By Stephen Nellis Friday, December 2nd, 2011

Venoco faces allegations from the State Lands Commission that it underpaid the state $9.5 million for the oil pumped from Platform Holly off the Goleta coast.

The claims came in a lawsuit filed Nov. 16 by the State Lands Commission in Santa Barbara Superior Court. It signals an impasse between the state and the oil company, which has corporate headquarters in Denver but large operations on the South Coast.

The state and Venoco are asking a judge to rule on a dispute that started in 2004, when the state began an audit of Venoco’s royalty payments from the South Ellwood oil field. The oil and gas resources there are technically owned by the state. In the 1960s, the state granted leases to private companies to extract and sell the oil and gas in exchange for royalty payments.

It is the precise terms of those decades-old leases that are in dispute. The royalty payments are based on the “market price” of the oil. Venoco contends the market price is what it sold its oil for, while the state contends that the price of similar oil from nearby fields must be factored in.

The state and Venoco also disagree over whether Venoco should be able to deduct capital investments from its royalty payments, as well as whether it should be able to deduct the cost of shipping Platform Holly’s oil to San Francisco and Los Angeles via barge.

“Venoco believes it has overpaid royalties, while the state claims Venoco has underpaid. Both the state and Venoco have concluded that the best way to resolve our differences is to have a court decide,” said Michael Edwards, vice president of corporate and investor relations for Venoco. “We look forward to the outcome.”

“We don’t have a very specific idea of how much they think they’ve overpaid,” said Jennifer Lucchesi, chief counsel for the State Lands Commission. “We hope to resolve this dispute in a way that protects the state.”
The South Ellwood field was first leased to private companies in the mid-1960s, when Mobil Oil began drilling there. Venoco acquired the field’s leases and Platform Holly in 1997. In 2004, the state began an audit of Venoco’s royalty payments for the oil pumped from the field.

The state argues that the “market price” used to calculate royalty payment is defined in the lease documents. The price “shall not be less than the highest price in the nearest field in the State of California at which oil of like gravity and quality is being sold in substantial quantities.” The state argues that the clause was included back in the 1960s to prevent oil companies from colluding in below-market price contracts in a ploy to deprive the state of its true royalties. “In fact, in the 1970s, the State sued numerous oil companies for anticompetitive price fixing,” the state said in its complaint.

The state argues that since 2006, Venoco has been selling its oil on the New York Mercantile Exchange at a price lower than oil from the Midway-Sunset onshore field near Bakersfield, the field the state claims meets the lease terms’ criteria. The state wants the “market price” for royalty calculations to be at least as high as the price of the Midway-Sunset oil, or, alternatively,  as high as offshore fields in federal waters off North Santa Barbara County that fetch even higher prices.

But Venoco maintains that the South Ellwood oil is less valuable on the market because it is lower quality and costs more to process, according to court documents. It also believes the sale price is a fair indicator of the market price because it sells the oil on the open markets to unrelated third-party buyers, rather than through intra-company transfers, as was common in the collusive days of the 1960s. Back then, Venoco maintains, there were no arms-length transactions on an open market to establish a fair price benchmark. That’s not the case today, the company alleges.

Platform Holly’s oil is pumped to an onshore holding facility in Goleta and then shipped by barge to San Francisco or Los Angeles. The company is building a pipeline to solve that problem, but in the meantime it believes it is entitled to deduct the cost of the barge ride from its royalty payments. The state alleges that only the costs of pumping the oil to a flow-measuring meter at the onshore holding facility is allowable. Venoco also believes its current capital investments in processing equipment can be deducted, but the state argues that the terms of a settlement with the field’s previous owner allow only investments made prior to 2000 to be trimmed from royalty payments.

The dispute with the state, which has grappled for years with billion-dollar budget deficits, comes as Venoco’s CEO and majority owner, Tim Marquez, is trying to take the firm private by offering $12.50 a share for the remaining stake in the company. That would value Venoco at about $770  million and has ticked off at least five lawsuits with investors, some naming the company and Marquez and some naming Marquez alone. In general, the suits argue that the Venoco’s assets alone are worth potentially hundreds of millions of dollars more than the value implied in the deal and that Marquez took advantage of a slump in the markets to time his offer.

The company has seen big increases in revenue but declining profits this year. For the first nine months of the year, revenue was $245 million compared with $223 million the year before. Net income, however, was down to $31.8 million versus $63 million for the previous year.

The state filed its complaint just as recent budget projections predicted revenues would come in $3.7 billion below expectations, resulting in a $13 billion gap next year.