Media call on latest BDCP Affordability and Financing Considerations report, plus a brief update on when to expect the recirculated BDCP docs

This morning, the California Natural Resources Agency held a media call regarding the release of the report, The Bay Delta Conveyance Facility: Affordability and Financing Considerations.  On the call today was Karla Nemeth, policy advisor to Governor Brown on water and also the lead on the BDCP, Tim Gage, former finance director for the State of California and a consultant to the State Treasurer’s Office, preparer of the independent economic analysis of the BDCP’s affordability, and Dr. David Sunding, the BDCP’s economist.

Here’s what they had to say.

Karla Nemeth

I’ll be very brief. I just wanted to describe the importance of the independent study to the ongoing discussion about the value of the Bay Delta Conservation Plan. As many of you probably know, Natural Resources Agency developed cost benefit information on the plan, but we had not yet addressed some of the broad questions about financing and affordability. This report certainly moves that conversation in the right direction.

We’re still clearly in the process of developing the proposal, more specifically improving its compatibility with Delta communities, developing effective cost containment strategies, and improving the science upon which the plan is based. But given where we are, we believe this report is a very positive assessment of the affordability of the proposal. It’s certainly consistent with the cost benefit information we’ve developed, and it’s also very clear-eyed and very timely about the financing considerations as we move forward.

So with that, I’m going to turn it over to Mr. Gage.

Tim Gage

I just want to spend a few minutes giving you some sense of what we tried to do in this report. As Karla mentioned, the BDCP process has put together information as it relates to cost benefits. We did not actually attempt to replicate or validate that information. Instead, what we did is we tried to estimate the costs of the project under different scenarios. We developed a sense of whether the additional costs of the project to the water contractors would be affordable; and we also identified several important financing issues and risks. In order to do that, we had to develop a number of scenarios and make numerous assumptions about how costs would be allocated to the various contractors.

For instance, how would costs be allocated assuming that financial responsibility would be driven by water deliveries? And basically that was the underpinning assumption in our report; basically the costs would follow those deliveries. We used water delivery data provided by the BDCP team that captures the precipitation and deliveries, and this data enabled us to capture the variability between wet and dry years. The data was also broken down into four delivery scenarios based on different operational assumptions for the project. In other words, how much water would flow through the bay, which in turn helps to determine how much water would be available for delivery.

With the help of the treasurer’s office, we constructed three scenarios regarding debt service costs. These scenarios were used to determine how much costs would increase or decrease based on higher or lower construction costs, higher or lower interest rate costs, and when bonds would be issued and construction would actually get underway on the project. These scenarios, which we dubbed the base case, the best case, and the worst case, are not intended to reflect the absolute best or worst cases, but rather provide some sense of the impact of changes in these different variables I just talked about on the debt service costs that would be borne by the water contractors and their customers.

Under these scenarios, the costs that would be debt financed would range from $14.7 billion to $25.2 billion – that’s the best case and the worst case scenarios, and the base case scenario is $19.7 billion. Now it’s important to note that these figures are all expressed in terms of so-called nominal dollars – what we have called in the report, ‘year of the expenditure’ dollars. This is a standard practice for projects that are financed over time. Any time you have a construction project that the state gets involved in, those dollars are expressed in terms of what the actual value of the dollars are at the point in time they are actually expended, and that’s in contrast to much of the cost information in the BDCP document itself, which is expressed most often in terms of constant 2012 dollars.

The reason that we did that is because expressing these costs in terms of year of expenditure dollars is going to be more familiar to the public finance community with whom we’re speaking in some respects in this report. But it’s worth noting that it has the effect of making the expenditures seem larger but they’re not, because they are simply expressed in terms of the value of the dollars in the year in which they are spent.

So with that background, peak annual debt service costs under the three scenarios for the water contractors range from $1.08 billion per year to $2.5 billion with the base case again coming in between at $1.6 billion.

Peak annual debt service costs represent the average annual costs for the highest ten years of debt service that would be incurred over the life of the project, but it’s worth noting that those costs are pretty constant when the project is underway. So using the estimated water delivery data and those debt service costs that we developed with the help of the treasurer’s office, we then estimated the annual average cost for four illustrative contractors. We wanted to identify the costs that they would face in terms of dollars per acre foot under the different scenarios. And those four contractors were Metropolitan Water District, the Santa Clara Valley Water District, the Kern County Water Agency, and the Westlands Water District. These four districts represent a substantial share of the water deliveries that would be provided under the BDCP, so as a consequence, we used them to illustrate what kind of costs those different water contractors would face.

Metropolitan’s average annual costs under the base case scenario would range from $260 – $400 per acre-foot, again in year of expenditure dollars, though the effective annual costs would obviously vary substantially, potentially, between wet and dry years. Santa Clara’s average annual costs would range from $290 to $360 per acre-foot, again in year of expenditure dollars. These additional annual payments in this range likely are manageable for contractors like Metropolitan Water District and Santa Clara, which have a diverse portfolio of water supplies and a large number of municipal and industrial water users, allowing them to spread these additional costs across a wider base and therefore should result in a lower rate increase to their residential and industrial and commercial customers.

For Kern and Westlands, we took a somewhat different tact. And that is we developed an estimate of capacity to pay for water based on agricultural production and cost data to assess whether the primarily agricultural consumers in these districts would be able to afford the additional costs of BDCP water. So Kern’s average annual cost of water under the base case ranges from $225 to $350 per acre-foot in year of expenditure terms; Westlands costs range from $290 to $300 per acre-foot, except that what we needed to do in order to understand whether or not those costs would be affordable for those agricultural consumers is to translate those costs back into 2012 dollars, and the reason for that is we don’t know what future crop prices are going to be or what future agricultural production is going to be 15, 20, 30 years from now.

So what we did was to translate, as I say, those dollars back into 2012 dollars. In 2012 dollars, Kern’s average annual costs range from $113 to $178 per acre-foot; this would be in addition to an average of $100 per acre-foot that Kern paid for State Water Project over the last 5 years, thus getting us to total costs that they would experience of $213 – $278. That compares to an average payment capacity that we calculated of approximately $277 per acre-foot. In other words, we’re saying that given the production mix and the cost of production and the prices that those agricultural producers get for those products, they have capacity to pay for water of $277 per acre-foot, and that compares to the cost that they would face for BDCP water in 2012 dollars of $213 to $278, so you can see that the costs that they would face is within the range of what they can afford to pay, based on their production.

In terms of 2012 dollars, Westlands average annual costs range from $144 to $192 per acre-foot; that’s added to $109 that they currently pay over their most recent historical period, getting us to $253 – $301 per acre-foot in 2012 dollars. And that compares to average payment capacity of $291. So again you can see that’s roughly in the range of what’s affordable for BDCP water. Now it’s worth noting that if the crop mix changes, then that would change the dynamics somewhat with respect to what’s affordable and what they would pay and what kind of prices they would get for their agricultural product, so that payment capacity is an average figure that reflects the mix, the current production mix, of high yield corps and somewhat lower yield crops.

In the report we also looked at a number of important issues that will need to be resolved before bonds could be issued to support construction of the conveyance facility, the most important of which is the revenue stream required to pay debt service. Because debt service is fixed and needs to be paid irrespective of how much water is delivered, the commitment of water contractors to make these payments is crucial. The contracts that the state water contractors have with DWR provide for a number of important guarantees to bond holders that debt service will be paid, which results in generally highly rated bond issuances on the part of DWR and a number of SWP contractors. Among these guarantees are so-called take or pay requirements where payments are made regardless of how much water is delivered. These contracts contain a number of other provisions as well that ensure that debt service will be paid.

In contrast, because the Bureau of Reclamation is provided funding for the capital costs of the CVP, the CVP has not had program of revenue bond issuances, including commitments such as take or pay provisions. CVP contractors will likely need to agree to take or pay contracts and other provisions to assure investors that they will be repaid regardless of the amount of water delivered in a given year.

We also identified finally a number of other important risks that could pose obstacles to a successful financing, including construction costs overruns or delays, regulatory uncertainty whereby efforts to restore the Delta ecosystem are into successful resulting in lower water deliveries to contractors than anticipated in lower revenues to pay debt service, failure to secure funding to restore the Delta ecosystem which could lead to changes in Delta operating parameters, earthquakes particularly during the construction period, and climate change and sea level rise, could potentially lead to lower than anticipated water deliveries.

And with that …

David Sunding

I’m just going to make a few remarks about the treasurer’s study and how it relates to other economic research that we’ve undertaken as part of BDCP.

Let me underscore first something that Tim mentioned at the beginning. The treasurer’s office study is addressing a related but fundamentally different question than what we’ve looked at previously with BDCP. The treasurer’s office study is really getting at the question of is this project affordable. Do the customers, the utilities, and the farmers that get water from the Delta, do they have enough free cash flow that the bond holders have a reasonable assurance of getting repaid? So that’s more of a finance question.

What we’ve looked at previously with respect to BDCP is more of an economics questions or a cost benefit analysis, which is getting at the question of is BDCP a good investment. And that’s a different question than do customers have the cash flow to pay back the bondholders. So what we’ve been looking at previously, it’s very normal for very large capital projects like this, is the question of do benefits exceed cost, so again, is this a good investment.

Let me underscore one other thing that Tim mentioned too. The treasurer’s office report is in year of expenditure dollars, which is normal in the public finance world. What we had done previously in the plan itself, in chapters 8 and 9 and then also in the economic studies is to look at either current year expenditures so treating the capital expenditures as if they all occurred at once, or even looking at discounted expenditures, which is more normal in a cost benefit analysis.

I want to emphasize, because sometimes this point is missed – we are all using exactly the same costs. It’s not that there’s been a revision, nothing has changed; we’re all using the same cost information. There are just a couple of different ways of presenting it, ways that resonate in different disciplines, So again it’s not that anything has changed, it’d just we’re looking at costs through the lens of our respective disciplines.

Now just to really briefly recap, the cost benefit analysis: it’s important to start with the fact that the water supplies with and without BDCP are very different. With BDCP, Delta deliveries are roughly plus or minus 10 percent within the level they’ve been at within the last 10 or 20 years, but without BDCP, there’s a significant deterioration that will take place over the coming decades with respect to Delta deliveries and it’s preventing that decline that generates the economic benefits that we’ve documented in the past.

Overall our findings are that for the proposed project, benefits exceed costs by a ratio of about 1.4 to 1, which is certainly within the acceptable range in cost benefit analysis, and the reasons that the benefits exceed the costs are really twofold. First, water is valuable to the urban and agricultural customers that receive Delta deliveries and shortage is expensive. Urban consumers and farmers alike are willing to pay something to avoid future shortages. The other source of benefits from BDCP is particularly for urban agencies that do have some alternatives available, like desalination or heavier investment in recycling, the cost of shoring up the Delta is much less than the per acre-foot costs of any of those alternatives, or virtually any of those alternatives, so combination of shortage costs and then the higher costs of alternative supplies in urban areas, that’s what generates the economic benefits of BDCP. So again, what we’ve done previously is a related type of analysis, but a different question than what Tim and the state treasurer’s office is talking about today.

And I’ll leave it there.

And what about those recirculated BDCP documents?

Karla Nemeth is asked about the schedule for the recirculated BDCP documents. Her answer:

As folks may know, we had a public comment period close late July on the public review draft documents, and we have committed to recirculating both the environmental review documents and the plan. We are right now sorting through the public comments received to determine the precise scope of that recirculation and our expectation is that we would have an answer that question in the beginning part of next year. And then, shortly thereafter, we would release the documents, the recirculated documents and it won’t be the whole 34,000 pages that people say last year, but a portion, and there will be a public review period associated with that, prior to finalizing both the plan and the environmental documents.

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