Summary

Port of Oakland: Despite Its Overall Financial Success, Recent Events May Hamper Expansion Plans That Would Likely Benefit the Port and the Public October 2001 2001-107 rotiduA etatS ainrofilaC S T I D U A E T A T S F O U A E R U B The first five copies of each California State Auditor report are free. Additional copies are $3 each, payable by check or money order. You can obtain reports by contacting the Bureau of State Audits at the following address: California State Auditor Bureau of State Audits 555 Capitol Mall, Suite 300 Sacramento, California 95814 (916) 445-0255 or TDD (916) 445-0255 x 216 OR This report may also be available on the World Wide Web http://www.bsa.ca.gov/bsa/ The California State Auditor is pleased to announce the availability of an online subscription service. For information on how to subscribe, please visit our Web site at www.bsa.ca.gov/bsa. If you need additional information, please contact David Madrigal at (916) 445-0255, ext. 201. Alternate format reports available upon request. Permission is granted to reproduce reports. C S A ALIFORNIA TATE UDITOR ELAINE M. HOWLE STEVEN M. HENDRICKSON STATE AUDITOR CHIEF DEPUTY STATE AUDITOR October 23, 2001 2001-107 The Governor of California President pro Tempore of the Senate Speaker of the Assembly State Capitol Sacramento, California 95814 Dear Governor and Legislative Leaders: As requested by the Joint Legislative Audit Committee, the Bureau of State Audits presents its audit report concerning the operations of the Port of Oakland (Port). Specifically, we reviewed the Port’s financial statements to determine the efficiency of its operations and to evaluate the return on the Port’s capital and real estate investments. This report concludes that, overall, the Port effectively managed its assets over the last 10 fiscal years (1990–91 through 1999–2000) and its $1.7 billion capital improvement program should benefit the public and allow the Port to remain financially competitive in the future. We found that two of the Port’s three revenue generating divisions—maritime and aviation—performed well during the past decade, while the third—real estate—has shown consistent losses. The real estate division’s losses were due to some unsuccessful business undertakings, inaction in controlling its operating costs, and the Port’s decision to rent to public and nonprofit entities certain real estate division holdings at below-market rates. The Port is also in the middle of planning and implementing large capital expansion plans for both its maritime and aviation divisions. Our review of the Port’s March 2000 feasibility study found that projections of the maritime and aviation divisions’ future revenues and expenses are reasonable and that their respective expansion plans should provide a number of public benefits. However, events have occurred since the March 2000 feasibility study that may significantly affect the aviation division’s plans for improving the airport. For instance, the aviation division revised its expansion plan to curb costs when updated construction cost projections proved higher than expected. The revised plan was only recently approved. In addition, an appellate court decision will require the Port to develop a supplemental environmental impact report. Finally, the terrorist attacks of September 11, 2001, could result in costly changes to airport security. Respectfully submitted, ELAINE M. HOWLE State Auditor BUREAU OF STATE AUDITS 555 Capitol Mall, Suite 300, Sacramento, California 95814 Telephone: (916) 445-0255 Fax: (916) 327-0019 www.bsa.ca.gov/bsa Port of Oakland: Despite Its Overall Financial Success, Recent Events May Hamper Expansion Plans That Would Likely Benefit the Port and the Public CONTENTS Summary 1 Introduction 5 Audit Results The Port’s Management of Its Major Business Lines Has Generally Been Effective 11 The Maritime Division Has Managed Its Growth Efficiently in the Past, and Its Future Plans Should Increase Its Competitiveness 13 The Aviation Division Has Increased Its Revenues Over the Past Decade and Is Implementing Expansion Plans That Should Significantly Benefit the Public 31 The Real Estate Division Has Operated at a Considerable Fiscal Loss but Plans to Finance Future Capital Improvements Without Incurring Additional Debt 43 Recommendations 52 Appendix 53 Response to the Audit Port of Oakland 57 SUMMARY RESULTS IN BRIEF T he Port of Oakland (Port) is an independent, self- supporting department of the city of Oakland charged Audit Highlights . . . with managing and operating a seaport, a passenger and cargo airport, and the waterfront real estate in and around the Our review of the Port of Oakland Estuary. Over the past decade, its effective administration Oakland’s (Port) financial of these properties resulted in an increase of its overall operating statements for the past income from $4.4 million in fiscal year 1990–91 to $47 million 10 years and its past and in fiscal year 1999–2000.1 It is now in the process of planning future capital and implementing a $1.7 billion capital improvement program improvement projects that includes substantial expansions of both its seaport and revealed that: airport. This program should not only enable the Port to remain (cid:1) Overall, the Port financially competitive but also benefit the public. effectively managed its assets, and its $1.7 billion Separate revenue divisions are responsible for managing the capital improvement program should benefit Port’s maritime, aviation, and commercial real estate activities. the public and allow it to In recent years the maritime and aviation divisions have con- remain competitive. tributed to the Port’s successful performance, but the real estate (cid:1) Its maritime and aviation division has struggled. The maritime division’s management of divisions have prospered, its resources has been particularly effective: Over the past 10 years and their expansion plans it almost doubled its revenues, while its operating expenses are based on reasonable increased by slightly more than half. The maritime division’s estimates of future revenues and expenditures. implementation of two important capital improvements— renovating one of its terminals and deepening the channel (cid:1) Certain recent events may accessing the port—contributed to its ability to remain competitive hamper the aviation with comparable seaports. Although significant delays did occur division’s plans to improve the airport. in the regulatory approval process of the dredging project, the maritime division consistently maintained a reasonable amount (cid:1) The real estate division of revenue to cover its debt service during the construction. To consistently operated at a deficit due to unsuccessful continue to ensure its competitive position, the maritime division business ventures, inaction recently implemented its capital improvement program, which in controlling operating includes constructing two new ship terminals, new roads, a rail- costs, and the Port’s freight transfer terminal, and a waterfront recreational park as decision to lease certain properties at below- well as deepening the channel from 42 feet to 50 feet. A feasibility market rates. study suggests that projected revenues should be adequate to cover the debt associated with funding these projects. 1 Operating income is the difference between operating revenue and operating expenses, including depreciation and amortization. 1 Similar to the maritime division, the aviation division has significantly increased its operating revenues during the past 10 years, and it has nearly doubled the number of passengers using the Oakland airport. This growth is particularly noteworthy considering that the number of scheduled flights serving Oakland has often fluctuated during this period. Although its past capital improvements have been relatively small projects, the aviation division is in the process of planning a substantial expansion of its facilities, including new terminal buildings, roads, and a parking structure. This expansion should benefit the public by relieving traffic congestion and enabling the airport to better serve an increasing number of passengers. Yet, despite the variety of funding sources identified in the initial feasibility study, the aviation division has recently met with a number of setbacks. A new internal review determined that it had signifi- cantly underestimated the cost of the expansion, a problem that may be compounded by a recent court decision ordering it to prepare a new supplemental environmental impact report before beginning construction on affected capital improvement projects. Moreover, the terrorist attacks on September 11, 2001, will almost certainly have a significant impact on the airline industry, the consequences of which are difficult to predict. As mentioned, the Port’s real estate division has not shown the same financial growth as the other two. Together, the maritime and aviation divisions have generated roughly 89 percent of the Port’s revenues over the past 10 years, while the real estate division generated the remaining 11 percent. In fact, the real estate division has consistently operated at a deficit during this time. Its losses appear to be the result of the real estate division’s inability to control high maintenance costs for its properties in Jack London Square, some business decisions that turned out badly, and the Port’s decision to use the real estate division to provide benefits to the public that has further exacerbated the division’s poor financial situation. In effect, the real estate division has subsidized nine public benefit projects by leasing eight properties for $1 a year and one property for $490 per year. The real estate division plans to improve its profitability but has not yet taken significant action. Although it is currently proposing several large capital improvement projects, the division does not intend to move forward with these plans unless the developers are willing to provide the necessary funding, thus ensuring that the real estate division will not acquire more debt. 2 RECOMMENDATIONS To reduce the effect of the commercial real estate division’s losses on the Port’s operations as a whole, the division should do the following: (cid:127) Complete the action plan approved by the board of port commissioners in 1999. (cid:127) Examine the effects of management’s decisions to lease land at below-market rates to determine if changes in the rates charged could increase revenues without harming the Port’s relationships with the community and other municipalities. (cid:127) Continue to look for ways to increase revenues and decrease costs associated with managing its assets. AGENCY COMMENTS The Port feels that our report will provide the State with the critical information needed to evaluate its value and impact. The Port also feels that it is taking steps to implement our recom- mendations. (cid:2) 3 Blank page inserted for reproduction purposes only. 4 INTRODUCTION BACKGROUND I n 1927 the city of Oakland amended its charter to establish the Port of Oakland (Port), an independent, self-supporting department responsible for managing and operating 19 miles of waterfront on the eastern shore of the San Francisco Bay. The waterfront properties under the Port’s jurisdiction include a seaport; a passenger, cargo, and general aviation airport; and waterfront real estate. A seven-member board of port commis- sioners (board), nominated by the mayor and appointed by the city council of Oakland, governs the Port. Board members, who represent diverse backgrounds, serve four-year staggered terms without compensation. Because the State granted the waterfront property to the city of Oakland in a series of Tideland Trust grants, most of the property is subject to state tideland grant restrictions. These restrictions require that tideland property and revenues generated by the use of that property be used for tideland purposes, including com- merce, navigation, fishing, and public access to the shoreline. Neither the city nor the Port owns the waterfront property; rather, the Port holds the property in trust for the people of California. The Port’s stated mission is to increase the region’s economic vitality, create jobs, and provide opportunities for waterfront enjoyment, while also generating earnings to reinvest in its activities. Figure 1 on the following page shows how the Port uses its water- front property: 665 acres are devoted to maritime activities, 3,000 acres to aviation, and 1,040 acres to commercial real estate holdings. Separate revenue divisions oversee the maritime, aviation, and commercial real estate activities, while the costs for several supporting divisions and units are allocated among all the Port’s enterprises. Figure 2 on page 7 depicts the Port’s overall organization. In June 2001 the Port’s executive director announced his retirement, and the board subsequently appointed his deputy as the next executive director. 5 6 ADELINE ST. MARKET ST. 980 BROADW AY OAK ST. E. 8TH ST. E. 12TH ST. 29TH AVE. AVE. VALE FRUIT- 80 7TH ST. EMBARCADERO M T B e u r R m r d m i . n a al ARITIM E ST. 880 Bou P n o d rt ary MIDDLE HARBOR RD. Port Boundary N E W S Aviation Division area Real Estate Division area Maritime Division area Property does not belong to the Port of Oakland HIGH ST. OAKPORT ST. HEGENBERGER 98TH AVE. EDGEWATER DR. DOOLITTLE DR. PARDEE DR. ORT AIRP .DR OGRACRIA Po B r o t undary Lak M e erritt D B O is u t a s r k i i b n la u e n t s i d o s n A P C i a rp e rk o n r t & t er C O o a l k is la e n u d m B B rid a g y e A B O r a a m s k e y . Oakland 9 Te th r m A i v n e a . l Coast Guard Is. 880 Terminal RD. M.L. King, Jr. Howard Embarcadero Union Point Regional Shoreline Terminal Jack Estuary Cove Basin Park London Park H O a u rb te o r r / Tran H C s a e p r n o b t r e o ta r r tion In U te n r i m on o d P a a l c Y if a ic rd Oakland Estuary P B or u t i l O di f n fi g ce Square Alameda A N ir o p r o th rt G C a G o lb u o r r a l s f i e th Bay Farm Island (Alameda) Ben E. Nutter Container Metropolitan Oakland Port Terminal Interrnational Airport Boundary Port View (South Airport) Park San Francisco Bay MH elddi robra FIGURE 1 Port of Oakland San Inner Harbor Lea B n a d y ro M D a e ri v ti e m lo e p / m In e t n e t r m Ar o e d a al HARBOR BAY PKW Y . AIRPORT RD. (under construction) 6/01 Source: Port of Oakland. FIGURE 2 Port of Oakland’s Organization Chart for Fiscal Year 2000–01 Board of Port Commissioners Communications Secretary of Executive the Board Director Strategic & Policy Port Planning Attorney Deputy Executive Financial Director Audit Services Corporate Equal Maritime Aviation Real Estate Engineering Administrative Opportunity Services Source: Port of Oakland. Denotes a direct reporting relationship Denotes an advisory relationship THE MARITIME DIVISION The maritime division is responsible for administering Oakland’s seaport. It designs, constructs, and maintains marine transporta- tion facilities, and acting as a landlord, it negotiates lease and use agreements for these facilities with private-sector companies. Under the terms of these agreements, the private-sector companies are responsible for managing and operating the facilities, and the maritime division operates the wharf. Currently, the maritime division has several capital improvement projects planned or under construction, including building new marine terminals, improving the rail infrastructure, and increasing the depth of channels and berths from 42 feet to 50 feet. It is also in the process of undertaking environmental mitigation measures to protect and improve air and water quality, developing a wildlife habitat, and improving public access. 7 THE AVIATION DIVISION The aviation division operates the Metropolitan Oakland Inter- national Airport. Its responsibilities include marketing facilities to tenants, including airlines and air cargo companies. In 2000 the airport boarded nearly 5 million airline passengers and almost 693,000 metric tons of air cargo. To accommodate an increasing demand for passenger and cargo services, the airport plans to add up to 12 passenger gates, build a new multilevel parking and ground transportation center, create new cargo facilities, and improve the roadways providing access to the airport complex. THE REAL ESTATE DIVISION The real estate division manages, leases, and develops land located along the Port’s waterfront, including office and retail facilities in Jack London Square and a commercial waterfront development along the Oakland Estuary. It is also responsible for overseeing Oakland Portside Associates (OPA). Originally a non- Port entity, the OPA was established in June 1987 as a limited partnership between Portside Properties and its financial partner to construct and manage most of the buildings currently located in Jack London Square. After Portside Properties’ financial partner withdrew from the partnership in December 1987, the Port became the majority general partner. In August 1990 it effectively became the sole owner. SCOPE AND METHODOLOGY The Joint Legislative Audit Committee asked the Bureau of State Audits to review the financial statements of the Port to determine the efficiency of its operations and to evaluate the return on the Port’s capital and real estate investments. To assess how efficiently the Port manages its operations, we reviewed revenues and expenses for fiscal years 1990–91 through 1999–2000 as reported in the Port’s annual audited financial statements. We also reviewed the segmented income statements covering the same period for each of the three revenue divisions. 8 Because the Port does not maintain complete asset information by division, we were unable to determine the rate of return for each revenue division. Instead, we calculated the rate of return for the entire Port for fiscal years 1990–91 through 1999–2000. This information is presented in the Appendix. We also calcu- lated the Port’s debt service coverage ratios from the year-end financial statements for fiscal years 1992–93 through 1999–2000 for each revenue division to determine whether they met the criteria of the Port’s bond covenant and its own internal goal. Due to record retention limitations, we were unable to calculate the revenue divisions’ debt service coverage ratios for fiscal years 1990–91 and 1991–92. To determine if the amount of long-term debt proposed to fund a portion of the Port’s future capital improvement plans is reasonable, we computed, for each relevant revenue division, the debt service coverage ratios over the next nine years (the Port’s planning horizon) using each division’s projected revenues and expenses. Then we assessed the adequacy of these projected debt service coverage ratios to support each division’s proposed issuance of long-term debt. We also examined the Port’s revenue and expense projections to determine whether they were based on reasonable assumptions. The Port’s engineering division produced the cost estimates for its proposed construction projects and then had an outside consultant review them to determine if they were reasonable. We therefore relied on the consultant’s opinion on the reasonableness of the Port’s estimated construction costs. To compare the Port’s fiscal performance with those of similar entities, we researched the characteristics of other ports to determine which were most comparable. However, since most ports differ in size and business structure, we compared the maritime and aviation divisions of the Port to similar business segments of other entities. We did not include the real estate division in our comparisons because real estate activities are generally specific to given geographic areas, and we did not feel a comparison to entities in other parts of the State and country would produce meaningful results. Finally, we determined whether the Port’s projections of the nonfinancial benefits of its capital improvement projects were reasonable by reviewing its calculations and methodology. (cid:2) 9 Blank page inserted for reproduction purposes only. 10 AUDIT RESULTS THE PORT’S MANAGEMENT OF ITS MAJOR BUSINESS LINES HAS GENERALLY BEEN EFFECTIVE O ver the past decade the Port of Oakland (Port) as a whole performed well financially, producing a 10-fold increase in operating income, from $4.4 million to $47 million.2 From fiscal years 1990–91 through 1999–2000, the Port’s operating revenues increased from $98 million to $172.7 million, and its total assets grew from $676 million to just under $1.7 billion. The Port’s operating expenses, including depreciation and amortization, increased at a slower rate than its operating revenues, from $93.6 million in fiscal year 1990–91 to $125.7 million in fiscal year 1999–2000. As shown in Figure 3 on the following page, two of the Port’s three core revenue divisions—the maritime and aviation divisions—contributed to the Port’s successful performance, producing roughly 89 percent of the overall revenue for the Port during this time. In contrast, the real estate division registered consistent losses, in part because the Port decided to use the division to carry out projects to benefit the public, a choice that falls within the scope of its mission. In general, the Port’s past capital improvement projects have proven financially beneficial, with the Port easily covering the costs of its investments. A planned $1.7 billion capital improve- ment program will expand the Port’s seaport by adding new wharf and container terminals, a new access road, and a more efficient railroad system, and will add a new passenger terminal, parking garage, and access road to the Port’s airport. We reviewed the Port’s initial feasibility study for this program, which was issued in March 2000, and found that estimates of future rev- enues and expenses at that time were reasonable. We also found that the Port’s expansion should offer a number of benefits to the surrounding community, including more job opportunities, less traffic congestion around the airport, and a better environment and improved appearance for the Oakland waterfront. 2 Operating income is the difference between operating revenue and operating expenses, including depreciation and amortization. 11 12 FIGURE 3 Operating Income for Each Division and the Port as a Whole for Fiscal Years 1990–91 Through 1999–2000 (In Millions) $50 Maritime Aviation Real Estate 40 Port Overall 30 20 --2200 10 0 -10 -15 1990–91 1991–92 1992–93 1993–94 1994–95 1995–96 1996–97 1997–98 1998–99 1999–2000 Source: Port of Oakland’s audited financial statements. Unfortunately, certain events that have occurred since the completion of the March 2000 feasibility study may significantly affect the Port’s plans for improving the airport. In August 2001 the aviation division increased its construction cost estimate by $453 million. Also, on September 26, 2001, an appellate court ruled that the Port’s environmental impact report for the aviation division’s expansion plans was inadequate and a new supple- mental report would have to be prepared that will require additional time and money. Finally, the terrorist attack launched on the United States on September 11, 2001, has the potential to negatively affect the Port’s financial situation in two ways. First, it is likely that the airport and seaport will require a number of costly security enhancements. Second, business in general and airline passenger business in particular could be slowed substantially. These factors could have a significant impact on the Port’s future expenses and revenues. THE MARITIME DIVISION HAS MANAGED ITS GROWTH EFFICIENTLY IN THE PAST, AND ITS FUTURE PLANS SHOULD INCREASE ITS COMPETITIVENESS Over the past 10 years the maritime division’s management of its resources has been appropriate and effective. During this time, it almost doubled its revenues, but its operating expenses increased by a little more than half. Moreover, the maritime division implemented two important capital improvement projects: renovating one of its terminals and deepening the channel accessing the port. Although some delays did occur in the regulatory approval process for the dredging project, the maritime division consistently maintained a reasonable amount of revenue to cover its debt service throughout the periods of construction. The eventual successes of both the dredging and renovation projects have contributed to the maritime division’s ability to remain competitive. The maritime division currently performs well compared with similar ports. However, to maintain its place in the market, the maritime division has begun implementing its capital improvement program, which will include the construction of two new ship terminals, new roads, a freight transfer terminal, and a waterfront recreational park, as well as the deepening of the channel by an additional 8 feet. According to the 13 division’s feasibility study, its projected revenues should be adequate to cover the debt associated with funding the capital improvement program. Revenues Have Increased Steadily While Operating Costs Have Risen More Slowly Overall, the maritime division’s financial records show that, although its operating revenues and expenses have steadily increased over the past 10 years, operating ex- penses grew at a slower rate. As shown in Figure 4, Typical Seaport Charges the division’s operating revenue almost doubled between fiscal years 1990–91 and 1999–2000, (cid:127) Dockage–an assessment for use of a berth growing from $39 million to $76 million. During or dock. the same period, operating expenses increased by (cid:127) Wharfage–an assessment for passing cargo over the wharf and through the $13.5 million (55 percent)—from $24.5 million to marine terminal. $38 million. (cid:127) Storage and demurrage–an assessment for cargo remaining in the terminal beyond a According to maritime staff, the changes in previously agreed upon date. operating revenues were mainly the result of (cid:127) Crane fee–an hourly charge for the use of changes in cargo volume. Because the maritime port-owned container cranes to support division’s primary sources of revenues are the cargo operations. assessments it charges customers for using its (cid:127) Tariff–published schedule of rates or facilities and equipment, fluctuations in cargo charges for a specific unit of equipment, facility, or type of service. volume affect the level of its operating revenues. The changes in operating expenses were primarily caused by increases in the maritime division’s share of allocated costs. At the end of each fiscal year, costs are allocated to each division (maritime, aviation, and real estate) for its respective share of general operating, maintenance, advertising, administrative, and utility costs. Increases in the cost of removing hazardous waste and main- taining facilities are two reasons why the maritime division’s share of allocated costs have grown. Past Capital Improvements Provided Financial Benefits and Fostered a More Efficient Approach to Current Projects Although the maritime division neither calculates the historical rates of return on its major capital investments nor maintains the information we would need to calculate them, our examina- tion of its debt service coverage ratio suggests that its past capital improvement projects have benefited it financially. From past projects, the division has also learned from certain mistakes it made and has been able to improve the efficiency of the current capital improvement project. 14 15 FIGURE 4 Maritime Division’s Operating Revenue, Expenses, and Income for Fiscal Years 1990–91 Through 1999–2000 (In Millions) $80 Total operating income Total operating expenses* 70 Total operating revenue 60 50 40 30 20 10 0 1990–91 1991–92 1992–93 1993–94 1994–95 1995–96 1996–97 1997–98 1998–99 1999–2000 Source: Port of Oakland’s audited financial statement of segments. *Operating expenses include depreciation and amortization. The debt service coverage ratio measures the revenue the Port has available to pay for obligations, such as bonds, over a set period. For example, a debt service coverage ratio of 1.0 would mean the Port had precisely the available revenue needed to make the principal and interest payment on its outstanding bonds, and a ratio above 1.0 would indicate that the Port had more than enough revenue for this purpose. The maritime division considers debt service coverage when deciding whether to invest in major capital improvement projects, and credit- rating agencies use it when determining the creditworthiness of the Port. Since the Port only computes its debt service coverage ratios on an entitywide basis, we computed such ratios for each Since part of its revenues of its three revenue divisions. As Figure 5 shows, for the past are based on leases that eight years, the maritime division has maintained its debt reflect the fair market service coverage ratio above both the ratio of 1.25 required by the value of its facilities and Port’s revenue bond covenant and the Port’s internal minimum the amount of cargo ratio of 1.6. moving through the port, the maritime division must Since part of the maritime division’s revenues are based on invest in capital leasing agreements that reflect the fair market value of its facili- improvement projects to ties and the amount of cargo moving through the port, it must remain competitive. invest in capital improvement projects to remain competitive. We reviewed two major projects: renovating a terminal and deepening the channel to 42 feet. Despite Significant Delays in One Project, Past Capital Improvement Projects Have Offered Financial Benefits During the period from fiscal year 1992–93 through fiscal year 1999–2000, the maritime division’s debt service coverage ratio ranged from a low of 1.84 to a high of 2.48, always remaining well above the Port’s internal minimum ratio of 1.6. This high debt service coverage ratio was in part due to the financial benefits provided by the capital improvement projects undertaken by the maritime division. These financial benefits resulted from the division’s ability to competitively price its maritime contracts. Generally, the maritime contracts are structured to provide a specified rate of return for the value of the land and berth area (submerged land), as well as for capital improvement projects funded by the Port. When berths are renovated, the value of the land is increased, allowing the maritime division to charge more for its use.3 3 When formulating a pricing strategy for its maritime contracts, division staff routinely review other port agreements obtained either through the Federal Maritime Commission or from other port authorities under the federal Freedom of Information Act. 16 FIGURE 5 Debt Service Coverage Ratios for the Maritime Division for Fiscal Years 1992–93 Through 1999–2000 2.5 2.0 1.60* 1.5 o ti1.25† a R 1.0 0.5 0.0 3 4 5 6 7 8 9 0 9 9 9 9 9 9 9 0 9 9 2– 9 9 3– 9 9 4– 9 9 5– 9 9 6– 9 9 7– 9 9 8– 9– 2 0 1 1 1 1 1 1 1 9 9 1 Source: Auditor’s calculations based on segmented income statements and bond payment records. *The Port’s internal minimum debt service coverage ratio. †Minimum debt service coverage ratio required by the Port’s revenue bond covenant. One of the larger renovation projects that benefited the mari- time division involved an agreement between the Port and one of its tenants for renovations made at the terminal occupied by the tenant. Funding for this project came from the 1992 sale of $53 million in bonded debt. According to the terms of the agreement, the tenant is responsible for paying all principal and interest owing on these bonds. In exchange, the tenant is able to customize the design and construction of the renovated termi- nal to suit its needs. Thus, the division was able to improve the maritime facilities without directly affecting its own cash flow. 17 The maritime division’s other major capital improvement project was the deepening of the channel and berths from 38 feet to 42 feet. Because it was an improvement to infrastructure, the project did not provide the maritime division with a direct return on its investment. However, by enabling the Port to attract and accommodate larger container vessels, it allowed the maritime division an opportunity to compete with other ports and increased its potential for handling more cargo. Although the dredging project took significantly longer to complete than originally intended, it ultimately benefited the maritime division. The 42-foot dredging project was a joint effort by the U.S. Army Corps of Engineers (Corps of Engineers) and the maritime The maritime division’s division. The Corps of Engineers conducted the original feasibility previous dredging project study for the project in 1972, and according to division staff, the enabled it to attract and original plan was to begin construction and dredging around accommodate larger 1980–82 and to complete the project by 1984–86. However, container vessels. because the maritime division first had to complete an Environ- mental Impact Report and Statement (EIR/EIS) for the State and federal government, construction had not yet started when, in 1986, the federal Water Resources Development Act authorized the Corps of Engineers to construct various projects to improve the harbors. According to the manager of the dredging project, the maritime division originally prepared a separate EIR/EIS for the outer and inner harbors but had to start again with a new feasibility study and EIR/EIS because of the new requirements for cost sharing included in the Water Resources Development Act of 1986. The manager further stated that between 1986 and 1994, when the division submitted its final version of the EIR/EIS for the dredging project, the division had already created four or five versions in response to changes in environmental laws, lawsuits, and difficulties in finding appropriate disposal sites for the dredged material. These changes also required supplements to the project’s initial EIR/EIS. Although the division filed the original EIR/EIS in March 1988, it did not complete the final supplemental EIR/EIS until May 1994. One reason the EIR/EIS for the dredging project took so long was that disposal of the dredged material was difficult. The maritime division’s initial plan was to dispose of the suitable dredged material at a designated disposal site. However, the division rejected this plan because regulatory agencies, environmentalists, and fishing groups voiced concerns. The intervention and litigation actions by resource and regulatory agencies also halted 18 subsequent disposal plans. The maritime division was eventually able to negotiate a plan that was acceptable to these agencies after agreeing to dispose/reuse dredged materials in several ways. Delays also occurred after the maritime division finally started the project in January 1996, when the primary contractor fell behind schedule because needed dredging equipment did not arrive on time. This was just one of many factors that eventually caused the contracting company to file for bankruptcy in January 1997. The Corps of Engineers, with the agreement of the maritime division, worked with the contractor to complete the project while the contractor was going through reorganiza- tion prompted by the bankruptcy filing. Although the project was scheduled for completion in May 1997, it was not finished until July 1998. Past Mistakes Taught the Division to Plan Its Current Dredging Project More Efficiently The maritime division applied many lessons learned from its earlier dredging project to more efficiently plan its current 50-foot dredging project.4 As previously discussed, the Corps of The maritime division Engineers first began working on the feasibility study for the took just 3 years to 42-foot dredging project in 1972, but the maritime division did complete the feasibility not submit a final EIR/EIS until 1994—22 years later. In contrast, and environmental studies the division initiated the feasibility study (including an EIR/EIS) for its current dredging for the 50-foot dredging project in 1996 and completed it in project, compared to 1999. In addition, by including the Corps of Engineers in the 22 years to complete planning process for the current dredging project, the maritime these studies for its division ensured that the feasibility study was consistent with previous dredging project. the Corps’ principles and guidelines. Division staff believes that this fact expedited the review process significantly and allowed the federal government to authorize the project in the Water Resources Development Act of 1999, making it eligible to receive federal appropriations beginning in fiscal year 2000–01. The Water Resources Development Act of 1996 made the Port and the federal government responsible for finding an appropriate disposal site for dredged material from the current project. According to maritime division staff, the division initiated early discussions with interest groups to reach consensus on a preferred plan for reusing dredged materials to mitigate potential lawsuits and interventions like those that delayed the earlier dredging 4The 50-foot dredging project is part of the maritime division’s latest capital improvement program. This program is discussed further in the following sections. 19 project. Further, it established an alternative plan in case the original plan proved to be financially unfeasible. The division also entered into negotiations with adjacent communities and businesses potentially affected by the project. These outreach efforts have led to a series of agreements that should minimize the ill effects on the community while allowing the project to move forward. Finally, the maritime division’s former director told us that to avoid the problems it faced when one of its main contractors went bankrupt during the 42-foot dredging project, the division divided the current dredging project into a number of smaller, individual contracts. This action should encourage competition and provide additional control over bids, budgets, schedules, and nonresponsive contractors. The Capital Improvement Program Should Attract Seaport Customers and Benefit Local Communities The maritime division is in the process of implementing its latest capital improvement program, which calls for the construction of two new ship terminals, new roads, a rail freight In addition to deepening transfer terminal, and a waterfront recreational park. In addition the channel to 50 feet, the to this program, the maritime division is working with the maritime division plans to Corps of Engineers on a project to further deepen the channel to construct two new ship 50 feet. To offset the environmental effects of the construction terminals, new roads, a projects, the program includes dozens of mitigation projects rail freight transfer aimed at improving the quality of the air, water, land, and terminal, and a park. biological life around the port. In addition, the division estimates that the program should create 3,580 local jobs by 2020. Based on the maritime division’s projected revenues in the Port’s March 2000 feasibility study, it appears that the division’s opera- tions should generate enough revenue to cover the debt service needed to fund these improvements. Business for the Seaport Should Increase According to its strategic plan, the maritime division believes it must make certain investments in capital improvement projects to remain economically viable, to continue to grow, and to provide economic resources for the city of Oakland and the region. The construction of some of the projects included in the maritime division’s capital improvement program began as early as 1999; as these are completed, they should help the port handle larger volumes of cargo. For example, a shipping terminal, which occupies two berths, began operations in June 2001, with 20 the first vessel using the terminal on June 18, 2001. It is the first of two terminals planned under the program to boost the port’s capacity for handling shipping containers. The construction of The first of two terminals the second terminal is under way and scheduled to be complete planned to boost the by July 2002. port’s capacity for handling shipping In addition, the maritime division has completed the first phase containers commenced of construction of a rail freight transfer terminal and is in the operations in June 2001. process of beginning the second phase, which consists of expand- ing the terminal by approximately 150 acres to accommodate more cargo. Market conditions will dictate the time it will take to complete this phase. The maritime division anticipates complet- ing the second phase in the next three to eight years. According to the March 2000 feasibility study, funding for the second phase is not included in the capital improvement program. When completed, the transfer terminal should provide centralized rail operations within the port and enhance the economics and logistics of the ship-to-rail transfer of containerized cargo, thus ensuring that the maritime division remains competitive with other freight carriers. Moreover, during the fall of 2001, the division should complete a system of new and improved roads that will provide ocean carriers with greater flexibility in moving containers between marine terminals, cargo support facilities, and rail freight transfer terminals. Finally, the maritime division’s project to dredge the channel to 50 feet is scheduled to begin in October 2001. This project should allow the maritime division to serve larger vessels, stimulating additional cargo activity throughout the port. However, maritime division staff believe that if the current dredging project encounters delays, the port could be forced to turn away vessels that require deeper channels than it can now offer. Because the trend in the design of next-generation container ships has been toward increasing their size and draft, many now require a 50-foot water depth to navigate. The possibility of delays in the current dredging project arises because of its reliance on federal funds. The cost of deepening the port’s channel to 50 feet is estimated at $293.2 million. Currently, $130 million is scheduled to come from federal matching funds, as authorized in the Water Resources Develop- ment Act of 1999 and allocated by the Corps of Engineers. In fiscal year 2000–01, the maritime division received $4 million of the $130 million of federal funds. The division intends to pay its $163.2 million share from the sale of bonds and its cash reserves. However, maritime division staff states that the division will 21 only match its share of the dredging project’s costs when it Current plans, which receives its annual allocation of federal funds. Under its current assume no delay in the plans, which assume no delay in the receipt of federal matching receipt of $130 million in funds, the maritime division has scheduled the 50-foot dredging federal funds, call for the project to be completed by December 2005. However, if the 50-foot dredging project Corps of Engineers allocates less in future annual budgets to the to be completed by projects it is helping to fund, the maritime division’s dredging December 2005. project may not be completed when planned. Such a delay would inhibit the port’s ability to accommodate the largest cargo ships and stall its efforts to increase its market share in this area. The Local Community Should Benefit From Environmental Mitigation Projects, Increased Tax Revenue, and New Job Opportunities In addition to offering significant financial gain for the maritime division, its capital improvement program also should benefit the public in a number of direct and indirect ways. For instance, as required by the EIR necessary for expanding the port, the program includes dozens of mitigation projects aimed at improv- ing the quality of the air, water, land, and biological life around the tideland properties. For example, the maritime division has committed to spending nearly $9 million on emission reduction programs and demonstration projects that promote technological advances in improving air quality. Some of these funds will be spent to retrofit diesel trucks, transit buses, cargo-handling equipment, and a tugboat with new engines designed to reduce exhaust emissions. Under the capital improvement program, the division also plans to create waterfront recreational areas for the public to enjoy. It has allocated $10 million to construct a 30-acre shoreline park that will include an education center, shoreline walkways, fishing piers, picnic areas, and a beach. The park will surround a 190-acre ecological reserve of shallow bay and shoreline habitats. Located in a retired naval basin, the ecological reserve project will use the clean sand dredged from the channel. According to the manager of the dredging program, reusing the dredged material will not only save the maritime division millions of dollars in disposal costs but will also create a new area for shallow- water marine life to flourish. Because of the expansion planned under the capital improvement program, the maritime division should also generate increased state and local tax revenues in future years. Specifically, the 22 maritime division’s tenants paid $96 million in state and local taxes in 1998, but staff estimate that by 2020 its tenants will contribute approximately $157 million. This projected increase of $61 million is based on the projections of the revenues the maritime division should earn once it completes its capital improvement projects. In addition to these benefits, the division’s expansion projects are expected to create an estimated 3,580 local jobs directly The maritime division’s related to the seaport by 2020. To estimate the number of new expansion projects are jobs, the maritime division used a model developed by an expected to create almost outside consultant and widely employed in the maritime and 3,600 new jobs by 2020. aviation industries. In using the model, Port staff supply a variety of activity measures, such as the amount of container cargo moving through the seaport, to estimate the number of direct and indirect jobs that will result from a new capital improve- ment project.5 Once they estimate the number of direct and indirect jobs expected to result from capital improvement projects, Port staff updates the activity measures each year to reassess the project’s economic impact. In the past, the model has proven conservative in predicting new job creation. For example, staff used the model to estimate that 2,400 new jobs would be created by calendar year 2000 from the 42-foot dredging project. According to the Port’s Office of Strategic and Policy Planning, the economic impact associated with the dredging project as of calendar year 2000 totaled 4,900 new direct and indirect jobs. The maritime division intends to use the Port’s employment development unit to ensure that local residents fill the majority of employment opportunities created by the expansion. The employment development unit acts as a recruiter, finding qualified job seekers within the local community and matching them with seaport tenants with job opportunities. The employment development unit also assists local job seekers facing various obstacles to employment by directing them to resources that will help them overcome these barriers. As portions of the port are expanded and new jobs created, the employment development unit will work closely with job training and education agencies to find local community applicants to fill open positions. The employment development unit is also striving to ensure that local residents fill a portion of the jobs created by the construction process. The Port developed an agreement between 5 New direct jobholders spending additional amounts on goods and services creates indirect jobs. 23 the expansion project contractors and the unions operating One of the Port’s within the Port that outlines two main employment goals. The employment goals is that first is to ensure that local residents perform 50 percent of the local residents perform work that results from the maritime division’s expansion plans. 50 percent of the work The second is to ensure that local apprentices perform 20 percent resulting from the of the work hours created by the actual construction of the maritime division’s projects. The employment development unit estimates that expansion plans. 900 jobs will result from the construction of the maritime expansion; thus, the construction should create approximately 180 apprenticeships. Projected Revenues Appear to Be Adequate to Fund the Debt Service on Capital Improvement Projects If no major changes occur in its new feasibility study, the mari- time division’s projected revenues should be substantial enough to cover the future debt service associated with financing its capital improvement projects. As shown in Figure 6, the division’s projections for the next nine fiscal years show that it will generate enough revenue to meet the debt service coverage ratio of 1.25 called for in its bond agreements. The division will also achieve its internal minimum debt service coverage ratio of 1.6 except in fiscal year 2002–03, when we project its debt service coverage ratio to be 1.56. Should revenues fall slightly below its projections, the maritime division should still be able to meet its required debt service coverage ratio of 1.25. The division based its projected revenues in part on minimum guarantee agreements or fixed compensation agreements that it currently has with 19 tenants. Our review of the division’s most recent feasibility study indicates that these fixed or guaranteed sources accounted for 68 percent of its projected revenues in fiscal year 1998–99. These fixed or guaranteed agreements are generally long term, with some lasting up to 29 years. However, 15 agreements, including 4 in 2001, will expire within the 9 years for which the maritime division made projections. Of the 4 agreements expiring in 2001, two tenants exercised options to extend their agreements by 2 and 5 years, respectively; one is negotiating a 7-year optional extension; and one has converted to a year-to-year agreement. According to the division, the other tenants whose agreements expire on or before December 2008 are all long-time occupants of the division’s facilities that have always renewed their agreements in the past. The maritime division further stated that because its infrastructure was oriented toward handling containerized cargo, 24 FIGURE 6 Projected Debt Service Coverage Ratios for the Maritime Division for Fiscal Years 2000–01 Through 2008–09 2.5 2.0 1.60* 1.5 o a ti 1.25† R 1.0 0.5 0.0 2 0 0 0– 0 1 2 0 0 1– 0 2 2 0 0 2– 0 3 2 0 0 3– 0 4 2 0 0 4– 0 5 2 0 0 5– 0 6 2 0 0 6– 0 7 2 0 0 7– 0 8 2 0 0 8– 0 9 Source: Auditor’s calculations based on the March 2000 feasibility study projections. *The Port’s internal minimum debt service coverage ratio. † Minimum debt service coverage ratio required by the Port’s revenue bond covenant. it would be hard for most tenants to move to another port in the area that could accommodate the same cargo volume. Because the maritime division’s primary means of generating revenues is through these agreements, it is important that they be renewed or extended as expiration dates approach. The remaining 32 percent of the maritime division’s projected revenues come from variable sources, including cargo activity beyond the minimums guaranteed in contracts with tenants as well as miscellaneous port charges. The division projected its variable revenue sources assuming that its planned capital improvements—expanded freight transfer connections, two new cargo terminals (five berths), and renovated terminal facilities— will spur moderate shipping cargo growth. It also assumed a moderate recovery of the Asian economy through 2003 and a robust recovery beyond that. Of the three possible scenarios described in the Port’s feasibility study, the division considered 25 this most likely. Because it functions as a landlord rather than an operating entity, the maritime division based its projected expenses principally on inflation rather than incremental activity changes. In light of the relatively modest increases in the division’s expenses in past years—typically less than $3.3 million per year—this assumption seems reasonable. Although the maritime division is in the process of revising its feasibility study, these revisions should not have a major effect on its projected revenue stream. According to staff at the division, Although the maritime the revisions proposed mostly involve moving tenants from one division is revising its terminal to another. For example, certain tenants currently in one feasibility study, these location plan to move into new berths once they are complete. revisions should not have Because the relocation of these tenants will create vacancies that a major effect on the the division can fill with other tenants, the projected revenues projected revenue stream. and expenses should remain unchanged, according to division staff. The maritime division is proposing to close the vacated terminals for a year to complete renovations. However, all the renovations to the vacated terminals will not occur at the same time, and once the terminals are renovated, the value of the leasing agreements should increase because of the improvements to the facilities. In addition, staff in the maritime division predict that the overall revenue projections may be slightly higher in the new feasibility study, in part because of the inclusion of projected revenues that should be generated once the Oakland Army Base (base) is reconfigured into useable maritime facilities. In April 2001, the Port, the city of Oakland, the Oakland Base Reuse Authority, and the Oakland Redevelopment Agency signed a memorandum of intent to identify the issues and timetable to negotiate a memorandum of agreement conveying the base property to the Port. The division expects the agree- ment to be finalized by the middle of 2003 and plans to use the land to expand its current container terminals. It also plans to reconfigure the freight transfer terminal to a more efficient location and layout, which should enable the port to handle increased volumes of container cargo. By reconfiguring the transfer terminal, the division will make additional land available so it can further expand the size of its other terminals. 26 The Division Compares Favorably to Other Ports, but Its Capital Improvement Program Is Necessary for It to Remain Competitive Overall, the maritime division compares favorably both finan- cially and in terms of cargo volume with the ports located in Seattle, Tacoma, Los Angeles, and Long Beach. As shown in Figure 7, the maritime division’s operating income for fiscal years 1997–98 through 1999–2000 exceeded that of the Port of Seattle (Seattle) and of the Port of Tacoma (Tacoma). Although the Port of Los Angeles (Los Angeles) and the Port of Long Beach (Long Beach) generated more operating income over this same period, these ports have more land available to handle larger FIGURE 7 Comparison of Five Ports’ Operating Incomes for Fiscal Years 1997–98 Through 1999–2000 (In Millions) $150 Oakland Seattle Tacoma 120 Long Beach Los Angeles 90 60 30 0 -30 1997–98 1998–99 1999–2000 Source: Audited financial statements for each port. 27 volumes of cargo. The maritime division has only 665 acres devoted to port activities, while Los Angeles and Long Beach have 7,500 acres and 3,000 acres, respectively. Of the ports that we compared, we found that the one most similar in business structure to the maritime division is Seattle. According to a 1999 ranking of container volume handled by ports located along the Pacific Coast, Seattle ranks fourth and the Port of Oakland (Oakland) ranks third. However, the one major difference between the two ports is that Seattle receives approximately $35.6 million annually in tax revenues, while all the revenues of the maritime division come from its business operations. Seattle uses its tax revenues to fund acquisition and construction of facilities and to pay environmental expenses. Another difference between the ports is that the maritime division acts as a port landlord, meaning that its tenants are responsible for operating the facilities, while Seattle generally provides all port services using its own employees except to load and unload ships. Such services include, but are not limited to, operating container terminals, grain elevators, and other equip- ment, as well as loading and unloading rail cars and trucks. Although we found some similarities between the other ports we analyzed and the maritime division, significant differences exist. Tacoma handles a similar volume of cargo, but its business structure is unlike the maritime division. Long Beach and Los Angeles have different busi- ness structures as well, and they are able to handle Definitions of Vessel Services from the American Association of Port Authorities substantially larger volumes of containers because of their greater acreage, as previously discussed. Accord- (cid:127) Liner cargo–carried in vessels according to a fixed schedule of routes and ports of ing to the maritime division’s fiscal year 1993–94 call. Most containerized as well as some business plan, the port’s one disadvantage was the breakbulk cargo falls in this category. limited amount of land available for expansion. (Breakbulk is cargo handled in units, packages, crates, or bags.) According to the American Association of Port (cid:127) Tramp cargo–dry cargo carried on chartered vessels. It includes mainly dry Authorities (AAPA), vessel services are categorized bulk cargo such as coal, grain, and into three areas: liner, tramp, and tanker. Since the fertilizers, as well as steel and, in some maritime division mainly services containerized cases, automobiles. cargo, we compared the ports by their rankings in (cid:127) Tanker cargo–bulk liquid cargo, such as liner services. In 1999 (the only year data were crude oil, carried on tanker vessels. available), the AAPA ranked Oakland in the top 28 10 of 50 ports for liner vessel service for U.S. waterborne foreign trade. As shown in Table 1, the highest-ranking ports were Long Beach and Los Angeles. In addition, for 1990 through 1999, the AAPA included Oakland among the top 10 of 164 ports ranked by the value of their annual cargo. Table 2 on the following page shows that the lowest ranking for Oakland was eighth, a ranking it held for 5 of the 10 years, and its annual cargo value grew from $17.2 billion in 1990 to $25.8 billion in 1999. The highest-ranked ports were again Los Angeles and Long Beach. TABLE 1 Five U.S. Ports Ranked by Vessel Service (Liner) for 1999 (In Thousands of Tons) Port Rank Total Tons Long Beach 1 18,324,978 Los Angeles 2 17,013,837 Seattle 7 7,613,947 Oakland 8 6,896,643 Tacoma 12 3,845,144 Source: American Association of Port Authorities. Finally, Table 3 on the following page ranks the ports by their annual capital expenditures. For five of the eight years considered (1992 through 1999), Oakland ranked in the top 10. Like other ports, the maritime division must make capital improvements in order to remain competitive. The amounts spent by its com- petitors suggest that if the maritime division does not continue with its own expansion plans, it may lose its position among West Coast ports. 29 30 TABLE 2 Five U.S. Ports Ranked by Annual Cargo Value for 1990 Through 1999 (Dollars in Millions) 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 Cargo Cargo Cargo Cargo Cargo Cargo Cargo Cargo Cargo Cargo Port Rank Value Rank Value Rank Value Rank Value Rank Value Rank Value Rank Value Rank Value Rank Value Rank Value Oakland 8 $17,243 8 $18,399 6 $24,132 5 $26,691 5 $29,015 6 $31,095 7 $26,820 8 $25,330 8 $26,170 8 $25,758 Seattle 5 26,737 4 25,882 4 26,891 4 28,357 4 36,135 4 37,113 5 34,079 5 33,625 5 33,982 5 32,227 Tacoma 6 24,303 6 22,017 7 22,967 7 23,086 8 20,851 8 22,786 9 20,557 9 19,519 12 15,018 10 16,985 Los Angeles 1 56,345 1 56,936 1 63,029 1 65,464 1 73,433 2 74,200 2 72,823 2 73,431 2 79,602 2 83,074 Long Beach 3 42,861 3 49,390 3 50,976 2 58,513 2 70,877 1 82,785 1 86,953 1 85,308 1 80,174 1 88,956 Source: American Association of Port Authorities. TABLE 3 Five U.S. Ports Ranked by Total Capital Expenditures for 1992 Through 1999 (Dollars in Thousands) Port Rank 1992 Rank 1993 Rank 1994 Rank 1995 Rank 1996 Rank 1997 Rank 1998 Rank 1999 Oakland 10 $24,998 NA NA NA NA 10 $ 29,913 7 $ 45,269 5 $ 53,542 NA NA 2 $125,243 Seattle 8 29,851 3 $62,062 NA NA 4 82,013 3 144,817 3 167,291 2 $135,654 6 62,622 Tacoma NA NA NA NA NA NA NA NA 5 57,625 NA NA 5 71,178 NA NA Los Angeles 4 48,400 4 54,991 2 $ 77,524 1 377,513 1 407,099 1 355,074 3 135,228 3 100,820 Long Beach 2 60,800 1 76,000 1 434,100 2 251,100 2 179,690 2 254,561 1 272,992 1 210,872 Source: U.S. Department of Transportation, Maritime Administration. NA: Not applicable because the port did not rank in the top 10 ports for capital expenditures in that year. THE AVIATION DIVISION HAS INCREASED ITS REVENUES OVER THE PAST DECADE AND IS IMPLEMENTING EXPANSION PLANS THAT SHOULD SIGNIFICANTLY BENEFIT THE PUBLIC The aviation division has significantly increased its operating revenues and the number of passengers using the airport in the past 10 years, although its capital improvements have consisted of relatively minor projects. This growth is particularly remarkable considering the fluctuating number of airline flights scheduled during this period. In response to the increased number of passengers it serves, the aviation division is in the process of implementing a substantial expansion of its facilities, including new terminal buildings, roadways, and a parking structure. This expansion should benefit the public by relieving traffic conges- tion and improving access, and it should enable the airport to remain comparable to other airports of its size that are planning similar improvements. The aviation division identified a variety of funding sources for the expansion in its March 2000 feasibility study, and financial projections in that study appear reasonable. However, several significant changes have occurred since the March 2000 study was completed. First, the aviation division has increased its estimate of construction costs by almost $500 million. Second, on September 26, 2001, an appellate court responded to a lawsuit filed by four petitioners, ordering that the division prepare a new supplemental EIR before proceeding with the expansion. It is now unclear when the division will be able to begin construction and what additional costs it will face. In addition, the acts of terror- ism against the United States committed on September 11, 2001, will certainly have an impact on the airline industry, but it is impossible to predict the precise nature or extent of that impact on the Metropolitan Oakland International Airport (Oakland airport) at this time. Revenues Have Increased and the Number of Passengers During the last decade, Using the Airport Has Nearly Doubled the aviation division’s operating revenue The aviation division has operated at a profit during each of the increased during all last 10 years. Despite some volatility in the airlines servicing 10 years, and the number Oakland airport during the last decade, the number of passen- of passengers boarding gers boarding planes increased during 7 of those years, and the planes increased during division’s operating revenue increased during all 10. Specifically, 7 of these years. as shown in Figure 8 on the following page, the airport’s operating 31 32 FIGURE 8 Aviation Division’s Operating Revenue, Expenses, and Income for Fiscal Years 1990–91 Through 1999–2000 (In Millions) $100 Total operating income Total operating expenses* Total operating revenue 80 60 40 20 0 1 2 3 4 5 6 7 8 9 0 9 9 9 9 9 9 9 9 9 0 9 9 0– 9 9 1– 9 9 2– 9 9 3– 9 9 4– 9 9 5– 9 9 6– 9 9 7– 9 9 8– 9– 2 0 1 1 1 1 1 1 1 1 1 9 9 1 Source: Port of Oakland’s audited financial statements. * Operating expenses include depreciation and amortization. revenue increased from $50.2 million to $81.5 million (62 percent) between fiscal years 1990–91 and 1999–2000. Revenue growth appears to be primarily due to an increase in the number of passengers boarding Oakland airport flights during the same period, as depicted in Figure 9 on the following page. The growth experienced by the aviation division follows a national trend in the airline industry but is still remarkable The growth at Oakland considering the lack of stability in the number of airlines servicing airport over the last the airport and the inconsistency in the number of flights 10 years follows a offered. For example, in fiscal year 1994–95, United Airlines national trend in the began “Shuttle by United,” offering frequent flights throughout airline industry. the western United States. A year later, it eliminated the shuttle services to Seattle, Ontario, and Burbank, and a year after that further reduced its service by eliminating some of the flights to Los Angeles. In a similar example, Delta Airlines eliminated its nonstop flight service from Oakland to Salt Lake City in fiscal year 1998–99, canceling approximately 33 flights a week. Capital Improvements in Recent Years Have Been Relatively Minor Over the past 10 years the aviation division generated adequate revenues to cover its expenses and the relatively small capital improvement projects it undertook during this time. These capital improvement projects did not, for the most part, generate revenues that we could use to calculate a rate of return on the investment. For example, in 1992 the aviation division expanded the baggage claim area in one of its terminals, and in 1998 it built a new state-of-the-art fire station. At $2.5 million, the baggage claim expansion was the least costly project undertaken during this time, and the fire station was the most expensive at $13.8 million. Although both improvements benefit airport customers, neither generates revenues. However, for each year from fiscal year 1992–93 through fiscal year 1999–2000, the airport generated at least 100 percent more revenue than it needed to cover its debt. As shown in Figure 10 on page 35, the aviation division was able to maintain the debt service coverage ratio required by its creditors of 1.25 and exceeded the Port’s more stringent internal goal of a 1.6 ratio. 33 FIGURE 9 Passenger Enplanements From 1991 Through 2000* (In Thousands) Oakland enplanements U.S. enplanements 7,000 700,000 6,000 600,000 5,000 500,000 4,000 400,000 3,000 300,000 2,000 200,000 1,000 100,000 0 0 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 Source: Port of Oakland and the Federal Aviation Administration. *The passenger enplanement figure was not available for the United States in 2000. Although Expansion Plans Promise Significant Public Benefit and Are Based on Reasonable Estimates, Recent Events May Necessitate Some Changes In March 2000 the Port completed and issued its latest feasibility study concerning the aviation division’s planned capital improve- ments of the Oakland airport. The major construction projects proposed in this study included expanding the terminal buildings, extending roadways, and constructing a parking garage. These plans offered a number of benefits to the public, including decreasing traffic congestion around the airport and increasing the number of jobs open to the local community. Moreover, in the March 2000 study, the aviation division outlined a variety of funding sources for the projects that appeared at the time to adequately meet its projected construction costs. However, since the Port completed this feasibility study, a number of events have occurred that significantly alter the assumptions on which it was based. First, the aviation division calculated that its costs would be higher than it had previously 34 FIGURE 10 Debt Service Coverage Ratios for the Aviation Division for Fiscal Years 1992–93 Through 1999–2000 8.0 7.0 6.0 5.0 o ti 4.0 a R 3.0 2.0 1.60* 1.25† 1.0 0 3 4 5 6 7 8 9 0 9 9 9 9 9 9 9 0 9 9 2– 9 9 3– 9 9 4– 9 9 5– 9 9 6– 9 9 7– 9 9 8– 9– 2 0 1 1 1 1 1 1 1 9 9 1 Source: Auditor’s calculations based on segmented income statements and bond payment records. *The Port’s internal minimum debt service coverage ratio. †Minimum debt service coverage ratio required by the Port’s revenue bond covenant. predicted, so it started revising its capital improvement plans. Second, while it was in the process of completing this revision, an appellate court upheld the complaints of several petitioners and ordered the division to submit a revised EIR before beginning construction. Finally, on September 11, 2001, terrorists used hijacked planes to attack the United States, an act that will clearly have significant financial consequences for the airline industry. Because it is impossible to predict how these events will affect the aviation division’s plans, the conclusions we draw in this section are based on the estimated costs and fund sources outlined in the March 2000 study and do not reflect the impact of recent events. 35 Planned Capital Improvements Should Reduce Traffic Congestion Around the Airport, Increase Tax Revenues, and Create Jobs As previously mentioned, the aviation division’s March 2000 feasibility study proposed a number of major capital improvements, including expanded terminal buildings, extended roadways, and a new parking garage. These projects offer a number of significant benefits to the public, including The aviation division’s less traffic congestion in and around the airport. To accomplish capital improvement this, the aviation division proposed widening a main roadway plans include expanding leading into the airport, reconstructing two intersections near the terminal buildings, the airport, and extending a roadway from one side of the extending roadways, airport to the other. The planned expansion should help to and constructing a accommodate the expected increase in passengers and may parking garage. result in travelers choosing the Oakland airport over more crowded, alternative airports. The airport expansion projects should also result in the aviation division generating additional tax revenues for the city, county, and State. For example, in fiscal year 1998–99, the aviation division’s tenants paid $111 million in state and local taxes. Division staff estimate that if the projects proceed according to schedule, the division’s tenants will contribute approximately $125 million in 2010, an increase of $14 million. The aviation division further estimates that if the expansion proceeds as planned, its capital improvements should create a total of 2,700 new jobs by 2010, a projection that the division reached by using the model employed by the maritime division. The 2,700 new jobs consist of an estimated 1,900 local jobs directly related to the airport and another 800 jobs created as a result of the goods and services purchased by the individuals filling the direct jobs. In addition to the jobs created as a result of the expansion, employment opportunities for local residents should arise during construction of the expansion projects. Like the maritime division, the aviation division will strive to ensure that local residents perform 50 percent of the work created by the expansion and 20 percent of the work created during the expansion. Port staff projects that 2,200 jobs should be created during the construction of the aviation expansion and conserva- tively estimates 400 will be apprenticeships. 36 The March 2000 Plans for Funding Were Based on Conservative Revenue Projections Involving a Variety of Sources In its March 2000 feasibility study, the aviation division estimated that it would need approximately $937 million to finance its capital improvement program. It anticipated that it would receive this funding through a variety of sources, including federal Aviation Improvement Program (AIP) grants, passenger facility charges, local taxpayer funding, the issuing of commer- cial paper, and the sale of revenue bonds. Its projections for each of these funding sources appear to be conservative. The aviation division estimated that it could receive $18.6 million in AIP grants that it could apply toward the airport expansion. AIP grants are allocated by the Federal Aviation Administration (FAA) based on annual congressional appropriation levels. Passenger facility charges According to our understanding of how the federal allocation collected by airlines and levels are computed, the aviation division’s expectations seem remitted to the airport reasonable. The aviation division also expected $235.6 million are expected to fund to come from passenger facility charges, which are fees collected almost $236 million of by airlines and remitted to the airport. The FAA must authorize the expansion program. the collection of passenger facility charges, and the division can only spend the funds on projects that improve safety, reduce noise, or enhance competition between airlines. Oakland airport is currently authorized by the FAA to impose a passenger facility charge of $3 per passenger, but it intends to apply to raise this charge to $4.50 per passenger in 2003. The aviation division expects to receive prompt FAA approval. We found that the division based its estimates of funding from this source on reasonable assumptions of future passenger growth. The aviation division has been cautious in projecting future funding from local voter measures and grants, only including in the March 2000 study those sources of funding already approved for its use. The division estimated it would receive approximately $73.9 million from Measure B, which Alameda County voters approved in November 1986 to finance the construction of an airport roadway. It also identified an additional $4.5 million in local funding that it was likely to receive in the near future from state and local sources, but because these amounts were not yet certain, the aviation division did not include them in the feasi- bility study. For example, it expected $1 million from Alameda County, subject to the approval of the county’s Congestion Management Agency board. 37 The aviation division also anticipated issuing bonds and commer- cial paper to fund its capital improvement projects. To date, the board of port commissioners (board) has authorized a total of $150 million in short-term (270-day) notes—called commercial paper—to fund the airport expansion. It also plans to issue revenue bonds to raise an additional $321.8 million. The Port is authorized to issue any amount of revenue bonds as long as its overall debt service coverage ratio remains above 1.25. Based on the projections of revenues, expenses, and debt service growth included in its March 2000 feasibility study, the Port should be able to issue the necessary amount of revenue bonds to finance the aviation expansion while maintaining its self-imposed minimum debt service coverage ratio at 1.6. Finally, the aviation division estimated that after payment of its operating expenses and debt service costs, it should have revenue in the amount of $137.5 million to fund a portion of the expan- sion plans. The division based its estimates on what we believe to be reasonable assumptions of revenue growth, operating expenses, and debt service amounts. For example, the revenue projections reflect decreases during construction periods and increases once construction concludes. During fiscal years 2000–01 through 2002–03, the revenue projections take into consideration that construction of the new airport parking garage will cause a decrease in parking lot revenues. In fiscal year 2003–04, the new parking structure is scheduled to be complete; thus, the division has projected an increase in parking lot revenues. Projections for operating costs appear to be equally reasonable because they are based on historical trends and adjusted for expected increases in future airport activity and staffing requirements. Preliminary Projections of Costs in the March 2000 Study Prompt Expansion Plan Revisions As previously discussed, the funding sources that the aviation division projected in its March 2000 feasibility study of its Although the 2000 capital improvement program appear reasonable. However, the feasibility study estimated division has since discovered that the construction costs it the airport expansion originally estimated were not accurate; therefore, it is currently would cost $937 million, revising its expansion plans. The March 2000 feasibility study the aviation division later estimated that the airport expansion would cost $937 million. estimated the cost would According to the director of aviation, this estimate was based on total nearly $1.5 billion. a preliminary study that was not intended to be fully compre- hensive. The aviation division subsequently performed a more thorough review and determined that the actual cost was likely to reach nearly $1.5 billion. 38 The aviation division presented its new projections to the board in May 2001. On June 1, 2001, the board instructed aviation division staff to consider two measures to cut projected costs and report its conclusions. First, the board directed the division to propose changes in the scope of the expansion project sufficient to reduce the overall cost to $1.1 billion. Second, it asked the division to identify up to $200 million in “soft” cost reductions that would not change the project’s scope. These reductions might involve items such as development and design costs, construction and project management costs, consultant costs, and certain mitigation and oversight costs. In response to the board’s request, the division submitted a study on June 22, 2001, containing three alternatives to the scope design and eight ideas for reducing costs without changing the project’s scope. All the alternatives outlined in the June study include expanding the airport terminal buildings, building a parking garage, and con- structing a two-level roadway for passenger pickup and drop-off, as planned for in the March 2000 study. The board reviewed the study and provided feedback to the aviation staff. On August 3, 2001, the division submitted a decision document to the board containing the staff’s final recommendations for the expansion. Although the final expan- sion plans necessitated a $1.49 billion budget, the aviation division staff believe there may be methods of reducing costs by at least $100 million. Therefore, division staff recommended that the board approve a maximum budget for the expansion of $1.39 billion. The board approved the staff’s recommendations for the airport expansion on August 7, 2001. The final revisions to the airport expansion plans were reviewed by consultants, who assessed the reasonableness of the estimated construction costs and underlying assumptions on which those costs were based and found both feasible. Recent Developments May Affect the Progress of the Planned Expansion After the board’s approval of the aviation division’s revised On September 26, 2001, plans, two events occurred that are likely to affect the airport an appellate court ruled expansion. First, on September 26, 2001, an appellate court that the aviation ruled that the division must submit a new supplemental EIR for division must submit a its planned projects. The process that resulted in this decision new supplemental EIR for began in December 1997, when the board certified the division’s its projects. EIR identifying the significant environmental effects and mitiga- tion measures of the airport’s expansion plans. Shortly thereafter, four plaintiffs, including the cities of Alameda and San Leandro 39 and two citizen organizations, filed petitions with the superior court challenging the board’s decision to certify the EIR and approve the expansion project. The superior court ordered the Port to set aside approval and certification of the EIR until the division prepared a supplement to the EIR in compliance with the California Environmental Quality Act (CEQA). In June 1999 the board certified and approved the completed supplemental EIR. Subsequently, three of the four original plaintiffs appealed the superior court’s ruling. This led to the appellate court’s modified order filed on September 26, 2001. The appellate court ordered the division to prepare a supplemental EIR that included a further discussion of project alternatives and cumulative impacts. The appellate court also found that the EIR failed to comply with the CEQA on four additional points. First, the court found that the EIR did not adequately analyze the noise impacts from additional nighttime flights. Second, the division erred in using outdated information in assessing the emission of toxic air contaminants. Third, the division failed to support with meaningful analysis its decision not to evaluate the health risks associated with the emission of toxic air contaminants. Last, the division improperly deferred devising a mitigation plan for the western burrowing owl, which would be affected by the expansion. Because of these deficiencies, the appellate court also ordered that the aviation division address these additional points in its new supplemental EIR, submit it for public review and comment, and certify it in accordance with the CEQA. The board is currently assessing the impacts of the court’s ruling. Although preparing a Although preparing a supplemental EIR will take additional time supplemental EIR will and money, according to an assistant attorney for the Port, it is take added time and conceivable that the division will be able to proceed with some money, an assistant projects while additional environmental review is being done on attorney for the Port other projects, thus reducing the delay. stated it may be able to proceed with some The court’s ruling, combined with the aviation division’s revi- projects, thus reducing sions of the estimated costs of construction, create a degree of the delay. uncertainty about the timing and the new sources of funding needed to pay for the revised costs of the airport expansion. This uncertainty is heightened by the fact that terrorists used commercial airplanes to attack the United States on September 11, 2001. Although difficult to predict in the long term, some impact on the airline industry is inevitable. 40 The Expansion Plans Should Enable Oakland to Remain Comparable With Similar Airports The aviation division is economically comparable with airports having similar operating capacities, such as San Jose International, San Diego International, and Palm Beach (Florida) International airports. As seen in Figure 11, nearly five million passengers boarded planes at the Oakland airport in fiscal year 1999–2000 compared with about six million passengers at San Jose and almost eight million at San Diego. According to Oakland airport’s director of aviation, airlines’ cost per enplanement is a common indicator used in the industry. Airports determine the cost per enplanement by dividing the FIGURE 11 Comparison of Four Airports’ Passenger Enplanements for 2000 (In Millions) 8 7 6 5 4 3 2 1 0 Oakland San Jose San Diego Palm Beach Source: Oakland, San Jose, and San Diego International airports and Palm Beach County Department of Airports. Note: Data for Oakland, San Jose, and Palm Beach are for fiscal year 1999–2000, and data for San Diego are for calendar year 2000. 41 sregnessaP total that various passenger airlines pay for using airport facilities by the total number of passengers that board planes.6 Airlines often use the cost per enplanement to determine whether to fly in and out of a particular airport. Most airports strive to keep their cost per enplanement low so more airlines will want to use their facilities. As shown in Figure 12, Oakland airport’s cost per enplanement for fiscal year 1999–2000 was slightly more than $3, the second lowest among the airports we considered. The cost per enplanement at the comparable airports ranged from $2.69 at San Jose to $8.16 at Palm Beach. FIGURE 12 Comparison of Four Airports’ Costs Per Enplanement for 2000 $10 8 6 4 2 0 Oakland San Jose San Diego Palm Beach Source: Oakland, San Jose, and San Diego International airports and Palm Beach County Department of Airports. Note: Data for Oakland, San Jose, and Palm Beach are for fiscal year 1999–2000, and data for San Diego are for calendar year 2000. 6 Enplaned passengers are those who board the aircraft at a particular airport. In general, airport use is measured by the number of passengers who board aircraft as opposed to those who disembark. 42 Although the Oakland airport can be compared with other airports in terms of number of passengers and cost per enplanement, we found it difficult to meaningfully compare Oakland airport’s cargo function with other cargo airports. Unlike other airports of its size, Oakland airport has two airfields— one used for passengers and a second devoted mainly to general aviation activities involving small private aircraft. Oakland serves as a hub for Federal Express and a mini-hub for the United Parcel Service, two major freight and mail carriers. Consequently, the amount of cargo activity at Oakland airport is much greater than the activity at the comparable passenger airports. Like Oakland, most of the airports in our review are currently planning expansions. San Jose and Palm Beach International airports both intend to expand their cargo areas, parking facili- ties, and passenger terminals, as well as improve their roads and runways. San Diego International airport is implementing construction projects designed to expand and improve its terminal facilities. If Oakland airport does not continue its expansion plans, it risks being left behind by comparable airports and losing the position in the industry that it has earned over the past decade. THE REAL ESTATE DIVISION HAS OPERATED AT A CONSIDERABLE FISCAL LOSS BUT PLANS TO FINANCE FUTURE CAPITAL IMPROVEMENTS WITHOUT INCURRING ADDITIONAL DEBT Of the Port’s three revenue divisions, only the real estate division The real estate division has has failed to significantly increase its revenues over the past consistently operated at a 10 years. In fact, the real estate division has consistently operated deficit, relying on the at a deficit during this time, relying on the other divisions to other divisions to fund fund its capital improvement projects. The division’s losses were its past capital due in part to its unsuccessful business undertakings and the improvement projects. Port’s decision to use the real estate division as a means to supply public benefits. To accomplish the Port’s overall mission, the real estate division has in effect subsidized a number of public benefit projects, including several parks and an Amtrak station. Despite plans to improve its profitability, the real estate division has yet to take significant actions toward this end. It is currently proposing several large capital improvement projects, including expanding Jack London Square and developing a large section in 43 the waterfront area in cooperation with the city of Oakland. However, rather than increasing its debt, it plans to move forward with these projects only if it can find developers who will agree to be responsible for the capital development funding. Consistent Losses Have Been Due to Costly Public Services, High Operational Expenses, and Ill-Fated Business Decisions Despite two studies and an action plan adopted by the board, the real estate division has taken few steps to alleviate the financial drain it has had on the Port’s overall operations. Despite two studies and Although real estate is the smallest of the three divisions in an action plan, the real terms of revenue production, averaging approximately 11 percent estate division has of the Port’s total annual revenue, its costs make up about taken few steps to 21 percent of the Port’s annual expenditures. As shown in alleviate the financial Figure 13 on the following page, between fiscal years 1990–91 and drain it has had on the 1999–2000, the real estate division lost between $4.3 million and Port’s overall operations. $12.4 million a year, for an average annual loss of $7.5 million. These losses appear to result from at least three different factors. The first is a conscious decision by the Port to have the real estate division enter a number of lease agreements at rates significantly below fair market values. The second relates to the high operational costs associated with the properties located in and around Jack London Square, costs that the real estate division failed to reduce. The third cause seems to be some ill-fated decisions the division made in pursuing certain business deals. The first of these factors stems from the nature of the Port’s mission. The Port has chosen to lease a total of nine different properties, some situated in prime locations, at nominal rates— eight for $1 per year each and one for $490 per year—to the city of Oakland, the Bay Area Rapid Transit, the East Bay Regional Parks District, Amtrak, and the Oakland Fire Department Historical Society. When we asked the Port why it offered these lease terms, its assistant attorney stated that unless required by federal, state, or other legal mandate, the Port will generally direct the real estate division to grant $1-per-year leases only if the board determines it is in the Port’s best interests. In making such decisions, the board uses the following criteria: (cid:127) The property generates a minimal amount of overall Port revenue, and the acreage is small enough so as not to affect Port revenue. 44 45 FIGURE 13 The Real Estate Division’s Operating Revenue, Expenses, and Losses for Fiscal Years 1990–91 Through 1999–2000 (In Millions) $30 Total operating loss Total operating expenses* 25 Total operating revenue 20 15 10 5 0 -5 -10 1 2 3 4 5 6 7 8 9 0 -15 9 9 0– 9 9 9 1– 9 9 9 2– 9 9 9 3– 9 9 9 4– 9 9 9 5– 9 9 9 6– 9 9 9 7– 9 9 9 8– 9 9– 2 0 0 1 1 1 1 1 1 1 1 1 9 9 1 Source: Port of Oakland’s audited financial statements. *Operating expenses include depreciation and amortization. (cid:127) The tenant is a public agency or nonprofit private entity that will use the property for Tideland Trust uses. According to the Tideland Trust, these uses include commerce, navigation, fishing, and recreation. (cid:127) The use provides special and important benefits in developing, operating, or protecting public trust lands and facilities that justify the minimal lease payments. (cid:127) The transaction does not result in the Port losing the opportu- nity to earn substantial net revenues. (cid:127) For leases executed after January 1, 1989, the lease will not have a substantial adverse effect on the revenues pledged to service the Port’s bond debt. Although the board considers all these criteria when deciding whether to direct the division to grant a nominal lease, it does not require that all be met before it can make such a decision. The Port’s assistant attorney stated that seven of the $1-per-year leases currently in place clearly satisfy the Port’s general criteria. According to the assistant attorney, two of the leased properties do not meet these criteria: One is used as a service center for municipal maintenance and supplies and the other for a munici- pal sewer pipeline. However, because of its minimal value and the fact that it does not interfere with trust uses, the assistant attorney also stated that the failure of the leased property used for the pipeline to meet the criteria was not significant. While the decision to lease land at below-market values may help the Port accomplish its mission to generate economic vitality, jobs, and waterfront activities, it has come at a high Although the Port’s price to the real estate division. The real estate division could decision to lease land at receive an additional $33.1 million annually in revenue if it below-market values may leased these properties for their estimated fair market value. To accomplish its mission to quantify this lost revenue, we asked division staff to provide generate economic growth estimates of what these properties could lease for annually and waterfront activity, it without any further upgrades or development. As shown in has been detrimental to Table 4, we used the division’s estimates to calculate the annual the real estate division’s amount of additional revenue it would earn if it leased the financial success. properties at full value, as well as what it would earn leasing the properties at 75 percent, 50 percent, and 25 percent of their value. The total added annual lease revenue would range from a low of $8.3 million a year (at 25 percent of fair market value) to a high of $33.1 million a year (at 100 percent of fair market value). In other words, leasing these nine properties for just 25 percent 46 TABLE 4 Estimated Fair Market Value of the Real Estate Division’s Below-Market Lease Properties Property Fair Market Percent of Fair Market Value Tenant Description Value of Annual Lease Name and Use Annual Lease 75 50 25 Lease Rate Expiration Bay Area Rapid 80 square feet Nominal NA NA NA $ 1 2004 Transit District of vacant land amount for emergency command post City of Oakland 21 acres for $ 1,116,000 $ 837,000 $ 558,000 $ 279,000 1 Pending a municipal renegotiation maintenance yard City of Oakland 0.5 acre for a 26,568 19,926 13,284 6,642 1 Pending fire station renegotiation City of Oakland 12.7 acres of 674,916 506,187 337,458 168,729 1 2029 land and water for a park City of Oakland 15,543 square feet 29,832 22,374 14,916 7,458 1 2007 of land and 7,406 square feet of water for a fire station City of Oakland 4,474 square-foot 5,448 4,086 2,724 1,362 1 2060 easement for a sewer line East Bay Regional 565 acres of 30,025,908 22,519,431 15,012,954 7,506,477 1 2002 Park District land and water for a park Amtrak 15,000 square feet 1,160,000 870,000 580,000 290,000 1 2061 of building plus land for public rail transportation Oakland Fire 7,000 square feet 21,000 15,750 10,500 5,250 490 Pending Department of warehouse space renegotiation Historical Society Totals $33,059,672 $24,794,754 $16,529,836 $8,264,918 $498 Source: Port of Oakland real estate division. NA: Not applicable. of their value would have generated enough revenue to cover the annual loss of $7.5 million that the real estate division has averaged over the last 10 fiscal years. The Port has commissioned two studies of the real estate division in an effort to improve its profitability—one in 1995 and one in 1998. The 1998 study examined the division’s operational problems and made recommendations for improvement. These recommendations included ways to increase revenues while reducing expenses and capital outlays. From this study, the Port 47 created an action plan in February 1999, which included 10 items and a timetable for completing them. However, it appears that this timetable was unrealistic. As shown in Table 5, as of September 12, 2001, the real estate division had only completed 1 item, had partially completed 7, and the remaining 2 were on hold pending the completion of one of the other items. According to the established timetable, 9 of the 10 action items should have been completed. The director of the real estate division feels that he may have been too aggressive in his timetable because he did not adequately anticipate the time a public entity with multiple stakeholders needs to reach decisions. However, he also feels that the division has made progress in implementing its plan over the past two and a half years. As Figure 13 on page 45 shows, the real estate division did reduce its losses by almost $4 million between fiscal years 1998–99 and 1999–2000. TABLE 5 1999 Action Plan for the Real Estate Division Scheduled Status as of Action Item Completion Date September 12, 2001 1. Port review and approval of plan 2/16/99 Completed 2. Market or sell Hegenberger Road 8/31/99 In process development parcels 3. Market or secure Jack London Square 8/31/99 In process strategic developer and leases 4. Market or secure marina lease 8/31/99 In process 5. Prepare and certify an environmental 3/31/00 On hold pending impact report for Jack London Square completion of item 3 6. Further develop Jack London Square 3/30/01 In process 7. Implement the Estuary Plan 7/31/09 In process 8. Restructure the division 2/29/00 In process 9. Implement new operations systems 4/28/00 On hold pending and policies completion of item 3 10. Restructure and pay down debt 3/31/00 In process Source: Real estate division’s restructure and development plan and recommendations. One item discussed in the 1998 study was the high cost of running and maintaining the land and buildings the real estate division manages. Over a period of three years, from fiscal years 48 1996–97 through 1998–99, the real estate division’s maintenance cost averaged roughly $4 million, approximately 32 percent of its total operating expenses during each of those three fiscal years. To combat these high costs, the consultant performing the study recommended restructuring the real estate division and finding a lessee for the marina, noting that the operating ex- penses for private marinas tended to be about half what public marinas expend. According to the consultant, workforce improve- ments, such as personnel training and specialization, contribute to the greater profitability of private marinas. The consultant also recommended that the real estate division find a lessee to operate the facilities in Jack London Square. In response to the first recommendation, the division received approval on August 7, 2001, from the board to send out a Request for Proposal for a management company to take over the marina. However, the division does not expect to complete this process until early next year. In fiscal year 1999–2000, the real estate division transferred its maintenance function to the engineering division’s maintenance unit, thus redirecting some of its labor costs. While this action did not reduce the Port’s overall operat- ing expenses, it did have a positive effect on the real estate division’s maintenance costs, which dropped from an average of 32 percent of its total operating costs to about 10 percent in fiscal year 1999–2000. Finally, some of the real estate division’s losses have been the result of business decisions that turned out badly. One of the key decisions involved Oakland Portside Associates (OPA), a limited partnership formed in 1987 to develop Jack London Square. Unfortunately, OPA lost its partner, which was supplying the necessary capital, shortly after the start of the development. At the time the OPA’s partner withdrew, the Port had already The Jack London Square started construction on various infrastructure improvements project has been operating including parking facilities, roads, and utilities with an estimated at an average annual loss cost of more than $30 million. Rather than walk away from its of $2.4 million since the investment, the Port became a general and limited partner, and Port became the sole in August 1990, it in effect became the sole owner of the OPA. owner in 1990. The OPA finished the project but has been operating at an annual loss averaging $2.4 million since fiscal year 1990–91. These losses, which are reflected in the operations of the real estate division, are included in the amounts shown in Figure 13 on page 45. Further, when it acquired the OPA, the Port wrote down the value of the OPA assets by almost $7 million in fiscal year 1990–91 to accurately reflect their value. 49 Another example of a business decision that turned out badly involved one of the real estate division’s tenants that operated a hotel adjacent to the airport until August 1994. The real estate division took possession of the building as part of the tenant’s bankruptcy settlement and attempted to run the hotel until it could locate a potential buyer. However, when it was unable to find a suitable prospect, it eventually demolished the building and cleared the land. During the period between fiscal years 1994–95 and 1996–97, the real estate division spent approximately $2.7 million more to operate the hotel than it received in rev- enues. It spent another $1.8 million to raze the site. The Other Divisions Have Subsidized the Real Estate Division’s Past Capital Improvement Projects The real estate division has only been able to minimally contribute revenue to pay for its past capital improvement projects because The real estate division has its expenses have generally exceeded its revenues. Specifically, the not generated enough real estate division’s debt service coverage ratio was negative for revenue to cover its debt six of the eight fiscal years spanning 1992–93 through 1999–2000. service costs for six of the A negative debt service coverage ratio means that the division’s last eight fiscal years. operations did not generate enough revenues to pay for both its operating costs and its long-term debt.7 Thus, one or more of the other divisions has had to subsidize the real estate division’s past capital improvement projects that, from January 1991 to May 2001, amounted to approximately $74 million. The real estate division’s two largest projects were a large parking garage that cost approximately $12.3 million and a new Amtrak station that cost about $10.5 million. Our attempt to determine the rate of return on the parking garage as an individual project was unsuccessful. The real estate division does not keep detailed accounting records, instead depending on the finance division of the Port for its accounting needs. As a result, the information that the real estate division provided us regarding the financial health of the parking garage did not contain the maintenance, utilities, and finance costs associated with the project. The finance division was also unable to provide us with the mainte- nance and utility costs because it does not record them on an individual project basis. Although the revenues and expenses reflected in the accounting records indicate that the parking 7 It should be noted that the debt service coverage ratio presented to investors is based on the Port’s activities taken as a whole. Therefore, as long as the Port’s other two revenue divisions maintain debt service coverage ratios high enough to cover the real estate division’s deficit, it should not preclude the Port from obtaining financing. 50 project is making a profit, any evaluation made of that data would be incomplete without inclusion of the maintenance and other operating expenses. The cost to construct the Amtrak station was around $10.5 million, but the real estate division was only responsible for a part of this total. State and federal grants paid for approxi- mately $8 million of the construction, while the real estate division paid the remaining $2.5 million. As mentioned earlier, the real estate division provides the land the station sits on for a lease of $1 a year. It does not receive any other revenues from this project. The Division’s Plans Should Not Increase the Port’s Debt The real estate division’s projected debt service coverage ratios for the next nine fiscal years, from 2000–01 through 2008–09, appear to be well below the 1.25 required of the Port as a whole. However, these projections do not take into account a number of the division’s current plans to reduce its losses. According to the division, these plans were not included when it projected its future revenues and expenses because it did not want to assume it could accomplish these tasks in the near future. According to the Port’s chief financial officer, the real estate division’s plans are not yet finalized and thus could not be considered in the capital improvement program contained in the feasibility study. This decision partially explains why the division’s projections continue to show losses. Because the real estate division has struggled in the past to improve its operations, this appears to be a conservative and appropriate approach. Some large developments that the real estate division is in the process of planning should not require the issuance of any additional debt. These projects, which include expanding Jack For its future capital London Square and developing a large section in the waterfront projects, the division will area, are part of a bigger overall plan the Port and the city of act primarily as a Oakland have for the waterfront called the Estuary Plan. To landlord while developers finance its Estuary Plan projects, the division intends to have the bear the burden of developers bear the responsibility for the capital development financing capital costs while it acts primarily as a landlord. The division is also development costs. attempting to sell some properties around the airport and intends to use the proceeds from those sales to finance its portion of the developments. Currently, the division is in negotiations with developers for the second phase of the Jack London Square project and has issued a Request for Qualifications for the water- front development. 51 RECOMMENDATIONS To reduce the effect of its losses on the Port’s overall operations, the real estate division should take the following actions: (cid:127) Complete the action plan approved by the board in 1999. (cid:127) Examine the feasibility of increasing below-market lease rates to cover its operational costs. It should also consider the impact of such an action on the Port’s relationships with the community and the other municipalities. (cid:127) Continue to look for ways to increase revenues and decrease costs associated with managing its assets. We conducted this review under the authority vested in the California State Auditor by Section 8543 et seq. of the California Government Code and according to generally accepted government auditing standards. We limited our review to those areas specified in the audit scope section of this report. Respectfully submitted, ELAINE M. HOWLE State Auditor Date: October 23, 2001 Staff: Doug Cordiner, Audit Principal Phillip Burkholder, CPA Dawn Tomita Nicki Ruszczycky Wesley Opp Patrick Browning 52 APPENDIX A s discussed in the Scope and Methodology section of the Introduction, the Port of Oakland (Port) does not inter- nally calculate the rate of return on its major capital and real estate investments but instead relies on the debt service coverage ratio as the key measure in determining the viability of its capital projects. We attempted to calculate the rate of return for each of the revenue divisions of the Port but were unable to do so because the Port does not maintain asset information segmented by division. Therefore, we calculated the rate of return for the Port as a whole by using information from the Port’s annual audited financial statements for fiscal years 1990–91 through 1999–2000. The rate-of-return-on-investment ratio measures an entity’s income in relation to its total asset value. The Port’s rate of return on investment ranged from -2.67 percent in fiscal year 1990–91 to a peak of 1.63 percent in fiscal year 1997–98. We were not able to compare the rate of return on investment to other ports because it is not a ratio that other ports use. Table 6 on the following pages show selected financial information, including the rate of return, for the Port covering the 10 fiscal year period 1990–91 through 1999–2000. 53 54 TABLE 6 Selected Information From the Port of Oakland’s Annual Audited Financial Statements for Fiscal Years 1990–91 Through 1999–2000 (In Thousands) Balance Sheet 1990–91 1991–92 1992–93 1993–94 1994–95 1995–96 1996–97 1997–98 1998–99 1999–2000 Assets Current assets $ 47,598 $ 67,980 $ 60,689 $ 83,999 $106,642 $106,810 $ 108,012 $ 126,322 $ 136,583 $ 113,263 Restricted cash and investments 30,360 82,912 156,389 119,085 109,813 95,487 132,985 130,672 81,339 456,249 Property, plant, and equipment 622,409 672,534 706,802 782,248 827,063 879,949 914,707 943,954 951,134 994,946 Less accumulated depreciation (158,229) (177,465) (198,616) (217,754) (241,348) (269,671) (298,906) (327,450) (343,653) (374,620) Land 108,262 98,693 132,725 115,928 123,269 138,158 165,746 198,653 340,713 475,266 Deferred charges and other assets 25,873 20,630 21,048 18,803 16,243 15,330 36,424 17,488 17,266 22,326 Total Assets $676,273 $765,284 $879,037 $902,309 $941,682 $966,063 $1,058,968 $1,089,639 $1,183,382 $1,687,430 Liabilities and Equity Current liabilities $ 32,615 $ 31,047 $ 35,017 $ 40,376 $ 47,034 $ 43,121 $ 39,599 $ 46,179 $ 77,848 $ 51,151 Current liabilities paid 42,272 46,652 9,405 17,295 18,776 22,752 21,951 20,654 23,900 69,971 from restricted assets Long-term liabilities 381,589 445,761 566,304 543,448 539,622 534,329 589,910 576,832 597,950 1,041,523 Equity 219,797 241,824 268,311 301,190 336,250 365,861 407,508 445,974 483,684 524,785 Total Liabilities and Equity $676,273 $765,284 $879,037 $902,309 $941,682 $966,063 $1,058,968 $1,089,639 $1,183,382 $1,687,430 Source: Port of Oakland, consolidated audited financial statements for fiscal years 1990–91 through 1999–2000. 55 Operating Statement 1990–91 1991–92 1992–93 1993–94 1994–95 1995–96 1996–97 1997–98 1998–99 1999–2000 Operating revenue $98,038 $107,389 $118,715 $120,805 $133,474 $143,860 $149,918 $157,838 $162,903 $172,725 Operating expenses (72,499) (55,920) (58,310) (67,693) (71,486) (76,476) (79,121) (84,094) (93,109) (90,830) Depreciation and amortization (21,172) (21,700) (23,211) (23,892) (30,242) (31,046) (32,199) (33,225) (34,227) (34,900) Operating Income $4,367 $29,769 $37,194 $29,220 $31,746 $36,338 $38,598 $40,519 $35,567 $46,995 Nonoperating income (expenses) (21,701) (19,720) (18,533) (15,917) (21,171) (27,864) (27,432) (23,028) (18,551) (23,970) Net Income Before Extraordinary Items (17,334) 10,049 18,661 13,303 10,575 8,474 11,166 17,491 17,016 23,025 Extraordinary items (839) 573 (5,552) 0 0 0 0 0 0 0 Net Income (Loss) $(18,173) $10,622 $13,109 $13,303 $10,575 $8,474 $11,166 $17,491 $17,016 $23,025 Rate of Return* -2.67% 1.47% 1.59% 1.49% 1.15% 0.89% 1.10% 1.63% 1.50% 1.60% Source: Port of Oakland, consolidated audited financial statements for fiscal years 1990–91 through 1999–2000. * Auditor calculated rate of return by dividing net income by average total assets. Blank page inserted for reproduction purposes only. 56 Agency’s comments provided as text only. Port of Oakland 530 Water Street Oakland, CA 94604-2064 October 10, 2001 Elaine Howle California State Auditor Bureau of State Audits 555 Capitol Mall, Suite 300 Sacramento, CA 95814 SUBJECT: PORT OF OAKLAND RESPONSE AND COMMENTS Dear Ms. Howle: The Port of Oakland is pleased to have an opportunity to respond to the findings of the audit conducted by the Bureau of State Audits. As the Port of Oakland experiences unprecedented growth and embarks on an aggressive expansion plan to meet those demands, it is critical that the State have an understanding of the Port, its operations, and economic impact. We trust that the audit provided the critical information needed by the State in its evaluation of the Port’s significant value and impact. With respect to the State’s findings and recommendations regarding the Com- mercial Real Estate Division, we offer the following comments: 1. Execution and implementation of the Restructure & Development Plan is well under way. All elements of the Plan are being aggressively executed. 2. Any perceived delays in execution and implementation of the Plan have been either a result of the challenges associated with managing a large and visible public agency with a diverse group of stakeholders and/or decisions made by the Port to address the goals and objectives of our Port-wide Mission and Strategic Plan. Examples of these decisions include the policy to lease real estate at below-market rates for public use and benefit as shown in the audit report Table 4 — Estimated Fair Market Value of the Real Estate Division’s Below-Market Lease Properties. We trust that these comments are responsive to your findings and hope that your audit of the Port of Oakland provides the State of California with the information necessary to evaluate and concur with our belief that the Port of Oakland plays a critical role in not just the San Francisco Bay Area economy, but also that of our entire State. Sincerely, (Signed by: Tay Yoshitani ) Tay Yoshitani Executive Director 57 cc: Members of the Legislature Office of the Lieutenant Governor Milton Marks Commission on California State Government Organization and Economy Department of Finance Attorney General State Controller State Treasurer Legislative Analyst Senate Office of Research California Research Bureau Capitol Press 58