Evaluating the economics of the BDCP: Dr. Thornberg reviews all the economic analyses for Metropolitan and says “From my perspective, this is a no-brainer.”

MWDBoardtalk2013_1.3-1_Page_01At the joint meeting of Metropolitan Water District’s Water Planning and Stewardship Committee and the Special Committee on the Bay-Delta held on December 9, Dr. Chris Thornberg, economist and founding partner of Beacon Economics, gave his opinion on the competing economic analyses of the Bay Delta Conservation Plan that have been produced by Dr. David Sunding, Dr. Jeff Michael, and Dr. Rodney Smith.  During his presentation, Dr. Thornberg explained why he felt the economic benefits of the tunnels penciled out, even when the value of environmental benefits and water quality benefits are not included.

Dr. Thornberg began by saying he had been contacted by Metropolitan to look at the economic analyses being produced by the state and others, and to come up with a neutral analysis.  It’s been a bit of a moving target, he said, as Dr. Sunding from the Brattle Group has already released two preliminary drafts of the report for the state and yet a third may be on the way.  He noted that the most vocal criticisms have come from Dr. Jeff Michael at the University of the Pacific, who has come up with completely different results and says the tunnels aren’t worth building.   Today he would be discussing where they are in the analysis, which is an ongoing effort.

The State’s economy is growing yet again

Dr. Thornberg then gave a rundown of the state’s economy.  “Over the last few years, of course, the economy here in California has taken quite a beating as well know as a result of the forces that pushed the overall US economy and the world economy into an economic downturn back in 2008 & 2009,” he said.  “However, in a very real sense, we have been very much in crisis mode for the last few years, but I think the evidence shows that California is indeed growing again and with that in mind, it’s actually growing faster than the U.S. overall at this particular point in time.”

There has been a lot of conversation about how the state’s economic problems have to do with a bad business climate, taxes, regulations, unaffordable housing, a strained infrastructure with the mantra over the last few years being that California is a place that people are leaving, not coming to, he said.  “But ultimately the benefits to being in this state, and that could be everything from climate to being the center of some of the most important industries and a growing technology economy, continue to bring people to our state, rather than the opposite.”

MWDBoardtalk2013_1.3-1_Page_04Dr. Thornberg then presented a map of the United States that displayed the growth in real Gross Domestic Product (GDP) by state.  “Yes, our business-unfriendly state turns out to have been the sixth-fastest growing economy between 2011 and 2012,” he said, noting that manufacturing was the single largest contributor to the state’s growth, followed by information, which includes everything from software production to the movie industry, and then real estate.

MWDBoardtalk2013_1.3-1_Page_05He then presented a slide that showed employment and payroll statistics for California.  “If you look at the payroll numbers, they don’t look so good for the state of California, it looks like we’re way behind, but we often forget that the payroll statistics miss an important part of the California labor force, which is what I call the informal work force,” he said explaining that only workers who receive unemployment insurance are counted in the statistics.  “That’s important, particularly in California where somewhere between 10% to 14% of workers don’t show up on that particular survey.  Over the course of this downturn, a half a million jobs the state supposedly lost weren’t lost at all – indeed, it was workers simply going from the formal unemployment insurance sector to the informal or uninsured sector.  A half a million – that’s over a quarter of all those supposed losses we saw in the state.”

Dr. Thornberg pointed out that the household employment numbers bear this out.  “Relative to 2003, California is about back where it was in 2007 whereas for the nation overall is about 2% behind,” he said.  “So the state is ahead of the overall US economy in terms of growth, and it’s not just a function of number of jobs, it’s a function of incomes.  …  Not only are our average worker wages here in the state higher, but they are growing faster as well; the average California worker is making about 14% more than your average worker in the US overall at this particular point in time.”

MWDBoardtalk2013_1.3-1_Page_06The state is succeeding and growing and of course that means the policy makers need to start getting ahead of the curve and start dealing with this, he said.  “Our employment rate grows much more dramatically than the US overall, but we’ve almost closed that gap.  The U.S. overall right now is running about 7%.  We expect when the new numbers come out in just a couple weeks, unemployment here in the state of California will probably be just a little bit over 8%, closing that gap to about one percentage point.”  He noted that population growth trend is starting to re-emerge as well.  “Population growth trends here in the state are a little less than about 1% per year, compared that to about 0.75% for the US overall.  Population base here is expanding and we need to start thinking about that.”

That population growth rate is occurring, despite the fact that the state continues to have a negative net migration rate, said Dr. Thornberg.  “We have higher rates of overall births in the state, and you can bet that within a year or two, people are going to start moving back here for all the economic opportunities available, as a result, I think we need to take a good hard look at what these numbers mean in terms of long-run population projections.”

MWDBoardtalk2013_1.3-1_Page_07The Department of Finance has released population estimates that say by 2060, 52.6 million people can be expected to be living here in the state, which is an increase of 15 million from today and an overall increase of 60%, he said.  “The question is, where are these new people going to live when they finally do get here?  Well, the answer is not along the northern coast where most of the water is,” he said.  “The vast majority of them are going to end up here in Southern California, including San Diego, Orange County, LA and the Inland Empire.”  He said about 7 million people will end up in Southern California and another 3.4 million people in the Central Valley, so  altogether, over 10 million people coming right here to the southern arid portions of the state over the next 50 years.  “We have to start planning ahead; we have to start thinking about how we’re going to meet the needs of these folks.  We need to meet their needs in terms of housing, roads, electricity, and of course, water.  Water is a central part of this whole thing.”

The state has a growing populace, but also the statistics show that a wealthier population is moving into the state which will increase the overall demand for water.  This demand will increase on a per person basis because of the higher wealth, as well as overall as a result of larger populations, he said.

At the same time, we are also dealing with what I would call the greater awareness of environmental impacts of water policies over the years,” said Dr. Thornberg.  “We understand more about the impact that we’re having on the Delta and some of the species there, but we also recognize the impact having to do with some of these agricultural areas and issues growing there, such as groundwater usage, and there’s also the issues having to do with different dams in different parts of the state. …  All these forces together mean we have to be smarter about how we use our water.

There will be greater variability of supply across and within years due to climate change, he said.  “I say across years because it seems that from the numbers I’ve seen, we can expect greater periods of dryness combined with greater periods of wetness; but also within years,” he said.  “Remember, if we don’t build up that snowpack, it doesn’t mean the water isn’t falling on those mountains; it just means that it’s coming down those mountains and immediately into the water system and we have to be ready to grab it in the few periods of time when it is actually available.”

The system is vulnerable to supply shocks, such as the issues having to do with the dikes and what would happen in the event that a major earthquake collapses them, and last but not least, rising sea levels, which is of course increasing some of the salinity inside the Bay Delta region, said Dr. Thornberg.

MWDBoardtalk2013_1.3-1_Page_09So what do you need to do about this?” said Dr. Thornberg.  “Well you need to ensure reliability of the existing supplies, you have to create new supplies, promote reuse and conservation, and last but not least, be able to invest in storage, and the numbers suggest that that’s exactly what MWD’s doing,” he said, presenting a slide detailing where Metropolitan obtains its water supplies, from 1990 to the plans for 2015 and 2035.  “If you look back in 1990, the SWP provided about 33% of the overall water supply for MWD; that’s since dropped to about 22% which is a pretty substantial decline, whereas conservation and recycling, just 7% of the portfolio back in 1990, is going to be up to about 33% in 2035.  So it’s a big shift, adapting to these changing circumstances, but it’s important to remember that the SWP is still a very important part of the overall water supply needs here in California, and particularly here in Southern California.”

A brief refresher: The Delta in context

MWDBoardtalk2013_1.3-1_Page_10He noted that the vast majority of water is in the northern part of the state, either along the coast or along the Sierra Nevadas, while the majority of the population lives in the drier areas.  “If you look across the overall water system, we have roughly 64 million acre-feet available to us in the average annual year,” Dr. Thornberg said, noting that he took this number from data from the PPIC, not Metropolitan.  “And of that 64 million AF, about 22 million of that falls along that northern coast – water that is largely inaccessible given our current water system that we have here in the state.  And then beyond, the second largest supply adding up to about 30 million acre-feet really comes from the Sierra Nevada Mountains, through the Sacramento and San Joaquin Rivers that bring that water down into the Delta, or the southern part of the Sierra Nevadas which brings it down to Tulare Lake.”

MWDBoardtalk2013_1.3-1_Page_11Dr. Thornberg said there were two things to keep in mind when looking at the average distribution of Delta water.  “If you think about the take from the Delta from the two aqueducts in the central part of the state, the state and federal projects, overall those exports from the southern part of the Delta only represent about 1/6th of the overall water supply in any particular given year,” he said.  “Yet that 1/6th of the water supply represents a pretty large share of water for a number of substantial economies, and these numbers are estimates that we pulled from a variety of sources.”

He pointed to a chart which showed how much Delta water was used by the state’s major urban centers.  He noted that State Water Project supplies comprise 40% of San Jose’s water, 44% of the city of LA’s water, 27% of Fremont’s supply, and 61% of the East Bay communities of Livermore, Dublin, Pleasanton, and San Ramon.  “If you look down in terms of federal water supply coming from the Delta, and coming from Tulare Lake, about 2/3rds of the federal water supply that flows in those two major aqueducts comes from the Sacramento Delta, so while it’s only 1/6th of overall water that flows through there, it’s a huge source of water for many of the cities across the state,” said Dr. Thornberg. “This is obviously a very important source for these particular areas.”

Prior to the federal biological opinions, annual exports from the southern Delta were averaging roughly 6 MAF per year, he said.  “As a result of issues having to do with primarily with fish populations, we know that in 2008-09, there were two major opinions that were passed down by the federal courts and basically they decided that the water operations diversions were jeopardizing the Delta smelt and salmon populations.  They put some new regulations in place that have led to a drop in total water exports to right now about 4.7 MAF per year, so an overall decline of a little less than 25%.  That’s pretty sharp.”

The problems do not seem to be fixed, said Dr. Thornberg.  “In 2013, an abundance count showed that the endangered Delta fish to date have showed some of the lowest totals in 46 years, so in other words, the populations continue to decline.  This is true for the Delta smelt, the longfin smelt, and the threadfin shad,” he said.  “Twelve new species have been added to the federal and state ESA lists in 1994, including two since 2010 when the biological opinions were put into place.  It’s pretty clear that without some broader programs and different approaches, exports are likely to be cut even further.

Dr. Thornberg then quoted Carl Wilcox from a presentation he gave at the Santa Clara Valley Water District:   “[reading Carl Wilcox quote: ‘From the Department’s perspective, the Department has maintained the positions that since the 1960s that the current diversions in the south Delta are probably the worst thing you could be doing for managing water within the Delta and exporting it.’ [Dr. Thornberg:] “So it’s pretty clear that the Department of Fish and Wildlife is still very worried about that southern pull of water out of the Delta and what it’s doing to the populations, and it’s clear that there’s got to be a new approach to how the MWD and the other consumers of that water, how we’re all going to get together and get that water from the Delta supply in a way that would secure those future deliveries,” he said.

MWDBoardtalk2013_1.3-1_Page_13And, of course, this comes down to the BDCP,” said Dr. Thornberg.  “Now the BDCP is a lot of things.  It’s not just the building of the tunnels; it also has to do with ecosystem restoration and preservation.  Things involved in reducing pollutants, reducing invasive species, reducing poaching, improving hatchery practices,  and habitat restoration which is very important for what’s going to happen with those fish stocks, and of course some expanded recreation areas as well, and along with this a new conveyance system, new intakes in the north, and two gravity flow tunnels.”  He noted the system would deliver 9000 cfs to the south and would complement the southern pumps.  “It would never be a complete substitute for pulling water out of the south, but rather you could go back and forth and use either one of those at any particular point in time.  It would allow for better management of the Delta species, it would have the potential to restore some of the supplies – not all of them, but some of the supplies back to the SWP and CVP.  It would also provide some protection against earthquake and sea level rises by allowing you to more or less avoid that southern part of the Delta if something happened like a major earthquake that pulled a bunch of salt water into the southern Delta.”

The Delta tunnels: Outlining a cost-benefit analysis

MWDBoardtalk2013_1.3-1_Page_14So it seems that building these tunnels would contribute to solving a lot of the current problems, said Dr. Thornberg.  So can we sit down and actually say are these tunnels a positive net present value exercise, that is to say, if we added up all the costs and added up all the benefits and put these in monetary terms, would these indeed be a profitable thing for the state to invest in?

There are a couple steps to this, he said.  “The first step is to estimate all these future costs, and these really boil down to what are called direct and indirect costs,” he explained.  “The direct costs are the costs of construction, along with the ongoing costs of maintenance for these projects, and the indirect costs would be those that would occur as a result of building the tunnels, but aren’t directly linked to the invoices that come from building the tunnels.  This would include a decline in agricultural output within the Delta because of slight increases in salinity, environmental impacts that might occur, and construction disruptions to the local economy as a result of the 10 year project going on.  To offset this, you have to estimate the value of future benefits – the restoration of water supplies, the increased quality of the water for users from the SWP or CVP, and of course the environmental improvements that are linked directly to the construction of the tunnels.”

On top of that, we have to think about option values dealing with uncertainty,” continued Dr. Thornberg.  “I talked a little bit about how a smaller snowpack means that certain times of the year, there’s going to be a ton of water rushing through the Delta out in through the Bay and into the ocean.  What is the option value of being able to use two extraction points for gathering that water in those short bursts of time, rather than just having one available to you, particularly if that one is constrained because of the biological opinions as to how much water can actually pull out?  What is the option value of making sure we have that in place, just in case some sort of earthquake occurs that creates salinity problems in the southern part of the Delta?  There is also the issue of increased usage values for other assets, mainly an enormous investment in reservoirs that has been going on in the state.  Can you use those reservoirs effectively without being able to access the water from the Delta from those northern points?

Last but not least, you collapse all these into a net present value form, hold up your two numbers and away you go,” said Dr. Thornberg.  “Simple, right?

Well, not quite,” he continued.  “There are a lot of pitfalls involved in these sort of analyses, and unfortunately these pitfalls and the confusion involved can make this a very tough thing, both from the point of view of just coming up with a right number, but also it leads to the ability for a lot of folk to throw darts at the analysis and to say this thing doesn’t make any sense because they can tweak different parts of the argument relatively easy.”

Where there is confusion, I can say that there’s going to be a push back from the public,” said Dr. Thornberg.  “In a very real sense, when I think about what Beacon Economics is doing here, we’re trying to reduce the confusion, try to clean this variety of opinions up and create what I call a clear message.”

Dr. Thornberg said there were couple of things to keep in mind, one of them being to take moral precedence out of your head.  “A lot of times I hear a lot of folks making statements such as ‘people in the southern part of the state shouldn’t have lawns.’  We might debate such moral precedences for years and years and never come up with an answer.  You can’t think about it that way … For example, as an economist, I find it offensive that people read People magazine.  You should all be reading The Economist.  But ultimately that’s not for me to decide.  People are going to make their own decisions, and if you want a lawn in Southern California, and you’re willing to pay for it, you’re allowed … that’s how our society works.”

It is the aggregate Net Present Value (NPV) that is important, he said.  “It’s everything added up together.  When you do these kinds of analyses, there typically are winners and losers.”  He gave the example of the NAFTA treaty, reminding that there was a lot of pushback against it at first.  Although the NPV of the treaty was positive – free trade is good, he pointed out – we also had to acknowledge that there would be winners and losers.  “Some companies were going to do great, some companies were going get hurt, and some workers were going to find more opportunity for them in the US; some are going to lose their jobs.”

So in terms of the NPV itself, there are two things to keep in mind, he said.  “Does this thing make sense from an aggregate net present value, and then how do we compensate the losers in order to make sure that they are not left in the dust as a result of these changes? That’s a separate debate.  There are going to be winners and losers in the context of making the tunnels but that’s something that we have to debate on the side,” he said.  “The first question is whether or not these tunnels are all by themselves worth building.”

Environmental benefits should be considered separately, Dr. Thornberg said.  “This came from one of the criticisms from Jeff Michael in his first critique of the Sunding analysis where he said that a lot of the environmental benefits that were added into the NPV are environmental benefits that stem not from the construction from the tunnels but from all the other efforts,” he said.  “By the way, he was 100% right on that.  That shouldn’t be included in the NPV in the tunnels because that environmental restoration, for example, taking those 145,000 acres and turning them into fish habitat, that’s a separate issue and should be thought about as a separate issue.”  However, that doesn’t mean that the tunnels don’t have a positive environmental impact, said Dr. Thornberg:  “I think they do.  And Sunding, when he did his second analysis, sort of threw that all out which I also think was incorrect.”

Also another issue is the impact of rising sea level and salt water encroachment coming into the Delta as a result.  “Is that a tunnel issue?  No, it’s not. It is true that if you prevent the building of tunnel and you are more or less maybe helping the salinity issue by simply saying to those people who take the water out of the CVP and SWP, sorry you can’t have any more, and that helps the salinity,” he said.  “But in reality, there are a lot of folks who consume water from the Delta.  Remember, about half the water that comes through that Delta ends up in the ocean and the other half is consumed, of which a third is consumed by those aqueducts.  Ultimately, the two-thirds of folks who also access water from the Delta are just as responsible for dealing with salinity issues as much as the one-third coming to the two water projects.  That’s an aggregate issue, not an individual issue for these tunnels, so again, you don’t want to confuse that because it’s not appropriate in the context of whether or not we build these tunnels.”

And there are a lot of other things:  “How do you value species preservation?  What is the value of the restoration of water supplies for usage?  What are the appropriate metrics in terms of the discount rate?  How do you deal with future uncertainties? A lot of things can happen,” said Dr. Thornberg.  “Ultimately, if you add it up, we understand that there’s not one number.  Anyone who holds up a point estimate and says this is correct, they are only fooling themselves. There are too many variables here.”

MWDBoardtalk2013_1.3-1_Page_15So what you need to do is study what your expected value is and then use some stress testing,” he said.  “How often do you end up in that net present value range?”  It’s much like a bell curve, he explained; there is a range of outcomes.  “How much of that, what percentage is you will, of that curve exists to the right side of 0?  In how many circumstances does this thing end up being a positive net present value? That’s what you have to be thinking about.”

What I’m trying to do here is come up with a standard set of values but be very cognizant of the fact that there’s multiple ways of looking at it,” he said.  “You want to look at a variety of different ways and see which one of these makes sense, gives you the best sort of result, and gives you an idea of the potential spread of potential outcomes of this project.

Comparing the various analyses

Pages from MWDBoardtalk2013_1.3So it really boils down to this,” said Dr. Thornberg.  “We had Dr. Sunding’s analysis part 1, which was his initial data, and part 2, which changed a number of things.  His first report had the NPV up in the $50 billion range or so – very high.  Most of that had to do with the environmental benefits which were removed from the second version.  Now Jeff Michael’s original criticisms said that the number’s completely wrong and shouldn’t be included, Dr. Sunding removed that; less because of Michael’s criticism and more because of the fact that he was doing this from a ratepayers perspective.”

Dr. Thornberg pointed out that Dr. Sunding is constrained in what he can do on the basis of some federal rules having to do with how the reports are considered.  “For example, he’s really only able to look at the value of 20 of 25 years of operation on these tunnels when realistically this is a 50-year project, so in a sense, he has to leave things out by certain rules, things which I’m allowed to bring in because I’m not constrained by such rules.”

In Dr. Michael’s analysis, he removed many of the positives having to do with the value of water because he doesn’t think there’s going to be any more reduction of water supply, said Dr. Thornberg.

There’s also a water consultant out there by the name of Dr. Rodney Smith,” said Dr. Thornberg.  “He doesn’t have any real analysis as far as I can tell.  He just does these blog posts where he throws darts at the overall thing and expresses some skepticism.  It’s hard for me to talk about Rodney’s analysis because he doesn’t have an analysis per se, but if he does come up with something at some point in time, we’ll certain roll that into our work.”

As for Dr. Michael, his critical difference is has to do with more of a theoretical construct,” said Dr. Thornberg.  “He actually more or less accepts most of the BDCP numbers that Dr. Sunding came up with.  He simply quibbles about which ones should be added and which ones shouldn’t be added in.  The only place he really comes up with a different cost has to do with the salinity impact of the ag; he has a higher salinity impact, although it’s worth noting that his negative salinity impact on in-Delta ag is still smaller than the positive economic impact of better salinity levels for the water going to the two water projects, so in a sense, it’s kind of an irrelevant point.  He dismisses again all the environmental use and non-use benefits and he does not see as noted future reductions in supply.  Dr. Smith, as already noted, doesn’t have a complete NPV analysis, but he’s worried about cost overruns and thinks the discount rate being used is too low because it’s not accounting for the risk of the particular project.”

MWDBoardtalk2013_1.3-1_Page_17He then presented a slide that compared Dr. Sunding’s numbers against Dr. Michael’s.  “Originally Dr. Sunding had about $30 billion NPV; his new analysis has between $4.7 billion and $5.4 billion,” said Dr. Thornberg.  “The big swing item between these two analyses really has to do with the value of water.  Remember, when you look at Dr. Sunding’s analysis, he says that the value of water is roughly $15 billion.  That would include two things.  It has to do with the restoration of some water supplies; in his analysis, he assumes restoration about 1 million cubic-feet per year on average, but then he also assumes that over time, the amount of deliveries that would be delivered without the tunnels would drop from 4.7 MAF to approximately 3.5 to 3.9 MAF.  So in other words, the losses in water get larger and larger as the economic losses get larger and larger as well.”

Dr. Michael says that’s not going to occur,” continued Dr. Thornberg.  “He thinks that there’s not going to be any change in the overall deliveries from the southern access point, with or without those tunnels, and that’s really the big swing item there.  Also, Michael says there would be $1.1 billion in losses because of increased salinity in Delta water, but then he agrees with Sunding that it’s going to be $1.8 billion gained as a result of reduced salinity into the SWP and CVP, so no matter how you look at it, it still ends up being a net present value positive.”

Even if you don’t believe Michael’s higher numbers or you do believe them, it’s still a positive impact, all said and done, so the value of water is a big deal here,” he said.

Dr. Thornberg’s analysis

MWDBoardtalk2013_1.3-1_Page_18Dr. Thornberg than gave his take on the water value.  “First of all, given the quote I read you [from Carl Wilcox], I think it’s pretty clear that with continuing degradation of the environmental quality of the Delta, and given those ongoing issues having to do with how they feel the southern extraction routes are just not good for fishing stocks, it seems clear to me that you’re going to continue to see reduction in our ability to take water from the southern end.”

You are really dealing with this on two levels, he said.  “First of all, you have the sheer restriction on the amount of water, but also, go back to this idea that there’s going to be greater variability in supplies coming through the Delta,” he said, giving the example of having a huge rainstorm, but being unable to pump from the southern Delta because Detla smelt are in the vicinity.  “If you have the ability to have two extraction points, you can work around the fish stocks, and that of course means you can get more water from the Delta, regardless of the time of year that it is.  All this says is that it’s going to be able to add more water back, relative to what the current restrictions are, and for future increased restrictions.  So add this up and Sunding’s estimate of those future gains, if you will, of keeping that water supply in place, $11 billion is probably closer to the truth.”

But Sunding estimates that there will be about 1 MAF in restored supply.  “Current estimates are that it may end up being less than that, maybe only half of that, when they finally get these tunnels built,” he said.  “That of course means that the restoration value could be less than 4 billion which would tend to tip in Jeff Michael’s direction, if you will.”

But then both are underestimating what I would call the value of the restored water,” Dr. Thornberg continued. “Sunding, for example, limits the time in his model to 23 years – it’s a 50 year project.  So you add that up, all these numbers are too low because they are missing 27 years of water deliveries in this particular analysis and that’s incorrect.

MWDBoardtalk2013_1.3-1_Page_19So how do you value that regained water?  “There are two ways of doing it,” he explained.  “From an economic perspective we can say that if we don’t get water from the Delta, we’re going to get it from other sources; for example, stormwater, groundwater recovery, recycled water, and desalination.  However, if you sit down and you look at the costs of these projects, you look at the small scale of these projects, it’s pretty clear that you’re not going to be able to restore this water supply.  Maybe a small portion of it, but take for example, something as basic as desalination.  A, as we are learning in San Diego, it’s very expensive … you add that all up and you’re talking $1000 an acre-foot for water from the Delta, even including the tunnels, and you compare that to $1600 to $3500 per acre-foot for desalinated water.”

At least at this point in time, it’s pretty clear that there’s no way of replacing the kind of water quantities we’re talking about using these other methods,” he said.  “These will always play some role in growing the overall portfolio and trying to meet population demand, but it’s very hard to see this dealing with what I would call those kinds of shortages in the short term, and indeed if we had to go this route, very quickly this thing becomes a positive net present value because these sources of water are so expensive.”

So with that in mind, I lean towards how Dr. Sunding deals with this, which is to say that if you’re not going to restore these water supplies, you can assume that these are simply water supplies that aren’t going to be consumed and the way you deal with that is by increasing the price beyond what people are willing to pay so they don’t consume it and they find other ways of doing what they want to do with that particular water,” he said.

MWDBoardtalk2013_1.3-1_Page_20He then presented a slide called the ‘willingness to pay analysis.’ The chart had two lines on it, a high band and a low band, which represented how much water would be restored over time if the BDCP was implemented.  “A high level number says 1 to 2.5 MAF from 2027 to 2077; at the low end, half a million to 1.25 MAF per year.  Now the question here is how much is this water worth.  Let’s just view that from a willingness to pay analysis.  How much are you willing to pay for this particular water?

Dr. Thornberg said that with the other environmental benefits to one side, the costs minus the benefits ends up to be an NPV of $11.5 billion.  “The open delivery costs I’m going to assume are about $850 per acre-foot for water coming from the Delta, and  I’m going to use a 1.5% discount rate, which is more or less what Sunding and Michael used.  Sunding came up with $15 billion worth.  It’s also worth pointing out that the prices currently paid in California range from $600 to  $1900 per acre-foot, and that’s what an urban residential user is roughly paying at this point in time.”

Dr. Thornberg then gave a basic analysis using the numbers.  “If you assume that an urban user values an acre-foot of water at $1200 and an ag person at $140 per acre-foot of water, the NPV of restoring those water supplies at the high end is about $12 billion per year,” he said.  “So forgetting everything else, the option values and all that sort of stuff, this thing already makes sense at those very reasonable rates.  People are already paying more than that for their water.

On the low end, the red line, you would have to say this thing makes still sense, given that a willingness to pay of about $1600 per acre-foot, but then again, that’s a fairly reasonable number in an arid Southern California region,” said Dr. Thornberg.  “There’s nothing particularly unusual about that number, and indeed, some folks are paying more than that for their water currently, and then I can bring in the option values and this thing starts to make a lot of sense.”

Now to give a nod towards Dr. Rodney Smith, he says we’re using a discount rate that is too low,” he said.  “So if I used a higher discount rate as per him, well now those numbers turn into $1400 to $2000.  Probably at the $2000 range, we have small delivery and a higher discount rate, so maybe at that point in time you are tipping into the negative NPV but again, I’m ignoring all of the option values which I haven’t even included those at this point in time.  And so you start to see without even getting too complicated or too sophisticated that these numbers start to add up pretty quickly and this thing makes sense.”

MWDBoardtalk2013_1.3-1_Page_21So what about those option values? “Two tunnels are better than one, and obviously there’s a value in being able to shift exports from north and south, depending upon environmental needs.  Where are the fish, where is the water.   Smaller snowpack means more shortage periods of water availability so you want to be able to go back and forth.  There’s dealing with water availability across years; in a wet year, you want to get as much water as you can in preparation for the next few dry years like the time we’re in right now.  We have to deal with earthquake risks and the value of not straining those assets, and we’re better able to deal with salinity issues from rising sea levels. You have an option, north or south, where do you want to pump the water, how do you want to manipulate the Delta, if you will.”

The truth on the environmental issue is somewhere in between,” he said.  “Dr.  Michael said, don’t include any of the environmental value, and indeed, that’s what Dr. Sunding did because he was doing this from a rate payer perspective.  But realistically, if you think there’s a value to restoring the fish stocks, you also have to recognize that restoring the fish stocks is improved by being able to use two access points.  Don’t just believe me – believe the Fisheries and Wildlife at the federal level because they believe that the southern extraction route is the worst thing for those fish stocks.  So with that in mind, you have to include some value of that non-use environmental impact.  Dr. Sunding says it’s close to $50 billion.  I’ll tell you what; I’ll be conservative and take 10% of that.  As a result of those tunnels, that’s still $5 billion.  Well that puts us way into the positive NPV range.”

MWDBoardtalk2013_1.3-1_Page_22Regarding earthquake risks, Dr. Thornberg said both Sunding’s and Michael’s reports have numbers concerning earthquake risks, but those numbers represent the percent chance of a major earthquake and how much consumption would be lost.  “You know what no one’s talking about in those earthquake analyses?  The secondary impacts,” he said.  “If you had a major earthquake in the Delta tomorrow and suddenly you were facing limited water extraction from the Delta for all those two water projects over the next two, two and a half years, it’s not just the reduction in the quantity of water.  We would probably be able to handle that from just some major conservation efforts and trying to extract some water from some different sources, but keep something in mind.  What would they have to do? The first thing they would do is put a moratorium on all new residential projects in the state for the next two years because there’s no water available for it.  What other industries would be impacted in that?  It could be pretty severe when you start thinking about the potential economic impacts and that’s not included at all in these analyses.”

Then there is the argument, can’t the levees just be repaired?  “Well you could pour $4 billion into them, but everybody I’ve talked to says that doesn’t guarantee that it’s going to reduce the potential impact of a major earthquake in the region, and of course, that’s ongoing and it’s something you have to do every few years because those Delta levees are constantly degrading in this particular point in time, so that’s no solution.  It’s $4 billion for partial protection on what could be a very serious issue.”

MWDBoardtalk2013_1.3-1_Page_23And then there are the stranded assets, Dr. Thornberg said.  “You have a situation right now where there’s about 2.7 MAF being stored in a system that can handle 5.5 MAF.  You have to fill those up and that means being able to extract water from the Delta when that water is available.  If you can’t do that, you may never be able to fully use that reservoir system, and that’s money that went up into smoke, and nobody’s putting this into the analysis.”

So if you add it up, it seems pretty clear that the tunnels are going to restore some supplies and increase reliability over time,” said Dr. Thornberg.  “It’s not the solution, but it’s a big part of it for water needs.  I keep telling people, stop hitting the panic button.  There’s way too much crazy talk about this.  It’s 33 million acre-feet annual runoff through the Delta of which half always goes out to the ocean, and the other half, 2/3rds of that is used by people outside those two water aqueducts in the south.  Yes, there are some broader issues that have to do with managing the Delta, but those broader issues need to be dealt with by everybody – upstream and downstream users.  It’s not fair to lump all those issues just on the users of water from those two aqueducts.”

Keep something in mind – you’re talking about 6 MAF exported before the biological opinions and there’s not one estimate I’ve seen out there that suggests that those two aqueducts are going to take more than that in the future,” said Dr. Thornberg. “Indeed, if they get up to 5.5 MAF to 5.7MAF, that seems to be an outside probability at this point in time, so we continue to talk only about restoring water supplies that were being taken up to 2008.”

So, in summation …

So if I had to sum it up, I think it’s pretty clear that the tunnels NPV is greater than 0,” said Dr. Thornberg.  “Alternative supplies are too expensive, the value of restoring water seems large enough to justify a project, but on top of that, you have to throw in the options values of having two access points from the point of view of managing the fisheries and the point of view of avoiding issues having to do with earthquake disruptions to the supply.  And to reiterate, broader issues having to do with the overall health of the Delta need to be met by all water users from the Delta, not just the CVP and SWP.”

MWDBoardtalk2013_1.3-1_Page_25Regarding a smaller tunnel, “According to my conversations with a couple of folks involved in this – if we did say a 5000 cfs tunnel or a 3000 cfs tunnel, some aren’t worth building it because ultimately you’re not going to be able to pull enough water out of the northern part of the Delta to really justify the costs of doing that. A smaller tunnel is not that much less expensive to build.”

If there are other options or ideas that some think would provide all of these benefits, he’d like to see it, he said.  “I have yet to see anything that would be a reasonable potential plan.  And we have to keep in mind, if you have an alternative plan, is it even reasonable and is it something that could actually occur?

There’s obviously more to figure out, particularly in the value of the options, the economic damage of an earthquake, and a better sense of what the environmental value is of having two access points.  “At least at this point in time, I’m fairly comfortable that in the positive zone is where it exists at this particular point in time, and really it’s just a function of continuing to pull more information and simply hone that message and make it that much easier for people to understand when this thing eventually ends up in the public forum for a vote.”

The directors have questions, but they are out of time.  They discuss Dr. Thornberg returning at a future date, once they’ve had a chance to review his presentation.

There’s a lot of questions here that need to be answered, but I think most of those questions are about the positive values,” said Dr. Thornberg.  “Here’s one of my thoughts … at this point in time, what’s unanswered are things that simply add to the positive value of this particular project.  If you think I missed something in the context of things we need to consider on the negative side, I’m obviously very happy to hear about that.  We’re all ears.”

I’m in this project, not because I have a prepaid point of view,” said Dr. Thornberg.  “They asked for my honest opinion on this once I’d gone through all the numbers, and I think in a very real sense, Beacon deserves its reputation for being a relatively straight shooter.  So I’m all ears.  If you have thoughts, worries, issues, by all means, please feel free to contact us and we’ll do our best to assuage those fears or add them to our analysis.”

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