Did taxpayers lose on deal for oil field?

Introduction

“For the last eight years, I have had the challenge of running the streamlining program called ‘Reinventing Government,'” Democratic presidential nominee Al Gore proudly declared at the final 2000 presidential debate, to bolster his claim that he favors smaller government. “And if there are any federal employees in this group, you know what that means.” In the case of the Naval Petroleum Reserve No. 1 near Bakersfield, Calif., a 47,000-acre oil field that Gore’s program “streamlined,” it has meant a questionable deal with millions, perhaps billions, of dollars in lost federal revenue. In 1997, the Clinton administration auctioned off NPR-1, or Elk Hills, as the oil field is more commonly known due to its prevalence of Tule elk. Occidental Petroleum Corp. made the highest bid, at $3.65 billion. But from the start, the sale – the largest single privatization in U.S. history – was greeted with disdain by many executive branch employees familiar with the deal.

“The government had already decided to sell out, regardless of what they thought they could get . . . because it was a political decision,” said Jerome Hinkle, a senior planner in the Department of Energy’s Office of Naval Petroleum and Oil Shale Reserves. That office, known as NPOSR, was the DOE office in charge of Elk Hills; it continues to manage other properties originally set up to ensure naval fuel supplies. “Given the narrow conditions of the way the auction was conducted, yes, Oxy paid a fair price,” Hinkle said of the deal. “But given its replacement value and what the government could have gotten [the public didn’t necessarily get a good deal].”

Estimate nearly twice what Occidental paid

Hinkle, like some of his past and present DOE colleagues, says the U.S. Treasury would have accrued more by holding onto the property and running it as a government corporation. But his view was not shared by a majority of nearly 30 analysts and government officials The Public i contacted, who maintained that the government got a fair price. However, a largely ignored but much more optimistic study conducted in 1997 by Elk Hills’ operators (NPOSR and Bechtel Petroleum Operations, Inc.) put its value at potentially $5.75 billion or $6.64 billion — nearly twice what Occidental paid. That estimate was not used in determining the “minimum acceptable sales price,” the lowest price the government would consider to be a fair offer for the field.

Occidental’s most recent estimate of Elk Hill’s oil and natural gas reserves matches, if not exceeds, the reserve levels underpinning the DOE-Bechtel $6.64 billion price tag — suggesting that the company did, indeed, get a bargain.

An ongoing analysis by The Public i — including the review of hundreds of confidential internal memoranda and dozens of interviews with current and former DOE officials, congressional staffers, petroleum experts and others — shows that the sale was a complex, White House-managed maneuver that critics say might have cost the public millions, if not billions, in lost income.

The Public i has found that:

• The sale came despite the efforts of Patricia Godley, an assistant energy secretary, who lobbied her own department and Congress to operate the massive oil field as a government corporation. The prevailing Clinton administration argument was that privatization of Elk Hills would unburden the government of a poorly run asset and bring in some much-needed cash to help reduce the budget deficit (see accompanying report, “Elk Hills: Private or Public?“).
• The sale of the field, which might have seemed a good idea when oil was $10 or $18 a barrel and the Middle East was relatively peaceful, is proving to be shortsighted, with oil prices topping $30 a barrel at a time of growing unrest overseas.
• The administrative costs to the taxpayer of closing the sale have totaled a staggering $84 million.

There is no evidence of official wrongdoing in the Elk Hills sale. But underlying questions about how Occidental Petroleum bested 14 other bidders for one of the nation’s biggest oil fields remain unanswered. Occidental has longstanding links to Gore and his father, the late Sen. Albert Gore Sr. (see The Public i‘s previous report, “How the Gores, Father and Son, Helped Their Patron Occidental Petroleum” from The Buying of the President 2000.)

Then-Secretary of Energy Federico Peña was all too aware of the possible conflict-of-interest perception. In a memo to President Clinton asking him to stage a signing ceremony in February 1998, Peña wrote, “Albert Gore, Sr. is on Occidental Petroleum’s Board of Directors. However, there is no dispute that Occidental was the highest bidder for the property in a very competitive and fairly administered sale process.” Vice President Gore has declined requests by the Center for an interview.

Surprise at Energy Department refusal

DOE has stonewalled attempts since January by the Center under the Freedom of Information Act (FOIA) to obtain the bids that culminated in the Occidental sale (see accompanying report, “Energy Department Has Denied Info Requests for Months“), claiming that the information falls under a “proprietary business information” exception to FOIA. Former government officials and congressional aides contacted by the Center expressed surprise at DOE’s refusal.

From 1959 to 1979, “I was in charge of procurement policy at DOT [Department of Transportation], FAA [the old Federal Aviation Agency] and the U.S. Railway Association, and never refused information — under FOIA or directly — and I don’t see this ‘proprietary’ junk,” said Alan Dean, a fellow with the National Academy of Public Administration. Dean was co-project director of a 1994 NAPA report to Congress on restructuring Elk Hills, which recommended that it become a government corporation. “In the bid, they [the oil companies] didn’t have to convey company strategy, just a price and over what period of time they would pay.”

And although Occidental’s winning bid exceeded the estimates of five independent appraisals commissioned by the Energy Department, it fell nearly $2 billion short of the DOE-Bechtel estimate.

NPR-1 was set aside in 1912 by President Taft as an emergency source of fuel for the U.S. Navy. Oil companies have long coveted the field; indeed, it was one of the fields involved in the Teapot Dome scandal of the 1920s, when the Harding administration’s Department of Interior was bribed into giving secret drilling leases. Production on the fields began only in 1976, when Congress passed the Naval Petroleum Reserves Production Act. The act, enacted at the height of the 1970s oil crisis, directed the Carter administration to start pumping oil from the field at what is called a “maximum efficient rate,” to ensure the field’s longevity .

For years, it did just that. Between its 1976 production start-up and its transfer to Occidental in 1998, the operation cost a total of $3.3 billion and yielded the U.S. Treasury $17.1 billion, returning a net $13.8 billion, or 415%. The field had produced a cumulative 1 billion barrels of oil, and various estimates projected millions more. That’s not to mention reserves of more than 1 trillion cubic feet of natural gas which, since Occidental bought the field, has proved to be even more lucrative than oil, petroleum analysts say.

But by 1995, net revenue at Elk Hills had declined to $200 million annually, and the historic mission of the field — to guarantee fuel for naval ships — no longer seemed pressing. To boot, Elk Hills was widely acknowledged — even at the Energy Department — as being inefficiently run because of uncertainty about appropriations, bureaucratic operating requirements and other investment constraints. The most lucrative government-run operation at the time, NPR-1 was required to send all net proceeds directly to the U.S. Treasury, with no option for reinvestment. Elk Hills’ managers in the Naval office grumbled about that and pushed internally for a government corporation. Various internal and external independent studies showed that such investments could have produced even higher earnings for the U.S. government.

While the Reagan administration first broached the idea of privatizing the fields in the early 1980s, it wasn’t until 1994-95, with Gore’s pet project of Reinventing Government and a new, Republican-controlled Congress, that the idea came to fruition. While many experts both inside and outside government agreed that the fields might be better organized under a publicly owned corporation, such as the Tennessee Valley Authority or the Postal Service, the Clinton administration chose to sell it outright.

Bumpers: Public was ripped off

Most notable among the sale’s critics at the time was former Senator Dale Bumpers, D-Ark., a Clinton ally and then-ranking member of the Senate Energy and Natural Resources Committee. Bumpers, now a lawyer in Washington, D.C., contends the public was ripped off.

“I was, and still am, strongly opposed to the sale. . . . I argued that oil is a finite resource and would only go up in value. It was a questionable decision, and I thought we would regret it,” Bumpers said in an interview. “Obviously we didn’t get fair value, even when oil was $10 a barrel [in late 1998 and early 1999]. Also, it was a naval reserve, and it was designed to make sure we had oil in a time of crisis.”

Professor William H. Becker of George Washington University, a specialist on public policy and the oil industry, said he believes the price of oil was a factor in the timing of the sale. “When prices are cheap, policy goes out the window,” he said.

Shortsightedness becomes clear

Now that prices are rising again, the shortsightedness of the sale becomes clear. Just on Sept. 22, the White House ordered the sale of 30 million barrels of oil from the Strategic Petroleum Reserves, which are maintained for national emergencies; retaining Elk Hills would have given the government another weapon against high oil prices. While the daily production of the field is low compared with total U.S. consumption, the allocation of government resources in a time of crisis tends to “send a message,” Becker said, noting that the recent announcement of the release from the Strategic Petroleum Reserves had an immediate effect of pushing prices down.

“No, oil wasn’t this high then,” Bumpers said of the timing of the sale. “But it won’t ever be $10 a barrel again, either.”

To what extent Elk Hills could have mitigated the high prices consumers have faced in the last year is uncertain, but what is clear is that the field was sold for less than the government’s own best estimate of its value, $5.575 billion. “The problem is that nobody knows [what the field was worth],” said Hank Banta, a Washington attorney who represented California in the sale of Elk Hills. “The geological formation is extremely complex. When you start talking to people, the truth is that everybody has a wild-eyed guess.”

“There are all kinds of techniques to value an oil field, these reserve categories, and there’s a wide margin in there,” agreed Anton Dammer, NPOSR’s current director.

To set a minimum acceptable sales price, DOE relied on five external appraisals in large part based on a conservative reserve estimate by Ryder Scott, a respected petroleum engineering firm. Ryder Scott concluded that there were only 174 million barrels of oil of proven reserves, and estimated the field to be worth $1.9 billion; four of the five financial appraisers then low-balled their estimate of how much oil and natural gas were left in Elk Hills. The five appraisals came in at a range of $1.8 billion to $2.6 billion, the average of which became the minimum acceptable sales price, a figure supposedly kept confidential from the bidders.

However, the DOE-Bechtel study, which showed more than $5.575 billion in assets or $6.64 billion in “upside” potential, was largely ignored by government overseers of the sale and all the bidding companies, apparently, except Occidental.

The 10-volume DOE-Bechtel “Upside Study” estimated that the field still had 303 million barrels of “proved” oil reserves, plus 195 million “probable” or “possible” barrels. Combined with estimates of 1.18 trillion cubic feet of natural gas and some natural gas liquids, the study put a pretax price tag of $5.575 billion on the property ($3.734 billion for the proved reserves alone), discounted at 10%, the government rate. In addition, the Upside Study included specific investment recommendations — some of which have been implemented by Occidental — to increase net present value by another $1.065 billion. (Within months of acquiring the property, Occidental installed new gas pipelines to increase capacity and has raised the cash to build a 500-megawatt power plant, even bigger than what the Upside Study envisioned.)

‘Keeping the contract’ . . . and ‘keeping their jobs’

Government officials say the Upside Study was provided to prospective bidders but was viewed as exaggerated “seller’s information” and was not trumpeted by DOE to government overseers of the sale. Most significantly, the General Accounting Office – which, along with the congressional armed services committees and the Department of Justice, had 31 days to review the sale and reject it if need be – says the DOE-Bechtel study was not promoted or even seen as an “official” document.

“The [Upside Study] figures were not officially published. It was considered an internal study, and it was done by DOE and Bechtel, so of course the intention was to keep the contract . . . and DOE staff was also concerned about keeping their jobs,” Godwin Agbara, the GAO evaluator in charge of overseeing the sale, told The Public i. “If that had been [widely] accepted, it would have been the minimum acceptable price. It would mean they would continue to operate.”

Elk Hills was a developed, well-established property — and thus uncertainty about its reserves should have been minimal, points out Thomas Stauffer, a retired Harvard professor and petroleum engineer in Washington, D.C. “It had been producing for ages, not necessarily well run, but there should have been limited uncertainty. Anybody evaluating Elk Hills should have had a relatively easy time,” Stauffer said.

As it turns out, Occidental’s assessment of what lies under Elk Hills is much closer to the Upside Study than the estimates by Ryder Scott or the five financial assessors.

In an annual meeting with financial analysts in November 1997, Occidental figured Elk Hills had proven reserves of 300 million barrels of oil and 665 billion cubic feet of natural gas, which converts into 410 million barrels of oil equivalent (BOE), recalls Fadel Gheit, senior energy analyst at Fahnestock & Co. in New York. In addition, Oxy told analysts that there were net remaining recoverable reserves of 670 million barrels of oil, plus 1.9 trillion cubic feet of gas; risk-weighted, Oxy was counting on nearly 1.33 billion BOE — actually higher than the Upside Study’s projection.

One year later, Gheit says Occidental upgraded its proven reserve level to 425 million BOE and net recoverable reserves to 980 million BOE, bringing the total, risk-weighted projection to more than 1.4 billion BOE. “So they’re still on record that although our proved reserves is 425 million, we have upside of another 980 million,” Gheit said. “They have only scratched the surface, tapped one-third of the potential of this field.”

Occidental did not hold an analysts meeting last year.

An Occidental spokesman said in an interview that Elk Hills’ average production this year is 40,000 barrels of oil, plus 294 million cubic feet of natural gas and roughly 6,000 equivalent barrels of natural gas liquids, per day. Oil companies typically do not divulge revenue estimates per property, but at current prices of $33 a barrel and $5 per cubic foot of gas, that production level would yield more than $1.018 billion annualized.

‘Insult to injury’

Adding insult to injury, according to Hinkle, the NPOSR official who remains opposed to the sale, is that Occidental is unlikely to make up the difference between what it paid and what it got in the form of taxes. The oil company is currently in dispute with its property tax assessors in Kern County, Calif., where the fields are located.

The administrative cost of the sale, which has not previously been disclosed, to date has totaled $84 million and will likely reach $90 million, according to Hinkle. Those expenses include the numerous engineering and financial assessments of the property’s value, investment bankers, lawyers, an environmental impact study and ongoing negotiations with Chevron, which has title to 22% of the property and was supposed to have settled its equity with the government prior to the sale. While Congress did not appropriate funds to DOE for the sale, the final figure obviously erodes the price the public received for Elk Hills.

The tab is being picked up by taxpayers, not Occidental. A spokesman said the company expects Elk Hills to have generated net cash of $1.25 billion from its takeover in February 1998 to December 2000. (Net cash, also known as free cash flow, is income after tax, capital and other expenditures, but does not take depreciation into account.) “That’s about a 15% return,” the spokesman said.

“The average return for the whole period is about 15%; but at current prices, it’s well over 25%,” Gheit added.

“Any way you figure it, $3.65 billion was a steal,” Bumpers said of the sale. “Don’t try to buy it back,” he said sarcastically, laughing.