Over the last 20 years, the Natural Energy Laboratory of Hawai`i Authority has fostered title development of many energy and aquaculture projects and companies at its facility at Keahole Point, in West Hawai’i. Among the most successful is the Cyanotech Corporation, a publicly traded company that produces microalgae products.
Today, NELHA’s largest tenant and its greatest success story is also potentially its biggest headache. Tom Daniel, scientific technical program manager for NELHA, describes the problem:
“We’re trying to attract new businesses… We don’t want to become one big business. Cyanotech is most of what we are right now. We have several other small ones that are making a go and I think that’s much more important. But we certainly don’t want Cyanotech to move away.”
However, unless a new $10.7 million seawater pipeline is installed, Cyanotech’s expansion will squeeze out ocean-thermal energy conversion (OTEC) projects and tenant growth at NELHA, according to Daniel. With the state backing away from supporting the facility with general funds, and the Department of Land and Natural Resources seeking to increase its rent from $1 a year to more than six million, NELHA’s future would appear bleak indeed.
OTEC to Algae
The Natural Energy Laboratory of Hawai’i (NELH) was established in 1974 during the administration of Governor John Burns, for the purpose of fostering ocean thermal energy conversion research (OTEC) at Keahole Point, Kona. High oil prices of the 1970s and 80s, brought on by the 1974 oil embargo, put pressure on the state and federal governments to seek and support alternative sources of energy.
With government funds in pocket, the Research Corporation of the University of Hawai’i secured a 65-year direct lease of 321.8 acres at Keahole Point in 1978 from the Board of Land and Natural Resources. NELH had a home, where it would give birth to a slew of OTEC and related aquaculture research projects over the next two decades.
In 1985, during the administration of Governor George Ariyoshi, the Hawai’i Ocean Science and Technology (HOST) Park was established immediately adjacent to NELH. The park, which would later house the former governor’s own aquaculture company, Cultured Technologies, Inc., was meant to provide a place for entrepreneurs – mostly aquaculture businesses who had already set up at NELH – to take advantage of the Point’s seawater resources, with help of the nearby technological and research support of NELH. The park, which cost $18 million, received a 60-year lease for 421.12 acres in 1987, with the lease term beginning September 1, 1985.
To streamline management of Keahole Point activities, the Legislature merged the HOST Park with NELHA in 1990, creating the Natural Energy Laboratory of Hawai’i Authority (NELHA). In 1991, the HOST Park lease was transferred from the park’s former manager – the High Technology Development Corporation – to NELHA.
Pumping In Money
The deep, cold seawater pumped up for OTEC work is used in aquaculture and agriculture projects throughout NELHA. According to Daniel, the U.S. Department of Energy, which was the principal source of funds for OTEC projects at Keahole, has refused to consider funding spin-off industries, “which,” Daniel adds, “are the things that have been somewhat successful.”
The state, on the other hand, has been very supportive of these spin-offs. For example, in 1988, the Legislature approved an appropriation for nori research, and in the mid-1980s, the Legislature approved special purpose revenue bonds for two tenants: Cyanotech and the now defunct Hawaiian Abalone Farms Ltd. (later known as Ocean Farms of Hawai’i).
In 1988, Reed Flickinger, writing in West Hawai’i Today; reported that, “Keahole Point and the HOST Park NELHA represent an investment of nearly $33 million of state and federal Department of Energy funds, as investment in two high technology futures, aquaculture, and the Ocean Thermal Energy Conversion (OTEC) process.”
Nine years later, NELHA claims its tenants have invested an additional $9 million into improvements at the site and, in 1996, had revenues totaling $13.6 million. Some 140 people are employed by the Keahole facilities. Using economic multipliers for revenues and capital improvements, NELHA estimates that the economic impact of tenant activities comes to more than $43 million a year.
Still, progress has not always followed a smooth road at Keahole. Consider the case of Ocean Farms Hawai’i, a salmon, abalone and sea urchin producer. In the late 1980s, it was regarded as the bright light in aquaculture enterprises at Keahole – and in Hawai’i more generally. In an effort to keep it afloat, the state lent Ocean Farms $1 million in 1990. In addition, the state pressured Nansay, a Japanese-owned developer trying to win permits for Big Island projects, into putting up another $1 million, as part of a “community benefit” package tied to certain land-use approvals.
It was not enough. By 1991, Ocean Farms was in serious financial trouble. A year later, when NELHA refused to purchase Ocean Farms’ six pipelines at a cost of $3 million, the course to bankruptcy was pretty well fixed. In the end, investors received just pennies on the dollar, while the state is still attempting to recover its loan through foreclosure on California properties owned by Ocean Farms’ initial promoter.
When Ocean Farms finally went bankrupt, a shadow of doubt concerning the state’s financial support of commercial ventures was cast over Keahole Point, and when the administration changed, so did the state’s attitude towards NELHA.
Pulling Back
Daniel described the dramatic turnaround to Environment Hawai`i: “Right after he [Gov. Cayetano] was elected, he wrote us a strongly worded memo saying that our sole purpose in life is to become self sufficient and he wanted a plan from us to say how long it was going to take us to become totally self sufficient.”
On March 10, 1995, Cayetano wrote Seiji Naya, director of the state Department of Business, Economic Development and Tourism, expressing his concern that “the state may be indirectly subsidizing the private enterprises by assessing a nominal fee for utilizing the NELHA facilities and services. Many state CIP [Capital Improvement Program] projects are currently being deferred or cancelled due to the present difficult economic times; therefore, it would be inappropriate for the state to finance projects that will primarily benefit private parties while some worthy state projects are being deferred due to lack of general obligation bond funds.
“In the NELHA’s FY 1993-2001 financial plan, it is estimated that approximately $600,000 to $700,000 of revenues will be generated per fiscal year, while the total cost to operate the NELHA facilities… is approximately $2.5 million per year. Since it does not appear that the NFLHA will be in a financial position to be self-reliant in the near future, I am concerned that the state will have to support the operation of the NELHA facilities indefinitely. Therefore, before I am able to commit additional funds for further CIP improvements at the NELHA, I am asking that you prepare a program effectiveness evaluation report and submit it to the Department of Budget and Finance for review.”
On top of that, legislators appeared to be starting to question when NELHA might be expected to stand on its own legs. Mason Young, the Department of Land and Natural Resources’ representative to the NELHA board, informed the board at its May 18 meeting this year that during a legislative hearing considering a bill to rescind NELHA’s special fund, a comment was made to the effect that the State had provided a great deal of money to NELHA and perhaps it was time to stop doing it.
Raising the Rent
But one of the biggest problems for NELHA was yet to surface. Most recently, the Department of Land and Natural Resources has proposed to increase the rental on NELHA’s HOST Park lease from $1 a year to more than $1 million.
Rent for the two leases under NELHA was set by the Land Board originally at $1 per year, with the NELHA lease rent to be reopened 35 years after its 1974 start date and every 10 years following. The HOST lease included a rental reopening every 10 years throughout the lease period.
In 1995, the rental reopening period for the HOST Park lease came across the DLNR’s table. The lease rent was reopened in late 1996, and a rate of $1,076,275 per year for 500-plus acres of vacant land was arrived at by an appraiser hired by the Department of Land and Natural Resources. This was offered for the period of September 1, 1995 through August 31, 2005. In November 1996, the proposal was sent for review to Tom Daniel, NELHA’s acting executive director at the time. In December, the NELHA board rejected the proposal.
According to Daniel, the proposal was “mind-boggling.” The HOST Park land remains vacant, he said, although a couple of tenants of NELHA are planning to move into the area soon, occupying a total of about 160 acres of the 400-odd acres that are developable. In addition, he said, Cyanotech may be using an additional 100 acres at the HOST Park site.
Under the present operating budget, such an increase could not be accommodated. The operating budget “used to be $1.2 million a few years ago,” Daniel notes. “This year it’s less than $100,000. Next year, it’s just about zero. So all the rest of [the money] comes from tenant revenues. The total cost of the facility is $2.2 million. More than half is coming from tenant revenues.
A plea for sympathy was sent on December 5, 1996 to DLNR Chairperson Michael Wilson by Gerry Cysewski, president of Cyanotech:
“Success at NELHA can be destroyed,” he warned. “Commercial aquaculture projects at NELHA are very capital intensive. Over $70,000 is resulted just to level one acre of pahoehoe lava. Aquaculture is a developing technology and involves a high degree of risk. Long-term, reasonable lease rates are required to attract new businesses to NELHA and to allow existing tenants to expand….
“If lease rates and terms are hastily and capriciously changed in a short term attempt to increase NELHA revenues, commercial activity will stagnate. The commercial occupancy rate at NELHA will stay at its present 13.9 percent (Would an office building increase its lease rates with only 13.9 percent occupancy?)”
Arbitration efforts between NELHA and the DLNR led to a proposal to consolidate the two leases. NELHA is also seeking to get the BLNR to accept new money-saving lease terms, i.e. allowing NELHA to deduct its operating expenses out of the gross sublease rent instead of the General Fund.
The proposal was on the Land Board’s agenda for its August 21,1997, meeting. However, it was withdrawn for reasons not stated.
Becoming Self-Sufficient
In response to Cayetano’s directive that NELHA become self-sufficient, NELHA established a Strategic Planning Committee. According to the committee’s report, prepared later in 1995, for NELHA to become self-sufficient by 2010, $25 million in capital improvements would be required from the state to complete a seawater pipeline system and to install seawater distribution systems and utilities needed to prepare more than 500 acres of unimproved land for new tenants.
“Assuming that the CIP requirements are adequately funded in the future, the economic impact projections of the tenants’ operations to the state of Hawai’i indicates that the cumulative state tax revenues would reach $137 million by the year 2010,” the report’s preamble states. This prediction was based on the projected contributions of two key commercial tenants: KMI Partners and Cyanotech Corporation. KMI Partners was a company that in 1990, planned to use 66.4 acres of NELHA land for OTEC use, Maine lobster aquaculture farming, and a visitor center/underwater oceanarium.
In an appendix to the evaluation report, KAD Partners was projected, by the year 2010, to employ 61 jobs, have made $25 million in capital investments, and to generate $39.5 million in annual sales.
By July 1997, such hopes had vanished. According to minutes of the NELHA board’s July 22, 1997, meeting, KAD “will not be exercising their [option to] lease.”
One constant and prominent feature in all of the committee’s projections was the role of Cyanotech as the primary economic contributor. Yet at the same time that NELHA’s plans for self-sufficiency center on Cyanotech, Cyanotech may also be an obstacle to NELHA’s plans to become a center for diverse aquaculture projects.
The House That Algae Built
In 1984, NELH subleased 15 acres of its Keahole Point land to a Nevada-based, microalgae production company. The company, Cyanotech, would use cold sea water in the refrigeration and drying processes of two microalgae products: spirulina, a high-concentration source of vegetable protein, and beta carotene, a microalgal derivative that reportedly reduces the risk of cancer when used as a dietary supplement. Both are in high demand in the nutritional supplements market.
Its beginnings were rocky. Big Island media reports from the late 1980s and early 1990s indicate that by 1988, the company still had not turned a profit. By May 1993, however, Cyanotech had reached the end of its financial slump. In the following years, it would explore new products and see its bottom line skyrocket, along with its influence on NELHA lease policy.
To attract new businesses, NELHA’s sub-lease rental rates are set low at $100 per acre per month or two percent of gross sales, whichever is greater. As a further incentive to set up shop, tenants receive an offset of 100 percent of the cost of land improvements and 35 percent of the cost of above-ground improvements on subleased land against the percentage rent.
Cyanotech’s plans for the rest of the 1990s include a mammoth leap in acreage at NELHA, which the company says will require an investment of several millions of dollars in capital improvements.
Two expansions in the acreage occupied by Cyanotech have been approved – first, in 1996, from 15 to 77 acres, and a year later, in 1997, to 90 acres. According to the December 1996 letter from Cyanotech president Cysewski to DLNR administrator Michael Wilson, Cyanotech’s pre-1996 investments came to more than $5.5 million. In 1996, the company planned to invest $3.2 million more in capital projects; $9.2 million in 1997; $6.8 million in 1998; and $7 million in 1999 and 2000, he said.
Against these investments, Cyanotech received a rental credit – or “offset” – totaling just $505,000 in its sublease payments to NELHA from 1992 to 1997, he noted. Cysewski, as president of the Keahole Point Association (Keahole’s tenant’s group), attempted to induce the NELHA board into creating a more favorable tenant environment. For example, on December 19, 1995, he recommended to the NELHA Board that it extend the period in which companies would be eligible for offsets two years from the current five – a recommendation he had first made more than a year earlier.
Beating the System
Cysewski’s attempts were unsuccessful in changing NELHA’s offset policy. (However, it appears from NELHA board minutes that an offset policy, developed by Cysewski, Board member Robert Kihune, and deputy attorney general Jim Nagle, that would address tenant expansions is now under review by the attorney general’s office.)
Meanwhile, Cyanotech was growing by leaps and bounds, so Cysewski sought to ease his company’s future rental obligations by taking advantage of the holes in NELHA’s still-maturing lease language. To do so, in 1991, Cyanotech set up NUTREX as a wholly owned retail marketing subsidiary. Its addition as a tenant of NELHA was welcomed, as it put all aspects of Cyanotech’s spirulina production at the Keahole facility.
However, five years later, NUTREX moved from NELHA to a site in the Kaloko Light Industrial Park, which translated into a loss of lease rent to NELHA.
“Cyanotech claims that the two percent lease rent applies only to the cost of the production of the materials that they are selling,” the NELHA board minutes for October 22, 1996, state. “Since NUTREX is their retail outlet, all of their retail sales are now excluded from the two percent requirement.”
Unprepared for the move, the board voted to ask the attorney general for an opinion on the calculation and interpretation of gross revenues for Cyanotech and its subsidiaries. A year later, in August 1997, the matter appeared to be settled, with NELHA having decided, on the advice of its attorney general, not to chase the NUTREX revenue.
According to the NELHA Boards August 19, 1997 meeting minutes, NUTREX’s move off site has caused a two-year slump in the revenue projections and, “NELHA may face a deficit in the operation budget.”
At the time, former NELHA Executive Director Robert Kihune attributed the problem to NELHA’s failing to catch a loophole in the Cyanotech sublease regarding offsite revenues.
But no sooner was the NELHA board wise to that loophole than it got caught by another one. Minutes of the same October 22, 1996, board meeting state that Cyanotech was “proposing to form a new corporation as a means of avoiding the 5-year limitation that NELHA imposes on the offsets against percentage lease rent allowed for capital improvements.”
A month later, Sea Bright, Inc., another wholly owned subsidiary of Cyanotech, requested a sublease from NELHA for 75 acres in the HOST Park area to produce astaxanthin. Astaxanthin is a red pigment and food supplement used to color pen-raised fish and shrimp. Cyanotech operates a demonstration processing facility and will transfer its technology to Sea Bright if and when the opportunity arises.
Forming Sea Bright would give Cyanotech five additional years of offsets against percentage rent for capital improvements, according to the minutes of NELHA’s November 19, 1996, meeting. “This issue has been discussed with the Attorney General, and Mr. [Winfred] Pong’s opinion was that we can treat this company as a new tenant,” reported Daniel.
This new tenant, according to Cysewski, would contribute $1 million in annual revenues to NELHA, after the five-year offsets against percentage rent. It would also, he said, employ 52 people by November 1997. According to the minutes, Cysewski promised NELHA that the astaxanthin produced by Sea Bright “will only be sold wholesale, so there will be no move for retail sales and all gross revenues will be subjected to NELHA percentage rent.”
A Bad Precedent?
The board’s research advisory chair Donald Thomas, noted that Cyanotech formed Sea Bright, Inc. because NELHA’s offset policy does not allow for capital improvements on expansion projects begun after the initial 5-year limit on offsets. “He feels this will set a bad precedent which will encourage the proliferation of subsidiaries for future expansions,” minutes of the meeting reported.
The NELHA board eventually agreed to work with the tenants to develop a new incentives policy, to work with Cyanotech to discuss plans to incorporate any incentive policy developed, and to defer accepting Sea Bright as a tenant, pending the development of a new expansion policy.
If Sea Bright moves in, it will use all 6,800 gallons per minute that is supplied by the HOST Park cold seawater pipeline. This troubles Daniel.
If Cyanotech lives up to its projections, “which they’ve always done in the past,” Daniel says, “they’re going to be using the total capacity of our system. Two years from now, we won’t have any water left to use for the OTEC project…. Two years from now, we won’t be able to take any new tenants unless we get that new pipeline.”
Volume 8, Number 5 November 1997
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