About Air and Water

Monday, November 19, 2007

City of Fort Worth losing bucks by outsourcing gas-lease work

By Mitchell Schnurman - Star-Telegram Staff Writer - Sun, Nov. 18, 2007Fort Worth may be sitting atop a fortune in natural gas, but that's no excuse for not minding the money.

For more than two years, the city has been paying through the nose to outsource its dealings in the Barnett Shale. Instead of doing most of the work in-house, it hired JPMorgan Chase to handle gas leases and monitor royalty runs.

Here's the kicker: It's paying a management fee based on a percentage of revenue, rather than an hourly rate -- a costly mistake, given the run-up in local mineral rights.

In the past two years, the city has paid $1.9 million in fees to JPMorgan, with $1 million more likely due in a few months. If the contract remains in place over the long term, the city's tab could reach $30 million.

Meanwhile, other public entities with major gas reserves, such as Dallas/Fort Worth Airport, the Tarrant Regional Water District and the city of Arlington, are paying far smaller amounts to outsiders. Their employees do much of the work, and they hire experts on a project basis.

Like the state of Texas, which does a huge business in mineral rights, they've decided not to give away part of a revenue stream that could run for 30 years.

Fort Worth has brought in $31 million in natural gas revenue. Compare its revenue and spending with Arlington's: It signed gas leases worth $42 million and spent $386,000 in outside fees.

Fort Worth and JPMorgan both defend the high-dollar arrangement.

"You get what you pay for," says Paul Midkiff, managing director at JPMorgan and the point man for gas work for the city. "Arlington may end up with more problems than they understand. There's more to it than just getting a lease signed."

JPMorgan gets 5 percent of the signing bonus for the leases it arranges and 4 percent of the annual royalties from the gas itself. Fort Worth officials say they're pleased with the arrangement.

"The city could not have generated the same amount of revenue without JPMorgan Chase expertise, knowledge and the respect they command in the gas leasing industry," Engineering Director Doug Rademaker said in a statement.

The city's endorsement has helped the bank land other public clients. Tarrant County and the Fort Worth school district have agreed to the same commissions on bonuses and royalties. And Midkiff says that Euless, North Richland Hills and several nonprofit groups signed deals for bonuses alone.

Midkiff says he provides many services for a city. He coordinates the bid process, evaluates offers for their effects on the community and, perhaps most importantly, cuts through the "analysis paralysis" that often grips government.

"Fort Worth has been signing lease deals for two years now, because they hired me," he says. "Tarrant County didn't make a single deal, but I've already done five this year. The benefit of hiring me is, you get somebody to push through the bureaucracy and do it right."

By all reports, Midkiff is a competent guy, who has done a fine job in getting top dollar for Fort Worth. My beef is with JPMorgan's fees. Couldn't Fort Worth get expert help on gas leasing -- maybe even Midkiff's help -- for a fraction of the cost?

Midkiff says the work is too hard for him to accept an hourly rate: "I wouldn't do it," he says.

But he did agree to serve as a consultant to D/FW Airport for a one-time fee. And JPMorgan monitors D/FW's royalties for a flat $100,000 a year.

"It wouldn't be fair to expect 4 percent on the amount of gas that D/FW is generating," Midkiff says.

OK, but Fort Worth isn't exactly chopped liver. The city says its natural gas revenue will total $742 million over the next 20 years.

Midkiff says that managing Fort Worth's project is more complicated that D/FW's. The city has dozens of leases, several drillers and a wide range of properties, from small street corners to big acreage under water-treatment plants. That's more labor intensive.

Maybe, but is the work 10 times tougher -- or 20 times?

Fort Worth can drop the JPMorgan contract with 45 days' notice, and it's disheartening that the staff hasn't proposed that already.

Hiring JPMorgan may have made sense in March 2004, when the deal was struck. Payouts hadn't soared yet, and city leaders and staffers were worried about their lack of industry knowledge.

They still say they don't want to get into the oil and gas business, but that line sounds timid and tired today. We're not talking about wildcatting here. Being a royalty owner is not that daunting.

Neighborhood groups in Tarrant County are regularly winning great lease deals by simply using volunteers and a legal review. Perhaps Fort Worth should hire a gas administrator, a position that D/FW is advertising for right now.

But somebody at City Hall has to get a lot more thorough on the subject. In September 2003, the staff recommended hiring a private management firm for gas leasing, and Rademaker showed the City Council a chart comparing the costs of an outside firm versus using city staff.

The outsiders would cost 28 percent less, he said.

The decision looked like a no-brainer, and the presentation was finished in 10 minutes, with almost no discussion.

Unfortunately, the chart projected costs for only two years, which is akin to choosing an adjustable-rate mortgage based just on the teaser payments. The really big bucks -- on ARMs and this deal -- are on the back end.

The staff also underestimated the revenue by a huge amount. It assumed a signing bonus of $500 an acre, the prevailing rate at the time; the city's latest deal topped $17,000 an acre. Prices of natural gas have surged since then, too, and the wells have been more productive than expected.

Higher bonuses and more gas revenue translate into much higher fees and change the equation entirely.

Maybe the staff and elected leaders couldn't know all this then. But they can't miss it now.

Gene Powell, who's been in the oil and gas business for 42 years, has criticized the city's gas-management deal from the start. He writes the Powell Barnett Shale Newsletter and says his readers include about 50 financial analysts.

"They're always asking me, 'What's the best deal you've ever seen in the Barnett Shale?'" Powell says. "That's easy: JPMorgan's contract with the city of Fort Worth."

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