Texaco Producing, Inc. v. County of Kern, F023931

• Decision Date: 28 August 1998
• Docket Number: No. F023931,F023931
• Citation: 66 Cal.App.4th 1029,78 Cal.Rptr.2d 433
• Court: California Court of Appeals Court of Appeals
• Parties: , 98 Cal. Daily Op. Serv. 7344, 98 Daily Journal D.A.R. 10,129 TEXACO PRODUCING, INC., et al., Plaintiffs and Appellants, v. COUNTY OF KERN, Defendant and Respondent.

Page 433

78 Cal.Rptr.2d 433

66 Cal.App.4th 1029, 98 Cal. Daily Op. Serv. 7344,

98 Daily Journal D.A.R. 10,129

TEXACO PRODUCING, INC., et al., Plaintiffs and Appellants, v. COUNTY OF KERN, Defendant and Respondent.

No. F023931.

Court of Appeal, Fifth District, California.

Aug. 28, 1998.

As Modified Sept. 21, 1998.

[66 Cal.App.4th 1033] Arrache, Clark & Potter and Thomas S. Clark, Bakersfield, for Plaintiffs and Appellants.

Brett L. Price, Bakersfield, for Defendant and Respondent.

OPINION

LEVY, Associate Justice.

This appeal concerns the assessment of oil producing property owned and operated by appellant, Texaco Producing, Inc. (Texaco), for the years 1984, 1985 and 1986. In an attempt to overcome the presumption that ad valorem property tax assessments are correct, Texaco challenges the legality of appraisal methods used by the Kern County Assessor (Assessor). Texaco further argues the appraised values are not supported by substantial evidence. However, Texaco has failed to meet its burden of demonstrating error. Thus, the assessments must be upheld.

STATEMENT OF THE CASE

In February 1984, Getty Oil Company (Getty) was merged into Texaco through Texaco's purchase of Getty's stock. Texaco's acquisition of Getty triggered a reassessment of the real property interests previously owned by Getty as a change of ownership under Proposition 13. (Cal. Const., art. 13A; Rev. & Tax.Code, § 64. ¹ ) This property transfer included fee holdings and leasehold interests in over 5,830 acres located in an oil producing area known as the Kern River Oilfield (Kern River).

The Assessor reappraised this Kern River property as of the March 1, 1984, lien date to establish a new base-year value. Thereafter, the Assessor made and enrolled annual assessments.

Texaco timely filed applications for changed assessment with the Kern County Assessment Appeals Board (Board) contesting the values established for the March 1, 1985, and March 1, 1986, lien dates. Texaco also contested the valuation and assessment for the base valuation year 1984/1985. The Board conducted 129 days of hearings on these applications between November 28, 1988, and June 4, 1990. On December 27, 1990, the Board issued its final statement of decision finding in favor of the Assessor "based on the substantial evidence presented at the hearing of this matter and a determination of the relative credibility of the witnesses."

The Board determined the full value of Texaco's holdings to be as follows:

1984/1985 $2,547,731,543

1985/1986 $2,154,440,247

1986/1987 $1,680,979,046

In contrast, Texaco argued the holdings should be assessed for these tax years at $1,325,000,000, $1,212,000,000, and $611,000,000 respectively.

Texaco filed a complaint in the superior court seeking recovery of ad valorem taxes paid for the tax years 1985-1986 and 1986-1987. Texaco claimed it was entitled to refunds of approximately $8.4 million for 1985-1986 and approximately $10.7 million for 1986-1987. Texaco further sought a declaration that the method used by the Assessor to appraise the Kern River property for the 1984-1985, 1985-1986, and 1986-1987 tax years was unconstitutional, illegal and improper. Texaco also claimed the Board erred, as a matter of law, in relying on "a totally unique, unfounded, untested, illegal, invalid and improper method of appraisal" and therefore abused its discretion, conducted itself in an arbitrary and capricious manner, and ultimately issued an opinion which was not supported by substantial evidence.

The trial court denied relief to Texaco and entered judgment in favor of respondent, County of Kern (County). The court found the methods used by the Assessor to determine the roll value of the Kern River property were "constitutionally and legally valid and proper." The court further held the Board did not abuse or exceed its discretion, properly followed applicable standards of law, and issued a decision supported by substantial evidence.

STATEMENT OF FACTS

Kern River is an area of approximately 9,960 acres which has been producing heavy oil since the late 19th century. This property has been intensely researched and developed. The systems and techniques employed are considered to be " 'state of the art' " and significant potential exists for additional development. Kern River has large gross proven reserves, an extensive production history, and a developed infrastructure for extraction, storage, and transportation. Consequently, the field is of above average quality and the risks associated with its operation are reasonably low.

In sum, Kern River is a very desirable property. It is against this background that the various methods which were used to value Texaco's interests in the property must be examined.

Property subject to general property taxation is assessed at its full value, i.e., the price at which the property would transfer if exposed for sale on the open market between knowledgeable parties in equal bargaining positions. (§§ 110 and 401; Cal.Code Regs., tit. 18, § 2.) State Board of Equalization Rules 2-8 (Cal.Code Regs., tit. 18, §§ 2 through 8), ² set forth various approaches the assessor is to use in estimating this full value. Two of these basic methods were applied by the Assessor's experts here, the comparable sales approach (rule 4), and the income approach (rule 8).

When market data is available, the preferred method of valuing real property is by reference to sales prices of comparable properties. (Rule 4.) However, due to the unique nature of oil and gas property interests, specialized appraisal techniques are required. Thus, a modified capitalization of income approach is the most commonly accepted valuation method. (Lynch v. State Bd. of Equalization (1985) 164 Cal.App.3d 94, 103-104, 210 Cal.Rptr. 335; Dominguez Energy v. County of Los Angeles (1997) 56 Cal.App.4th 839, 845, 65 Cal.Rptr.2d 766; rule 468.)

Here, in valuing the Kern River property, the Board determined the income approach was the preferred and more accurate method. The Board stated it arrived at this conclusion because "the intrinsic value of oil producing property stripped of unrelated surface improvements is the value of income that can be reasonably anticipated to be derived from the property over its economic life." However, the Board also used and considered "the factors and value conclusions resulting from the Assessor's comparable sales approach appraisals for the purpose of comparing, verifying, and establishing the validity and accuracy" of the income approach components and value conclusions. The Board specifically rejected Texaco's contention that the only appropriate or allowable valuation method was the income approach. Consequently, for purposes of this appeal, it is necessary to examine both methodologies.

A. Oil and Gas Appraisals

One concept which underlies all oil and gas property appraisals is "proved reserves." This notion, which is unique to oil and gas properties, is an integral component of such appraisals. In fact, the State Board of Equalization rules require that the market value of an oil and gas mineral property interest be "determined by estimating the value of the volumes of proved reserves." (Rule 468, subd. (b).)

"Proved reserves" are defined as the volumes of crude oil and natural gas "which geological and engineering information indicate with reasonable certainty to be recoverable in the future, taking into account reasonably projected physical and economic operating conditions." (Rule 468, subd. (b).) They do not include "probable" or "possible" reserves. Further, "proved reserves" are not synonymous with amounts of oil known to be recoverable under existing technology. Rather, recoverable oil and gas will be included within proved reserves only if an augmented recovery program is economically justified. (Lynch v. State Bd. of Equalization, supra, 164 Cal.App.3d at pp. 104-105, 210 Cal.Rptr. 335.)

1. The income approach to value.

The State Board of Equalization's general rule on the income approach to value states, "Using the income approach, an appraiser values an income property by computing the present worth of a future income stream. This present worth depends upon the size, shape, and duration of the estimated stream and upon the capitalization rate at which future income is discounted to its present worth." (Rule 8, subd. (b).) This method rests upon the assumption that in an open market a willing buyer of the property would pay a willing seller an amount approximately equal to the present value of the future income to be derived from the property. (Bret Harte Inn, Inc. v. City and County of San Francisco (1976) 16 Cal.3d 14, 24, 127 Cal.Rptr. 154, 544 P.2d 1354.)

The process of converting an income stream into a stated value is known as capitalizing. Thus, this appraisal technique is also called the capitalization method. (Freeport-McMoran Resource Partners v. County of Lake (1993) 12 Cal.App.4th 634, 642, 16 Cal.Rptr.2d 428.) " 'The assessor capitalizes "the sum of anticipated future installments of net income from the property, less an allowance for interest and the risk of partial or no receipt." [Citation.]' " (Ibid.) The discount factor or capitalization rate which is applied reflects interest, the risk of no return or a lesser return of income, liquidity, investment management, taxes, and depreciation, where appropriate. (Ehrman & Flavin, Taxing California Property (3d Ed.), § 17:19.) Thus, a high risk investment carries a proportionately higher capitalization rate.

In the context of valuing oil and gas producing property, the appraiser first estimates the proved reserves. The appraiser then determines the expected schedule of future production from those reserves and estimates the future gross income. The next step is to subtract the estimated costs of such production to arrive at the future net income. The final step is to discount this future net income to reduce it to present value. This...