Hospitality Uses and Mineral Leases Practice Problem Aiming to bring the most jo

Question

Hospitality Uses and Mineral Leases

Practice Problem

Aiming to bring the most jobs and economic development to the county,

the San Luis Obispo County Council commissioned a study which evaluated the

highest and best use for land at the end of Avila Beach and Lighthouse Road.

There are potential energy reserves on the publicly owned land nearby and within

the countys boundaries. The reserve report found that substantial oil reserves

exist on the county-owned land adjacent to Port Harford. Several oil companies

have submitted bids for exploration leases on the land adjacent to the port.

The owners of Obispo Convention Center, a 320-room hotel farther inland

near the Pacific Golf Courses would rather see an expansion of the hospitality

uses in the county. The existing harbor building could expand recreational

boating. It already encompasses an outdoor pool deck, concession businesses

such as food and beverage outlets, and a parking area, which the owners believe

could be expanded for further recreational use.  

The county is considering granting a mineral lease to Energy Development

Co. (EDC), to begin extracting the oil over the next ten years from the adjacent

land. The owners of Oxnard Convention Center are concerned that oil drilling will

interfere with the tourism industry in San Luis Obispo.   They would rather see the

development of a new 280-room hotel and golf course at the location.

This is an arial photograph of the location.

PROPOSED NEW HOTEL INFORMATION

County annual averages:

Daily room rate: $220

Countys Occupancy rate: 75%

Operating expenses: $175 per room per day

General Market Conditions:

Occupancy began to show positive yearly growth and hotel capitalization

rates began to decline. Capitalization rates for new hospitality uses derived from

select lodging REIT data for the county averaged 11.5%.  

PROPOSED MINERAL LEASE INFORMATION

There is presently one working oil well on the land. In estimating reserves,

EDCs engineer estimates that the proved developed producing (PDP) reserves

at the site are a total of 1.7 million barrels of oil, with an annual decline rate of

30%. The company is considering a 15-year lease. The average price of oil for the

last year has been $95 per barrel. The county has indicated it will require that a

discount rate of 15% be used for valuing mineral leases in San Luis Obispo County.

EDC expects to pay a tax rate of 10%. Exploration costs will be 7% of

revenues. Production expenses are projected to be approximately 42% of the

leases gross revenue and management costs are less than 5% of gross income

due to recent modernization measures the company has undertaken. The county

would require that the land be returned in the same condition as it was when

leased. EDC budgets 9% of gross revenue to cover the expense of restoring the

property when extraction operations cease.    

Question:

1. Estimate the value of the mineral leases working interest.

Explanation / Answer

Expenses of restoring the property:

Value of the restoration of land at the end of the project = 9% of total gross revenue =9% * ($4,727,449,082.83) = $425,470,417.45.

Present value factor in 15th year = 0.12289

Present value of restoration of land = 0.12289 * $425,470,417.45.=$52,287,967.92

Therefore working interest = present value of net earnings over 15 years - present value of restoration of land

=1,380,019,358.86- $52,287,967.92

=$1,327,731,390.94

Year Revenue (A) exploration costs (7%)         B = A * 7% Production costs (42%)      C= A *42% Gross income    D=A-B-C Management costs (5%)                E = 5% of D Net income before tax        (F=D-E) Net income after Tax   (G = F*90%) Present value factor @15%(H) Present value (G*H) 0 0 1 $1,425,000,000.00 $99,750,000.00 $598,500,000.00 $726,750,000.00 $36,337,500.00 $690,412,500.00 $621,371,250.00 0.8695652 $540,322,826.09 2 $997,500,000.00 $69,825,000.00 $418,950,000.00 $508,725,000.00 $25,436,250.00 $483,288,750.00 $434,959,875.00 0.7561437 $328,892,155.01 3 $698,250,000.00 $48,877,500.00 $293,265,000.00 $356,107,500.00 $17,805,375.00 $338,302,125.00 $304,471,912.50 0.6575162 $200,195,224.79 4 $488,775,000.00 $34,214,250.00 $205,285,500.00 $249,275,250.00 $12,463,762.50 $236,811,487.50 $213,130,338.75 0.5717532 $121,857,962.91 5 $342,142,500.00 $23,949,975.00 $143,699,850.00 $174,492,675.00 $8,724,633.75 $165,768,041.25 $149,191,237.13 0.4971767 $74,174,412.21 6 $239,499,750.00 $16,764,982.50 $100,589,895.00 $122,144,872.50 $6,107,243.63 $116,037,628.88 $104,433,865.99 0.4323276 $45,149,642.21 7 $167,649,825.00 $11,735,487.75 $70,412,926.50 $85,501,410.75 $4,275,070.54 $81,226,340.21 $73,103,706.19 0.375937 $27,482,390.91 8 $117,354,877.50 $8,214,841.43 $49,289,048.55 $59,850,987.53 $2,992,549.38 $56,858,438.15 $51,172,594.33 0.3269018 $16,728,411.86 9 $82,148,414.25 $5,750,389.00 $34,502,333.99 $41,895,691.27 $2,094,784.56 $39,800,906.70 $35,820,816.03 0.2842624 $10,182,511.57 10 $57,503,889.98 $4,025,272.30 $24,151,633.79 $29,326,983.89 $1,466,349.19 $27,860,634.69 $25,074,571.22 0.2471847 $6,198,050.52 11 $40,252,722.98 $2,817,690.61 $16,906,143.65 $20,528,888.72 $1,026,444.44 $19,502,444.29 $17,552,199.86 0.2149432 $3,772,726.40 12 $28,176,906.09 $1,972,383.43 $11,834,300.56 $14,370,222.10 $718,511.11 $13,651,711.00 $12,286,539.90 0.1869072 $2,296,442.16 13 $19,723,834.26 $1,380,668.40 $8,284,010.39 $10,059,155.47 $502,957.77 $9,556,197.70 $8,600,577.93 0.162528 $1,397,834.36 14 $13,806,683.98 $966,467.88 $5,798,807.27 $7,041,408.83 $352,070.44 $6,689,338.39 $6,020,404.55 0.1413287 $850,855.70 15 $9,664,678.79 $676,527.52 $4,059,165.09 $4,928,986.18 $246,449.31 $4,682,536.87 $4,214,283.19 0.1228945 $517,912.16 Total $4,727,449,082.83 $1,380,019,358.86

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