Lumber Dispute Coming To A Head

Lumber dispute coming to a head
State water panel to rule on harvesting

Tom Abate, Chronicle Staff Writer

Sunday, June 12, 2005

Scotia, Humboldt County -- Once upon a time, the Pacific Lumber Co. sawed massive redwoods into fine lumber at this company-owned town 240 miles north of San Francisco. Now most of those big trees have either been cut or set
aside in preserves.

Palco, as it's called up here, is betting its future on a new $30 million sawmill and planer designed to cut the young, small-diameter redwoods that it now harvests. But that new mill is barely running at two-thirds capacity,
company officials say, because regional water regulators won't let them cut enough trees on company lands.

"This time of year, we should have three to four weeks of logs on hand,'' said Palco operations manager Dennis Wood. "Right now, we've got about two days."

About 30 miles north of the sawmill, Kristi Wrigley stood alongside the Elk River, which borders the farm her family has owned since 1903. About 5 feet of silt fills the hollow where Wrigley, 59, used to fish with her three
children. She has no doubt -- and there is evidence at the water board and some acknowledgment from the company -- that the silt is a consequence of logging by Palco, which owns and has cut much of the watershed.

"All my life, this was a rocky river bottom,'' said Wrigley, a member of the Humboldt Watershed Council. This activist group has spent several years pressuring the North Coast Regional Water Control Board -- a local body with
purview over everything from sewer hookups to timber harvests -- into creating the tree-cutting rules that Palco blames for starving its sawmill.

On Thursday, Palco and its critics are expected to face off before the state Water Resources Control Board in Sacramento. The five-member body, which sits above the various regional water boards, must decide whether to lift a
stay that has, so far, prevented Palco from harvesting timber in two watersheds -- one above Wrigley's Elk River apple farm and the other in the upper reaches of Freshwater Creek, between Eureka and Arcata.

That hearing is a pivotal point in the nearly 20 years of disputes that have pitted loggers against environmentalists, profit against wildlife protection -- even neighbor against neighbor.

Officials of the embattled timber company recently heated up the debate when they warned in a financial statement that if it isn't allowed to cut the disputed trees, "Palco could be forced to take extraordinary actions, which may include reducing expenditures by laying off employees ... and seeking protection by filing under the bankruptcy code."

Opponents consider this a ploy. "If they can't make money, who's fault is it?'' asked the Humboldt Watershed Council's Mark Lovelace. He cited an analysis for the water board showing that Palco made money under its prior ownership but has lost money ever since its corporate reincarnation.

The specifics of silt aside, the controversy goes back to 1986, when Pacific Lumber was acquired by Maxxam Corp., the Houston firm controlled by Charles Hurwitz. He turned the company into a magnet for protest by cutting the big
redwoods at a faster rate to service the $750 million debt he had incurred to help finance his leveraged buyout.

In an April rebuttal of Palco's warnings, a state water board staffer said that if the company is in trouble now, it's mainly because it has carried too much debt for too long. Despite refinancings in 1993 and 1998, its debt stood at $692 million as of May, not much below where it stood 19 years ago.

"Palco has over-leveraged the value of their timberlands, and even if they cut every tree they own, it may not be enough to pay back its current debt,'' water board staffer Michael Gjerde wrote in an 18-page report.

'The geologist's analysis'

During a recent interview at Palco headquarters in Scotia, chief executive Robert Manne and Chief Financial Officer Gary Clark dismissed what they called "the geologist's analysis." (The water board notes that Gjerde has a master's degree in economics in addition to his primary expertise in Earth sciences). The timber executive painted a different picture of how Palco got into a jam.

Manne traced the troubles back to the 1999 Headwaters deal brokered by Sen. Dianne Feinstein, D-Calif. Under its terms, the state and federal governments paid Palco $480 million for 10,000 acres of old growth groves.

In addition, Palco and several state and federal agencies agreed on a new habitat conservation plan. It was meant to govern how the company logged its remaining 220,000 acres of private land and subjected it to rules and scrutiny over and above regular logging regulations, Manne said.

In return, Palco thought it had won the right to cut enough timber -- 178 million board feet a year -- to cover its debts, pay employees and turn a profit, he said.

But right around this same time, the North Coast Regional Water Board, which was not a party to the Headwaters deal, began hearing from people who lived downstream of Palco logging operations in Elk River and Freshwater. They
complained of flooding during rainstorms that closed country roads or damaged drinking systems that tap directly into the waterways.

Years of meetings

Thus began several years of meetings, hearings and studies. As a result, regional and, more recently, state water board officials have reduced or, as is now the case, stopped Palco from cutting timber in the two watersheds.

Manne said these water board restrictions have meant that since 1999, Palco has been allowed to cut about only 85 percent of the logs it had expected to harvest under the Headwaters deal.

"They have not enabled us to operate at our sustainable level,'' he said. Palco estimates this has cost its timber operation about $13.5 million a year for each of the last several years. It blames that string of revenue shortfalls for the bankruptcy warning.

But that warning -- and Palco's corporate structure -- bear some explaining. Using a blackboard, Manne showed how the company most people would think of as "Pacific Lumber" is actually two separate legal entities that are inextricably intertwined.

The first is Palco, which owns the sawmills and other lumber-making facilities -- the big green buildings visible in Scotia along Highway 101.

Complex ownership

The second entity is Scotia Pacific, which owns the forest lands, including the disputed areas in Freshwater Creek and Elk River. Scotia Pacific sells logs to Palco, and both are ultimately owned by Maxxam.

CFO Clark said the creation of Scotia Pacific put all the company's timberlands into a bond offering at lower interest rates -- and thus lower payments -- by securing the debt to ownership of the trees. He likened it to refinancing a home at a better rate.

Clark said Scotia Pacific sells logs to Palco to earn the revenues it needs to pay the interest on those bonds. But with water board restrictions reducing harvests for several years running, Scotia Pacific has used up its financial reserves and may not be able to pay the entire $27.9 million in interest due July 20. That, says the company, is why it needs the green
light Thursday to start cutting trees.

Financial issues

With financial issues becoming central to the silt debate, Palco's critics argue that its woes result more from its own decisions to maintain a high level of debt than from regulatory interference. And here they can point to "the geologist's analysis" by Gjerde, the state water board staffer.

"Maxxam has put Palco at risk by borrowing large sums of money, not paying down its long-term debt, and thereby keeping Palco a highly leveraged company,'' Gjerde concluded.

In his analysis, Gjerde noted that in the four years before the Maxxam takeover, the old Pacific Lumber averaged pre-tax profits of $20 million a year. Using figures provided by Palco, he calculated that in 19 years under Hurwitz, "it has averaged over $22 million in losses each year." Lovelace, the Watershed Council activist, said the water board should focus on the silt build-up and its relationship to logging.

"The only thing that's really going to allow it (the affected streams) to recover are time and rest,'' he said.

River may be getting better Back at Palco headquarters in Scotia, forester Stephen Horner acknowledges that the company bears some responsibility for what it calls "legacy impacts" of its logging practices. But he says its current practices are so carefully planned, executed and regulated that cutting in the two watersheds will not worsen the silt problem, which the company thinks is getting better.

"The river is cleaning itself up even as we cut under these new practices, '' said Kate Sullivan, senior scientist for Scotia Pacific's watershed sciences program.

The whole morass goes before the five-member state Water Board on Thursday. Spokeswoman Liz Kanter said the board could let Palco cut in the two watersheds or could continue the stay that prevents additional logging. Either way, she expects a decision that day.

Palco has the support of at least one long-time Elk River resident. Retired rancher Gene Senestraro, 76, served on the regional water board before the Maxxam takeover and still sides with Palco. "What's happened in the past has
happened,'' he said. "With today's logging rules, I can't imagine doing a better job than Palco has to do.''

But further upriver, closer to the logging, Wrigley said the silty conditions that regularly flood her 7-acre apple orchard -- cutting its yield from 3,000 boxes a decade ago to 400 boxes today -- is more than a financial loss. She has a job in town anyway. It's a sign, she said, that the river is dying.

E-mail Tom Abate at tabate@sfchronicle.com