Gas Department's manager of oil operations Curtis Henderson explained to port officials in an April 2009 e-mail.

These tidelands oil operations are split into two distinct areas – the West Wilmington Field, which basically encompasses the port area and land north of the port, and the Long Beach Unit, which encompasses the four oil islands in Long Beach Harbor.

The Tidelands Oil Production Company, or TOPKO, is the city's oil production contractor for the West Wilmington Field and THUMS is the contractor for the oil islands. Oxy owns both – the firm purchased TOPKO in 2006 and THUMS in 2000.

Due to geologic fault lines running north and south, the oil reserves beneath the West Wilmington Field sit in roughly five isolated regions. Ownership of each of these "fault blocks" is split in differing proportions between the state, the city, the port and various others.

According to an internal port document detailing the ownership of the oil rights in these five regions, the state owns a total of 61 percent, the port owns 31 percent, the city owns 7 percent and various unidentified others own 1 percent.

However, the split of profits from the roughly 450 active wells in the West Wilmington Field are dictated by two contracts – one between Oxy and the state, and one between Oxy and the city (which includes the port's interests).

Under the current contract between the state and Oxy, the state receives 95 percent of the oil profits from state-owned reserves and Oxy receives 5 percent. 

Under the previous city contract with Oxy, the port received about 95 percent of the profits from existing oil production in city-owned reserves while the city received about 5 percent – Oxy received an administrative fee but no net profits from the city portion of the West Wilmington Field.

Under the terms of the new contract between Oxy and the city, which took effect Jan. 1, 2010, profits from any new production will be now be split between City Hall and Oxy, with no money going to the port. The city will receive 51-percent of these new profits while Oxy will receive 49-percent. Most of these new profits for the city will go to the City Hall-managed Tidelands Fund, with a small portion going to the General Fund.

Due to this delineation between existing and future oil production, it was critical while formulating the terms of the new Oxy contract to determine exactly what the future production of existing wells was. Oxy proposed using an estimate of what is called the base production amount. This base amount is a mathematically derived production level for any given point in time.

For example, if this calculated base amount was 1,000 barrels of oil for the month of July, 2015, this amount is all that is covered under the old contract terms. Even if all the wells were drilled 50 years ago, any oil produced over the base amount of 1,000 barrels would be considered new production and covered under the revenue split of the new contract.

In 2007, the State Lands Commission (SLC), the Long Beach Department of Oil and Gas (LBGO), and Oxy formed a technical team to work on developing a base production estimate for the West Wilmington Field.

While the state participated in the technical team's effort, the SLC participants grew dissatisfied over the eight-month long effort. In an October 2009 letter to LBGO's Henderson, a senior SLC official explained, "the SLC did not fully agree with the methodology used by the [technical team] to forecast future production from the West Wilmington Field."

After the technical team released its findings, the SLC decided to develop a separate estimate in conjunction with the port, which was looking to develop its own estimate.

In an April 2009 e-mail from port Chief Financial Officer Sam Joumblat to LBGO's Henderson, Joumblat explained why the port sought its own base production estimate.
"It is [the port's] fiduciary responsibility to get an independent appraisal of our asset before we sell to Oxy," wrote Joumblat.

Through their various consultants, the SLC and the port eventually came up with their own joint estimate, while Oxy and LBGO supported the technical team estimate.

The difference between the two estimates, each based on differing methodology, was substantial. According to internal port documents obtained, the Oxy-supported estimate was 62-percent lower than the SLC/port estimate.

If the SLC/port estimate was correct, then over the next decade each existing well would produce vastly more oil than predicted by Oxy and LBGO. But in this scenario, the base amount in the new contract would be 62-percent lower than actual production and a tremendous amount of oil from existing wells would be covered by the terms of the new contract. This would greatly increase profits for City Hall and Oxy and conversely reduce what the port might have earned.

"Since Oxy is proposing to split profits over the existing reserves, then the lower the existing reserve (the base amount), the higher the amount they will split," wrote the port's Joumblat in a March 2009 e-mail to port senior executives.
LBGO had another reason to support the Oxy estimate and discredit the SLC/port methodology – namely, taxes.

In an April 2009 e-mail to port officials, LBGO's Curtis Henderson wrote, "The combined tax bill for this year is approximately $18 million. Any agreement offering a different methodology (from that of the technical team) would be subject to review by the county tax assessor and it would increase [the city's] total bill by at least $10 million."

Despite repeated SLC and port objections about the Oxy-supported estimate, City Hall eventually accepted the much lower base amount. The City Council approved the new Oxy contract for future oil production in November, 2009. It utilized the 62-percent lower base amount estimate supported by Oxy and LBGO.

Internal port documents show that port officials initially estimated the lower base amount would result in shifting as much as $150 million in potential port profits over ten years to the city. Based on the average annual port oil profits over the past ten years – about $13.1 million a year – the amount potentially going to the city under the lower base estimate over ten years would likely be closer to $81 million.

The SLC, which is negotiating a separate contract with Oxy for the state portions of the West Wilmington Field, has yet to agree to the same terms as the city – in part due to disagreements with Oxy over the base amount and in part due to disagreements over the profits-sharing split.

Under the terms of the city contract with Oxy, if the SLC manages to strike a better deal with Oxy, the terms of the state contract will apply to the city contract.