Question: Hospitality Uses and Mineral Leases Practice Problem Aiming to bring the most jobs and economic development to the county, the San Luis Obispo County Council commissioned a study which evaluated the highest and best use for land at the end of Avila Beach and Lighthouse Road. There are potential energy reserves on the publicly owned land nearby and within the county?s boundaries. The reserve report found that substantial oil reserves exist on the county-owned land adjacent to Port Harford. Several oil companies have submitted bids for exploration leases on the land adjacent to the port.
The owners of Obispo Convention Center, a 320-room hotel farther inland near the Pacific Golf Courses would rather see an expansion of the hospitality uses in the county. The existing harbor building could expand recreational boating. It already encompasses an outdoor pool deck, concession businesses such as food and beverage outlets, and a parking area, which the owners believe could be expanded for further recreational use. The county is considering granting a mineral lease to Energy Development Co. (EDC), to begin extracting the oil over the next ten years from the adjacent land. The owners of Oxnard Convention Center are concerned that oil drilling will interfere with the tourism industry in San Luis Obispo. They would rather see the development of a new 280-room hotel and golf course at the location. This is an arial photograph of the location. PROPOSED NEW HOTEL INFORMATION County annual averages: Daily room rate: $220 County?s Occupancy rate: 75% Operating expenses: $175 per room per day General Market Conditions: Occupancy began to show positive yearly growth and hotel capitalization rates began to decline. Capitalization rates for new hospitality uses derived from select lodging REIT data for the county averaged 11.5%.
PROPOSED MINERAL LEASE INFORMATION There is presently one working oil well on the land. In estimating reserves, EDC?s engineer estimates that the ?proved developed producing (PDP)? reserves at the site are a total of 1.7 million barrels of oil, with an annual decline rate of 30%. The company is considering a 15-year lease. The average price of oil for the last year has been $95 per barrel. The county has indicated it will require that a discount rate of 15% be used for valuing mineral leases in San Luis Obispo County. EDC expects to pay a tax rate of 10%. Exploration costs will be 7% of revenues. Production expenses are projected to be approximately 42% of the lease?s gross revenue and management costs are less than 5% of gross income due to recent modernization measures the company has undertaken. The county would require that the land be returned in the same condition as it was when leased. EDC budgets 9% of gross revenue to cover the expense of restoring the property when extraction operations cease.
1) Estimate the total value of both projects, if done together, and whether they are compatible with each other.