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" Senator STENNIS. Without going back over it in detail, you are actually offering now a 15-year contract, according to the lines of your statement here?
Mr. McGANNEY. We would be glad to have a 15-year contract, but our understanding is that the limitation of the service contract under the law is 5 years.
Senator ŠTENNIS. Five years?
Senator STENNIS. Yes. So far as you are concerned, you can make it 15 years— . Mr. McGANNEY. Yes, sir.
Senator STENNIS. By way of options or understandings or whatever device might be used ?
Mr. McGANNEY. Yes sir; that is right.
Now, by the way, this Southern Pacific name, that is the Southern Pacific Railway?
Mr. McGANNEY. Yes. The Southern Pacific Pipe Lines, Inc., is a wholly owned subsidiary of the Southern Pacific Railway, the railroad.
Senator STENNIS. You operate through these lines here instead of actually hauling it by rail ?
Mr. McGANNEY. Yes. We found, Mr. Chairman, that it was very much more advantageous to move petroleum products by pipeline than by rail. The operating ratio of pipeline is in the thirties, whereas the operating ratio of a railroad is anywhere from 75 to 80.
Senator STENNIS. Yes. That is where you have the advantage of experience, too. Mr. McGANNEY. That is right, sir. Senator STENNIS. Who represents the Navy on this matter?
STATEMENT OF EARLE E. CORLISS, BUREAU OF YARDS AND DOCKS,
DEPARTMENT OF THE NAVY Mr. CORLISS. My name is Earle Corliss of the Bureau of Yards and Docks.
Senator STENNIS. We had the general explanation of this the other day, but we have not had anything specific.
Let me ask you a preliminary question. If you contract for this with these gentlemen you pay this bill per year out of your maintenance and operation funds; is that right?
Mr. CORLISS. Yes, sir.
Senator STENNIS. All right. What do you have to say specifically in answer to this proposal ?
Mr. CORLISS. Mr. Chairman, the present nearest pipeline through which we could accept deliveries of jet engine aircraft fuel is nearly 200 miles away.
The pipeline which we propose is 95 miles long. There is no set of circumstances under which any commercial enterprise could even come close to the prices which the Navy could enjoy the benefit of with its own pipeline under those circumstances.
Senator STENNIS. Well, that is very stoutly contradicted here, as I understand the figures. Mr. CORLISS. Well, Mr. Chairman, this has about 2 years
Senator STENNIS. You are talking about the Navy. This committee thinks in terms of the Department of Defense in matters of this kind. Mr. CORLISS. Yes, sir.
Senator STENNIS. There is no chance to save money if we are going to separate the Navy from the Air Force. Your proposal covers both? Mr. McGANNEY. Yes, sir.
I might add, Senator, that the Air Force has been pressing us vigorously for the last 2 years to try to find a way to build to Castle, but the volume is just not there unless we have the two.
Senator STENNIS. All right. Excuse me now. I did not want to stop this gentleman unnecessarily. But do you have any figures here in answer to the figures represented, the total figures involved, or are you speaking just for the Navy?
Mr. CORLISS. I am prepared to speak in either direction.
Mr. CORLISS. Let me speak of the sequence of things which have happened.
We have met on a number of occasions with the Southern Pacific Pipe Line Co.
Senator STENNIS. Yes. · Mr. CORLISS. Their most recent proposal up to this time, which I have not seen, represented a cost of 98 cents per barrel of product delivered to Lemoore.
Senator STENNIS. Pardon me, you have not seen this proposal that is nresented here by this gentleman?
Mr. CORLISS. No, sir.
Mr. STENNIS. I think we had just better take a recess. There is no use for us to sit here and argue about this thing when you have not had a chance to study it.
Mr. CORLISS. I would be delighted to study this, sir.
Senator STENNIS. You go ahead and develop it and we will just skin the figures until we have had a chance to study it.
Senator CANNON. All right.
On this tax writeoff you read for me the 60-2 Bureau of the Budget Bulletin, have they recognized in other cases or do you know, that the tax writeoff is a proper consideration in determining the costs ?
Mr. McGANNEY. Senator, I do not know. The fact is that it was only within the last 3 or 4 weeks that we learned of this Bureau of the Budget directive.
It came out through the action of Congressman Mahon introducing it completely in the House hearing on this proposal, which was the first we knew about it, although we have been contending for the last 2 years that the Air Force and the Navy should recomize the fact that we are giving this money all back to the Government in income tax. We had no backing for it until this directive came out.
Senator CANNON. So you do not know whether they have recognized that the inclusion of the tax, or exclusion, whichever way you look at it, is a proper item in comparing whether the private contractor could furnish it at a comparable cost to the in-house cost?
Mr. McGANNEY. I do not know that, Senator. All I can add to what I said is that I do know that the Secretary of Defense, Secretary Gates, issued a letter to the services directing them to follow this Budget Bureau directive.
Senator CANNON. Well, I am glad to hear that, and I think that should properly be done because certainly if the services can be furnished through a private contractor, private enterprise, at comparable costs, then my personal feeling is that that should be done.
In arriving at your figures, you indicated that if private enterprise builds the line it would benefit the local governmental subdivisions, which I recognize as true.
May I ask you this: Have you deducted those costs first in determining how much your tax would be to the Federal Government by reason of this increased operation?
Mr. McGANNEY. They were included in our expenses; yes, sir.
Senator Cannon. Did you also include your amortization, the cost of the project, in determining what your tax would be to arrive at this formula?
Mr. McGANNEY. No, we did not, sir; and I will tell you the reason for that is that we are in a rather unusual situation probably.
This line will cost in the neighborhood of $61,2 million, as we propose it. We happen to have the $61/2 million in the treasury, so we will not borrow any money nor will we pay any interest until after taxes.
The Bureau of Internal Revenue does not permit us to deduct interest until after we pay it, so that the income subject to tax does not include amortization nor interest on our money.
So that the income tax, that is one reason why the income tax, is as large as it is on this project.
Senator CANNON. All right. Now, does it include depreciation writeoff? Mr. McGANNEY. It includes depreciation; yes, sir. Senator CANNON. On how fast a schedule ? Mr. McGANNEY. At the declining balance basis. Senator CANNON. I see. Mr. McGANNEY. The depreciation under the Interstate Commerce regulations would be 3.31, but under the declining balance would be 6.62, so we have greater depreciation in the first several years, and we run out of depreciation altogether for tax purposes in the 12th year, and thereafter we have to credit it back.
Senator CANNON. In other words, you did not attempt to write off this on a 5-year basis, but on a 12-year basis this declining depreciation 12-year basis total?
Mr. McGANNEY. Yes, sir.
Senator CANNON. I do not know which one of you gentlemen can answer this, if the Navy went ahead with its own line, does that still leave the problem of furnishing fuel to Castle as it now is? In other words, must the Air Force still pay for their haulage in there as they are presently doing?
Mr. McGANNEY. I would say yes to that question, sir, definitely. Mr. CORLISS. Yes.
Senator CANNON. In other words, the Navy line from Estero Bay to Lemoore does not help solve Castle Air Force Base's problem of getting their fuel in?
Mr. CORI CANNON. So hate they appare
Mr. CORLISS. That is correct.
Senator CANNON. So they would still have the unsatisfactory problem of truck haulage that they apparently have at the present time?
Mr. McGANNEY. That is right.
I might say, and Mr. Corliss will recall, in the discussion we had in my office that the operating officers from Castle mentioned that their handling of jet fuel into Castle under the present method of getting through 45 to 50 doubleheader tank truckloads a day was a very large problem to them, and they are very anxious for pipeline service.
Senator CANNON. Have you tried to work out an agreement with the two services together, involved on this up until now or have you been trying to work with each one independently on their own problem?
Mr. McGANNEY. We have done both, Senator. We have worked with the Navy, we have worked with the Air Force, and more recently we have been working, trying to work, with them together.
Our problem has been, the main problem that we have, the stumbling block we have had to try to bring this thing to a head amounts to two things:
First, the unwillingness of the services to recognize this income tax return; in other words, they won't look at it as a U.S. Government; and, secondly, the unwillingness to seriously consider, up until a very recent time, say the last 3 weeks, or month, a 5-year service contract.
Now, we believe sincerely that we cannot afford to risk $6.5 million in a pipeline service that is a military line exclusively if we had not got some assurance that it is going to last at least 5 years.
We are confident in our own minds that it will, but you need a little bit more than that to justify spending that much money.
Senator CANNON. Now, is your initial contract price based on a minimum fixed amount per month irrespective of whether they did or did not use a certain amount of gallonage?
Mr. McGANNEY. That is correct, for 5 years; 167,000 barrels a month to Lemoore; 150,000 barrels to Castle.
Senator CANNON. Is that amount equal to the amount they are using in those installations at the present time?
Mr. McGANNEY. It is equal to the amount that is being used at Castle, and it is the estimate of the Navy of what they will use at Lemoore.
Senator CANNON. Based only on an estimate at Lemoore? Mr. McGANNEY. And their own studies. In fact, Admiral Chew, in testifying before the House, used a higher figure, but we have been playing safe by using what figure Mr. Corliss gave us, 167,000 barrels, and we have been working on that.
Senator CANNON. Why are you not able to use an experience figure? Is it because the Navy is in the process of moving to Lemoore at this time?
Mr. McGANNEY. Yes, sir. The base is not yet built. It is under construction at the present time.
Senator CANNON. And that will be the facility to move out of the coastal area there? Mr. McGANNEY. Alameda and Moffett. Senator CANNON. Is that correct, Mr. Corliss ?
Mr. CORLISS. Yes, sir.
Senator CANNON. Let me ask you, Mr. Corliss, is there any indication or intention on the Navy's part that they would not keep this base in operation, based on your present anticipation, for at least a 5-year period ?
Mr. CORLISS. All of our computations for the economics of any. thing we build, Senator, are on the basis of 15 years.
Senator CANNON. Have you ascertained whether or not the Air Force has any proposal to reduce their operations at Castle within the foreseeable future or within the next 5 years?
Mr. McGANNEY. They tell us, no. That is the Strategic Air Command's principal training base in the United States, and they are confident that it will last for a number of years. In fact, they tell me 13 years, but no one is going on record to that effect, because no one knows what is going to happen with respect to missiles and things of that sort, so that is why we think we ought to at least be assured of 5 years.
Senator CANNON. Your company has had considerable experience in the operation of pipelines. Have you examined the Navy's estimate as to the cost of operation of that line from Estero Bay to Lemoore?
Mr. McGANNEY. Well, we have, yes; only in a preliminary way we have.
I will say this, first, that we have not engineered this line. We have accepted the Navy's figure that it will cost $4,759,000. We have not conducted an engineering study to determine whether that is right or wrong.
I will say that we have gone over the territory and we know that for the first 61 or 62 miles from Estero Bay to about Kettleman City it is awfully rough country.
However, a pipeline can be built through there; there is no question about that.
What it will cost, I say we have accepted the Navy's figure in the absence of making an engineering study of our own.
We believe that the Navy's figure for operations of the line are a little low, and I will illustrate that by pointing out the difference in their approach to this problem from ours.
The line cost $4,759,000. They amortize that over 15 years, so one-fifteenth each year is $317,000.
Interest at 41/4 percent on the same amount is $202,258, leaving only $42,000 the first year to operate the line. We think it should cost at least $145,000 to operate the line.
Now, they go along that way until the ninth year before they reach $150,000 balance remaining to operate the line. So what they are doing is taking a loss in the first years and averaging it out in the last years; whereas we have done just the opposite. We have put the heavier costs in the first 9 years or 10 years, and tapered off on the remaining years. That is why our rate for the first part of the operation is higher than the later part of the operation.
In other words, after we recover our capital we reduce the rate.
So the Navy would only have $42,000, as I say, to operate that line the first year, where I think it will cost at least $145,000.