Assembly oversight hearing on the funding structure and economic impacts of the Bay Delta Conservation Plan (part 2): Anton Favorini-Csorba and Dr. Jeff Michael on funding the BDCP

BDCP Meeting 1On February 12th, the Assembly Committee on Accountability and Administrative Review held an oversight hearing on the funding structure and economic impacts of the Bay Delta Conservation Plan.

Citing the ‘ever-expanding’ costs of the BDCP, Assemblyman Frazier started by stating he had concerns who will pay for the project, the assumptions surrounding state and federal funding, the adequacy of the funding structure of the BDCP, and the cost allocations among the contractors, among other things, and he hoped the hearing would address these issues.

This is the second of four parts.  The first part featuring the Deputy Director of the Department of Water Resources Laura King Moon and ICF International’s David Zippin on the Administration’s perspective is posted here:  Assembly oversight hearing on the funding structure and economic impacts of the Bay Delta Conservation Plan (part 1): The Administration’s Perspective. Tomorrow’s installment will cover Dennis Cushman with the San Diego County Water Authority and  Marguerite Patil with the Contra Costa Water District who discuss their concerns about the project.  The fourth and final part posting on Friday will cover Delta stakeholder views from the perspectives of Melinda Terry from the North Delta Water Agency, Larry Ruhstaller with the Delta Protection Commission, Charles Gardiner with the Delta Vision Foundation,and Bill Wells with the California Delta Chambers & Visitor’s Bureau.

Anton Favorini-Csorba, Legislative Analyst’s Office

Anton Favorini Csorba with the Legislative Analyst’s Office began the second panel of the hearing with a discussion of the financing of the BDCP, highlighting the points related to the LAO’s overview.

About 150,000 acres of habitat are proposed to be restored with the BDCP, he said.  “Some of that will have to be done prior to the operation of the tunnels because we’re looking at a range of exports under BDCP,” he said.  “We need to know how well the habitat restoration is doing in order to figure out where in that range we’re going to fall.”

Mr. Favorini-Csorba said that to date, about $176 million has been spent on the planning process for BDCP, with that being paid for by the water contractors.  He acknowledged the costs may have increased as some time has elapsed since they obtained that number.  Costs for the project are estimated at $24.8 billion, according BDCP documents, which does not include financing costs.  It also does not include discounting, which he explained as a way that economists look at the costs of projects, accounting for the fact that a dollar spent in the future isn’t the same as a dollar spent now.

We found that the cost assumptions were generally reasonable, and the contingencies are relatively in line with engineering practices from what we can tell, said Mr. Csorbra-Favorini, noting that there were some cost assumptions identified that could be improved.

BDCP LAO ChartBDCP is required by law to identify funding sources for the entire cost of the plan and they have done so,” said Mr. Csorba-Favorini, noting that there is some uncertainty around some of them.   “There is $16 billion for conveyance that, according to BDCP, is funded entirely by the contractors; there has been some discussion of the terms of the current contracts that are used to fund the State Water Project and how they protect the state, regardless of whether there are water deliveries or not.”

Mr. Csorba-Favorini said that the ecosystem restoration is being principally funded, about 90%, by the state and federal governments, with state’s share of the funding anticipated to come from two water bonds, one of those being the one that is currently on the ballot in November, 2014, and the other being a second water bond in the future with no particular time specified.  He noted that there is more detail in the chart of page 4 of the LAO’s report.

The LAO’s report identifies some issues for legislative consideration.  The first issue are the costs that were used to estimate land acquisition.  “We think that the costs could be a little bit higher just because you’re looking at purchasing so much land in the Delta in a relatively concentrated period of time, so that might drive up demand for land in the Delta, and therefore the price,” he said.

There is also potential for cost overruns, said Mr. Csorba-Favorini.  The figure in the LAO report cites 34% on average, but he noted that’s for transportation projects, which is what most of the research is focused on.  “Of the research that we’ve seen on water projects specifically, there are some indications that cost overruns may be smaller in magnitude,” said Mr. Cosrba-Favorini.  “One salient example of water projects that I’m aware of is the Freeport Regional Water Project, which was just recently completed nearby, and that was a billion dollar project and it came in pretty much on budget.”

But cost estimates are based on assumptions and the actual costs can turn out to be significantly different, he said.  “One of the issues that we’ve raised with BDCP is that they provide a single-point estimate of what the cost is going to be,” he said.  “We might like to see a broader range of a high cost and low cost estimate so that the legislature can look at and see that if everything goes really well, this is what it might cost, and if everything goes wrong, this is what it might cost.”

BDCP Anton 1“It’s unclear whether the benefits of the tunnels will necessarily outweigh the costs,” said Mr. Csorba-Favorini.  “The BDCP does describe the benefits being 34 to 40% greater than the costs of the tunnels, at least to the folks who would be paying for them.   That may end up being accurate but there are two factors that could affect the net benefits. The first one is the question of cost overruns; if the costs end up being higher, the net benefits are lower.  The second one is that the benefits of the BDCP are predicated on essentially what the value of the water coming out of BDCP would be.  If there’s lower demand for water, that would reduce the benefits to some degree.  Similarly, if there are lower costs for alternatives to BDCP like water recycling or desalination, that might lower the relative benefits of BDCP.”

How a project is procured can affect the potential for cost overruns, Mr. Csorba-Favorini pointed out, explaining that the state typically uses a design-bid-build model, which is where there are two separate contractors are used, one for the design and one for the construction.  There is an alternative model called design-build where the same contractor does both, he said, but each has its relative advantages and disadvantages, he said.  “You may get greater certainty about what the project looks like under a design-bid-build because you have a little bit more control over that,” he said.  “On the other hand, a design-build allows the contractor to make some changes to a project but potentially stay more within budget, so it depends on what your priorities for the ultimate outcome of the project.”  He added that the legislature may want to ensure that DWR is considering all the different forms of procurement when looking at this project.

Turning to the funding sources, the LAO has identified some areas for the legislature to consider.  The first is that currently, there are contract terms in place that with the State Water Project contractors that protect the state from risk, he said.  However, those contracts are actually in the process of being renegotiated right now, and those terms are not necessarily guaranteed going forward or they may not necessarily apply to BDCP, so that will be something to watch as those negotiations proceed, he said.

Secondly, the state sources for ecosystem restoration have not yet been approved by voters, and the legislature is currently considering changes to the 2014 bond, so whether or not those materialize in the form and vision by BDCP is something of an open question, he said.  “One point thing to note is that the BDCP now explicitly states that State Water Project and Central Valley Project contractors will not pay additional costs or forego any water in the case of a funding shortfall,” said Mr. Csorba-Favorini.  “Ms King Moon said that the contractors could voluntarily contribute, but there would be nothing requiring them to do so.”

The third point is that there may be a potential for additional public liability if some of these species restoration measures don’t work as anticipated, he said.  The Delta is affected by a wide variety of factors, many of them outside of the Delta, and if those factors were to put endangered species at risk of extinction, the state and federal endangered species act would require some actions on the part of some entity – it’s not entirely clear which, to make sure that those species don’t go extinct, explained Mr. Csorba-Favorini.

Under federal regulatory guidelines, you essentially can’t charge the permittees for those,” he said.  “The intent of a NCCP plan is that is provides some assurance that if you do everything in the plan, that will be all that you are required to commit.  What that means is that maybe the state and federal governments might be on the hook for any additional measures to help compensate.”

There are some potential legislative actions you could consider, Mr. Csorba-Favorini said.  The legislature will be asked to appropriate funding for some of these measures if the BDCP goes forward, he pointed out.  “You also have the opportunity to go a little further to perhaps ensure either that BDCP succeeds or to minimize some of the risks associated with it,” he said.  “One of those might be to designate some other entity as a backstop in case state or federal funding doesn’t materialize.”

If the backstop were to be the contractors, it seems likely that you’d have to do that before BDCP is approved by the Department of Fish and Wildlife, he said.  “I think once it’s approved, you get into some murky legal waters in terms of whether it’s violating the regulatory assurances there.”

Another potential legislative action could be to expand some of the policies that the legislature has already adopted to control some of the factors outside of the Delta, such as the requirements for conservation or groundwater management.   “This might ultimately take some pressure off the Delta and therefore reduce the risk that the state might need to come forward with additional funding for ecosystem restoration,” he said.

BDCP FrazierChair Jim Frazier asked Mr. Csorba-Favorini to expand on his observation that it is unclear whether benefits of the tunnels will outweigh the costs.

The BDCP’s net benefit analysis made the case that the project made sense by putting a value on people’s willingness to pay to avoid shortages in the future, said Mr. Csorba-Favorini.  “Right now they are projecting net benefits of around $4.5 billion over the life of the project.  If there were to be cost overruns, you would see the amount of net benefit shrinking because you had higher costs.  A second consideration there is that BDCP is assuming a certain amount of water in the future which is a fundamental input into what they think the benefits are going to be. If it turns out that there’s less demand south of the Delta for water, then the value of BDCP goes down to, so the benefits side of that would go down.”

Dr. Jeff Michael, economist, professor, and consultant for Delta Protection Commission

Dr. Jeff Michael began by clarifying the costs of the BDCP as it relates to the cost of High Speed Rail.  He noted that he’s studied both BDCP and High Speed Rail financing in detail.  “The High Speed Rail financing and cost estimate of $68 billion does include inflation but does not include financing costs, and there are not as many revenue bonds associated with that financing plan.  The BDCP $25 billion is current dollars so it does not include inflation like High Speed Rail estimate and also does not include financing costs.  It is not really directly comparable to the High Speed Rail costs.  However, I do think it is fair to say a comparable figure would be more than $25 billion, somewhere in the middle.”

Dr. Michael stated he would be focusing on three issues: the cost allocation, the shifting of risk, and the economic studies.

BDCP Michael 1First, in regards to financial feasibility, Department of Water Resources’ own guidebooks define that financial feasibility requires that a project has benefits that exceeds the allocated costs for every single participant, he said, noting that BDCP has yet to provide a cost allocation amongst the agencies. “This is a really difficult problem that they are working on behind closed doors, and so without that, they cannot claim that they have shown financial feasibility for the project,” said Dr. Michael.

The costs of the BDCP are absurd for an irrigation project, Dr. Michael said.  “The majority of the water exported from the Delta is for agriculture,” he said.  “The BDCP working assumption to date is that all agencies are going to pay an equal amount per unit of water received via the tunnels.  That means agriculture would bear the majority of the costs of the tunnels, and that assumption is what’s behind Metropolitan Water District telling its urban ratepayers the cost is $5 month.  The question is it feasible for the agricultural users, and to date, BDCP hasn’t looked specifically at them.”

Dr. Michael said that a recent presentation to Westlands Water District by Citigroup and DWR estimated tunnel debt service to be between $1.3 billion and $2 billion per year, in contrast to the $1.1 billion figure in Chapter 8.  “Agriculture’s share of this would be about 60% or $1 billion per year,” he said.  “That’s an enormous cost for agriculture to bear for water supplies and conveyance and is completely out of scale with anything that’s been done before.”

The BDCP EIR/EIS says that in an average year, water exports will increase between 0 and 800,000 acre-feet per year,” said Dr. Michael.  “As the Administration said earlier, last year, they would have gotten another 800,000 acre-feet exported from the Delta; this year 0, and in a really wet year, more than one million acre-feet.  That’s the best case scenario.

But just do some simple math,” continued Dr. Michael.  “Divide that debt service by the best case of 800,000 acre-feet of additional year per year and you get a range of between $1500 & $2500 per acre-foot.  That’s pretty steep for agricultural prices; that’s pretty steep for urban agency.  … The costs are really nonsensical for agriculture compared to the benefits.” He added that he couldn’t think of anything worse for the Central Valley economy then to give them a billion dollars of debt service for a project that wouldn’t help significantly with drought relief.

The BDCP has basically yet to demonstrate that the plan makes sense for farming or to propose any reallocations of costs, he said.  “I don’t see how investing in BDCP would be a profitable investment for farmers unless their cost share goes way down.  …  My estimate is that the cost share would have to go down to 10 to 20% before it would even start to make sense for agriculture.”

These cost issues could complicate bond financing, because investors are going to be concerned about the financial feasibility of some of the agencies and may require a taxpayer backstop, said Dr. Michael.

The costs could also be reallocated from farms to urban ratepayers, he said.  “If those costs were reallocated, their costs could be two to three times higher than what they’ve been told under the current cost estimates.”

BDCP Meeting 1“The costs are unlikely to be reallocated to urban agencies without some reallocation of the water supplies, and this is another part of my concern about the Central Valley,” Dr. Michael said, noting that in the BDCP EIR, there is some language that raises the possibility of ag to urban transfers as part of the new water contracts that would be part of financing the BDCP.  “The BDCP could cause water to be moved out of Central Valley agriculture into urban areas to help pay that debt service, and obviously that would have economic impacts in the Central Valley, so that’s something I think we should get to the bottom of and understand what the potential for that is.”

The second point is risk reduction or risk shifting.  “Water contractors have said they are willing to pay for BDCP despite that it’s not increasing water supplies over the current levels because it reduces their risk of a future loss,” he said.  “The BDCP would provide assurances and reduce those water export risks and that has value; it would prevent or at least reduce the ability of them being asked to contribute more money or water in the future to help endangered species, but I do not believe that the BDCP does much to reduce the state’s overall risk.”

“There is a lot of uncertainty about how BDCP will work,” Dr. Michael continued.  “This isn’t a scientific hearing but there’s certainly uncertainty about these habitat measures and the tunnels themselves and how the impacts on species.  Under BDCP, the risk of failure doesn’t fall on those agencies.  That’s their assurance; it falls on others.  It could fall on upstream water interests, it could fall on the in-Delta interests, it could fall on the environment or on the species themselves or it could fall right back on taxpayers.  And considering that most of the habitat elements of BDCP that are actually going to help the endangered species are financed by taxpayers, the question is what regulatory assurances do the taxpayers receive for their investment?  I don’t see much here and I see that they are actually paying for the things that would reduce risk to the endangered species and also receiving risk in that transaction, so it’s not clear that it’s a good deal for taxpayers.”

Third, in regards to the economic analysis, “I would argue that if an agency or administration is going to make a proposal as divisive and as controversial as these tunnels, and they certainly are all that, you better be able to show an overwhelming statewide economic case for the project.  And you better make sure that accepts all the best practices and your own guidelines as very conservative in the analysis.”

Dr. Michael recently wrote a 16 page review of the economic analysis  for Delta counties, Review of the Bay Delta Conservation Plan Statewide Economic Impact Report, August 2013 draft.  “To the credit of the consultants for BDCP, they have already acknowledged a few errors in that work and are working on a revised draft now,” he said. Some of the problems identified in his report include overstating the future demand for water, assuming no further investments in local supplies beyond what is in progress now, the habitat measures and the tunnels need to be justified independently, and inconsistencies among the assumptions used in the various analyses that have been produced to date, he said.

But the core issue here is the policy analysis and what’s best for the state,” he said.  “We know the trade-off between environment and water exports is critical, and that people of the state would like to see some consistent assumptions under all these sorts of analyses.  The fact that they can’t get a benefit cost ratio without making these sorts of changes is really a red flag about the economic value of the project.”

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