Imagine yourself as the mayor of a city of 80,000 who must inform citizens the city has been slapped with a potentially devastating lawsuit. How would you tell voters they might have to come up with $40 million?
Elected city officials had responded to protests from angry and fearful residents by denying a multi-state oil drilling company the permit to drill next to residential neighborhoods. The problem was the resulting lawsuit against the city, in which the drilling company claimed $40 million in damages for lost revenues—a staggering amount that could bankrupt the city and cause severe damage to the self-funded municipality insurance pool. It was no surprise that city officials were distressed, to say the least.
The permit application had prompted very vocal outrage from residents near the proposed drilling site, with particular concerns relating to the release of hydrogen sulfide. City officials felt they had no choice but to deny the application because of fears of serious health hazards posed by a drilling operation, as well as the loss of property value to the residents. “City says no to risky drilling request” and “Mayor agrees: drilling may cause health hazard,” exclaimed the local newspaper headlines.
The attorneys representing the city called on O’Keefe to help them defend the case. By the time we joined the team, the public hearings and the inflammatory headlines were things of the past. Now those same city officials who had protected their constituents faced the possibility of a crippling judgment that, if awarded, threatened municipal services. Citizen reaction to the suit could be worse than their reaction to the drilling request.
Our role as financial experts is to quantify damages – if a court decided that the oil company had in fact suffered damages due to the city’s actions, how much did those damages really amount to? Was $40 million a reasonable number?
Our job is first to assess the validity of the opponent’s damage figure, identifying any errors or unreasonable assumptions used in their calculations. Then we conduct our own analysis and calculate what we believe is a reasonable damage figure. Finally, through our skilled expert testimony, we prove to the court why our number is correct.
We began by combing through the oil company’s books and records to establish how they calculate revenues from individual drilling sites. We then compared their accounting methods to industry standards in order to identify any potential issues. The speculative nature of drilling added a unique complexity to the case. Even the drilling experts can only estimate how much oil a site can produce – nobody knows for sure what the revenues will be until a well is actually operational. This uncertainty regarding production levels made it particularly difficult to assess damages.
We came back from an intense week
of indoctrination into the plaintiff’s business processes and put together our planning
steps:
1. Complete a thorough review of the plaintiff’s documentation.
2. Identify and analyze all the relevant forecasting variables and the Plaintiff’s method for calculating revenues per drilling site.
3. Using the variables and proper calculation methods, form our opinion of the potential revenue stream from the Plaintiff’s proposed drilling site
4. Assist the city’s attorneys in assessing the key damage issues and determining the resulting litigation strategy.
In order to tackle the tricky issue of uncertain production levels, we worked with a well-respected geological expert. We relied on him to assess the various risks associated with the geophysical and geological properties of the site. He applied his industry-standard scientific methods of analysis to create a number of scenarios regarding the actual supply of oil that might be below the surface. Defining these different scenarios allowed us to create a bracket of reasonable and scientifically supported production estimates from the site in question. But, that was only half of the equation.
The oil drilling business is speculative not only in terms of production results; pricing is also extremely volatile. As a result, we needed to create a number of financial scenarios for each of the geological expert’s production scenarios. We applied our knowledge of the oil and gas industry to our understanding of the plaintiff’s existing developments and to their proposed drilling site, and factored that information into our analysis.
We applied statistical methods to generate analyses incorporating the range of risk probabilities, and then used the discounted cash flow method to quantify damages assuming both temporary denial of drilling and permanent denial, in which the city could exercise its eminent domain power without actually divesting the plaintiff of its title to the property.
After many months of intense analysis and financial modeling, we completed our report. It contained both scientific and financial analysis that was supported by a thoughtful, logical process and reflected industry standards, and we were attentive to the need to communicate highly technical data in terms that could be easily understood by laypersons. Using the plaintiff’s own business model, we demonstrated that their claim of $40 million in lost revenues was grossly exaggerated.
We are pleased to report that our analysis was critical to securing a very favorable outcome for the city. Upon reviewing our analysis and considering the powerful impact our testimony would have in court, the Plaintiff decided to avoid a trial and agreed to a settlement that reflected our findings; total damages of approximately $700,000. City officials were exuberant. In addition, all of the O’Keefe professionals who worked on this case were very proud of the intellectual capital contained in our expert report, and extremely pleased with the end result.