Thursday, October 7, 2010

City Financial Demands On Long Beach Port May Pose Long-Term Risks

A recent series of efforts by Long Beach City Hall officials to tap the Port of Long Beach to cover declining city revenues could have serious long-term financial implications for the port, including: threatening the port's exceptionally positive bond credit rating; impacting the port's timely investment in infrastructure; raising the specter of increased cargo diversions; and, creating concerns regarding the autonomy of the port from city politics.

The Port of Long Beach, the second busiest container port in the Western Hemisphere, is owned by the state of California but operated by a nearly autonomous City of Long Beach department in trust for all the citizens of the state.

Long Beach operates as a landlord port, receiving no taxpayer funds and generating revenue primarily from leases of marine facilities to private firms and docking fees on vessels calling at the port.

Port revenues are prohibited by law from being used by the city for General Fund purposes, however, port revenues can be utilized through a special city fund for mainly maritime-, navigation-, and recreation-related expenses within the coastal tideland areas of the city. The city in turn can then offset General Fund expenses that would have been expended in the tidelands by utilizing the port funds.

City Budget Woes
The city of Long Beach, like many cities in California, is currently facing serious financial problems primarily related to increasing personnel-related costs and declining revenues from such sources as property taxes. Last month, city officials were forced to cut more than $18.5 million to achieve a mandated structurally-balanced city budget for fiscal year 2011.

Projections indicate that the city faces even further budget problems in coming years.

City officials, desperate to find new sources of revenue, have begun turning to the vastly profitable port, already a sizable revenue stream for City Hall.

In the past 20 years the port has paid City Hall nearly $440 million in either direct transfers or in payments for city services. This is an average of $22 million a year, or roughly 20 percent of the port's average annual profits.

Despite this apparent steady stream of port revenue to City Hall, city officials in the past 12 months have launched several efforts to divert even more funds from the port.

Port Oil Revenues
Late last year, city officials signed a deal with a major oil firm that essentially cut the port out of any revenue from future oil wells developed on port-owned oil property. Under the deal with Occidental Petroleum, revenues from future oil production will now be split between City Hall and Occidental. The deal is estimated to shift up to $15 million a year from port coffers to City Hall.

While the deal does not impact current wells generating revenue for the port, City Hall officials have also targeted these existing wells in a November ballot measure that proposes changes to port-related language in the Long Beach city charter.

Measure D, drafted by Mayor Bob Foster and several City Council members, seeks to turn over control of all port-controlled oil property and revenues to City Hall. The measure also seeks to change the way an annual port-to-city transfer of port profits is formulated.

Foster has argued that the oil-related portion of the ballot measure is meant to clarify charter language and is not an attempt to take more money from the port.

However, a study conducted by port staff prior to the announcement of the ballot measure estimated that the port expected to make $120 million in oil revenues from existing wells between 2010 and 2014. This would mean, if Measure D is approved by voters, that an average of $24 million a year will be diverted from the port to City Hall coffers.

Port-to-City Transfer
The ballot measure was crafted after port officials rejected City Hall's request to change the way port staff formulate the port's net profits. The annual transfer is currently limited by the city charter to 10 percent of the port's annual net profit--based on the port's annual audited financials.

The transfer portion of the ballot measure seeks to change the transfer formula from 10 percent of port net profit to 5 percent of port gross earnings. The average transfer over the past 10 years has been $11.7 million per year.

Despite no analysis being conducted to determine the future financial impacts of the measure, Foster has maintained that the fiscal impact to the port will be minor. He has repeatedly stated that the Measure D change in the charter is an effort to simplify the calculation of the transfer and is not about increasing the amount of the transfer.

However, based on the net and gross revenues of the port over the past ten years, the city stands to receive an average of $3 million more per year under the "5 percent of gross" formulation proposed in the ballot measure.

The port has also been tapped by City Hall to cover the debt service of the city's financially flagging Aquarium of the Pacific. This year the port paid nearly $3 million to cover the aquarium debt. In previous years, the amount has been even higher. Based on the financial situation of the city and the aquarium, it is likely that the port will have to cover the aquarium debt in the future as well.

Bottom Line
These four efforts alone have the potential, based on the various estimates of each revenue stream, to divert more than $45 million a year from the port to the city. Adding in the port's average $22 million a year in either direct transfers or payments for city services, and the port could be looking at sending roughly $67 million a year in revenue, or nearly 58 percent of its average annual profits, to City Hall.

In addition, City Hall is turning to the port more and more frequently for small items. This year alone the port was asked to offer up tens of thousands of dollars to support such city services as the municipal band and the Fourth of July fireworks show. These are in addition to the dozens of city events like the Long Beach Grand Prix and the Long Beach Seafest that the port is routinely asked to sponsor.

While the port can potentially sustain these diversions of revenue in the short term, the growing rapidity and size of the diversions has the potential for long-term problems.

Port Bond Rating
One area is in the port's bond rating. The port currently enjoys very positive bond ratings from each of the major bond rating agencies.

This rating assess the credit worthiness of a business entity's debt issues and serves almost the same function as a credit rating or FICO score does for individuals.

On a basic level, a high bond credit rating allows an entity like the Port of Long Beach, to obtain easier access to credit and at better terms. The opposite effect results from a lower bond rating.

Just like Equifax or TransUnion generate credit ratings for individuals, so to do a group of ratings agencies issue bond ratings for businesses and municipal entities like the port. In the case of bond ratings, the "big three" ratings firms are Fitch, Moody's and Standard & Poors.

In their evaluations of the port, each of these agencies cites similar specific port strengths that could be impacted by the continued diversion of port revenues.
Port Development

One of these strengths is the port's infrastructure, including, as detailed in a March 2010 Moody's report, "state-of-the-art facilities, including mega terminals and good road and rail connections."

In order to maintain this infrastructure the port has to invest sizable amounts of money. For example, the port's cost for the recently started Middle Harbor Project, which will rehabilitate and reconfigure several smaller terminals into one larger and more efficient mega terminal, is expected to be $751 million over ten years.

An increase in the amount of port revenues headed to City Hall could not only delay such port projects but could cause the port to re-evaluate which projects are deemed a priority. This in turn could cause a re-evaluation of the port's bond rating by the ratings agencies.

At least $1.2 billion of the port's 10-year $4.7 billion capital development project is expected to come from issuing debt. Any change in the port's bond rating would add significant cost to obtaining this debt. Based on the findings of a recent study by the non-profit Civil Federation on the cost of bond rating downgrades to the state of Illinois, the port could face more than $120 million in additional payments on the $1.2 billion in planned debt if the port's bond rating slips just one level.

Cargo Diversions

The rating agencies have also cited any increase in cargo diversions from the port as a potential risk to the port's rating.

The shifting of port revenue to City Hall could result in such diversion, if the port were forced to increase service fees or even implement a container fee to cover the loss of revenues to City Hall.

And it would not take much of an increase to force shippers to look elsewhere, according to a recent a recent analysis done by the Southern California Association of Governments, or SCAG. This group, the largest regional planning group in the nation, is mandated by the federal government to research and draw up plans for transportation, growth management, hazardous waste management, and air quality for the Southern California region.

The SCAG analysis, which looked at the impact of container fees on Southern California port traffic, found that a $100 fee per container would drive away 10 percent of the port's total imports in the short term and 23 percent over the long term. A $200 per-container fee would drive 19 percent of the port's total imports away over the short term and nearly 43 percent over the long term.

In other words, a $200 per-container fee would, over the long term, eliminate all the traffic gains made by the port in the past 15 years of growth. Even the $100 per-container fee's short term impacts would return the port to the same levels experienced during the height of the economic downturn in late 2008 and early 2009.

Loss of Autonomy
The City of Long Beach Harbor Department, which operates the port, was set up under the city charter to be nearly autonomous from the day-to-day politics of City Hall. In fact, City Hall only has several ways to directly impact the operation of the port: the mayor and City Council appoint the five members of the port commission; the City Council must approve the port's annual budget; the Mayor has line-item veto power over the port budget; and, the City Council can remove a sitting port commissioner under specific circumstances. Beyond these actions, City Hall has very little control over port staff beyond the application of political pressure on port officials.

In the past, all three rating agencies have cited the port's autonomy from City Hall politics as a distinct strength enjoyed by the port that figures into the port's strong ratings.

However, Foster has made it clear in recent days that while the port should be kept at "arm's-length," the port has a fiduciary responsibility to the city in addition to its trust responsibility to the state.

While this opinion runs counter to numerous legal decisions by the state Supreme Court stretching back to the early days of the port, the mayor and city staff have become more aggressive in the past year on imposing the will of City Hall on the port.

Examples of this include the development of the oil deal with Occidental. During the negotiations, City Hall officials sided with Occidental over the valuation of the port oil property and attempted to pressure port officials who disagreed to go along with the valuation. City Hall also led port officials to believe that the port would still be receiving the revenues from any future oil development. Port officials were notified shortly before the deal was signed that City Hall had unilaterally decided that the city, and not the port, would be receiving any revenue generated under the deal.

Another example was the recent dressing down of port officials at an Aug. 3 public council meeting by the mayor. After two port commissioners rose to question the timing of Measure D and the fact that no financial impact study was done, Foster and nearly all of the council members slammed the two commissioners for not cooperating with City Hall on the transfer timing issue, despite initial assertions by the City Auditor that the port had been very cooperative. The mayor and council repeatedly stated during the meeting that the "us-versus-them culture" of the port needed to change.

The most recent example was the recent veto of a $60 million item in the port budget by the mayor. Foster intimated that the line item, for the removal of a port maintenance yard sitting in the path of an impending bridge replacement project, was a way for the port to move forward with a decade-old plan to build a new port administration building--despite several assurances by port officials prior to the veto that the administration building was no longer moving forward. Foster told port officials that the port could seek approval for the funds from the council as a budget amendment, thus placing the council in the position of approving the funds for the port project instead of the port commission.

Gag Order
While none of the bond rating agencies have suggested that any change in the port's bond ratings are being considered, all three agencies have said that they are watching the moves by City Hall closely.

For their part, port officials have said that the port can handle the current financial demands placed upon them by City Hall. In fact. in some cases, such as the municipal band and fireworks show, the port has offered to pay voluntarily.

However, it is unknown how port officials feel about Measure D and its potential impacts. Shortly after the Aug. 3 council meeting where the two port commissioners were dressed down, the City Attorney's office forwarded a memo to the port admonishing port staff from publicly discussing the ballot measure. The memo, which cited state fair election laws, even warned port staff of possible criminal penalties.

Due mainly to the public dressing down and the warning memo, no opposing view to Measure D will appear on the ballot--only the pro-measure argument drafted by City Hall. When a prominent trade group tried to compose an opposing argument in the several days provided to craft an argument before the ballot deadline, the group found many people in the industry that were opposed to the measure but none that would be willing to sign on to the argument.