CALIFORNIA WATER FIX: Metropolitan Committee hears presentation on Cal Water Fix cost allocation and financing

On August 14th, Metropolitan’s Special Committee on the Bay-Delta and the Water Planning and Stewardship Committee held a joint meeting to hear a presentation on the last of three white papers that staff has prepared on the California Water Fix, this one focusing on the costs and financing for the project.  Staff has developed the white papers to inform board members prior to an expected decision on the project, currently scheduled for September 26th.

PUBLIC COMMENT

But prior to the presentation, there were quite a few members of the public present to address the committee members.  The crowd was nearly evenly split: Of the 35 people present, 19 spoke in favor of the project and 17 spoke in opposition to the project.

Those that spoke in favor of the project were mostly representing business and construction interests; they spoke of the need to upgrade infrastructure, the risks to Delta levees, water supply reliability, and the importance of water security and reliability to the economy and the preservation of jobs.  Those that spoke in opposition to the project were a mix of environmental groups and concerned citizens.  They spoke of their concerns for the costs to water users, the project is not cost-effective, the white paper understates the costs, there is not a finance plan, environmental concerns in the Delta, agricultural stakeholders have not committed yet, and that the project will yield no additional water.

MODERNIZING THE SYSTEM: CALIFORNIA WATER FIX FIANANCE AND COST ALLOCATION WHITE PAPER

The presentation on the third paper was given by Gary Breaux, the assistant general manager and chief financial officer for the Metropolitan Water District of Southern California.

His presentation centered on answering four questions:

  • What is the cost allocation principles and assumptions?
  • What is the financing plan?
  • How does the California Water Fix impact Metropolitan’s cost and water rates?
  • What is the cost of project alternatives?
QUESTION 1:  What are the cost allocation principles and assumptions?

Throughout the process, the two key principles are that beneficiaries pay and costs follow water, or more specifically, costs will follow benefits and participation in the State Water Project system, Mr. Breaux began.  He also said the assumption in cost sharing between the State Water Project and the Central Valley Project contractors has been 55% and 45% and that assumption still holds.  On the State Water Project side, the allocation mechanism will be the State Water Project contracts with costs to be allocated according to each contractor’s Table A amount.

Metropolitan’s share is 47% of the State Water Project share, or 26% of the total project costs.  For the 45% CVP share, the Department of Water Resources and CVP contractors are negotiating terms over a master agreement to use California Water Fix facilities, and there are a variety of mechanisms that already exist or are being developed to allow contractors to adjust their participation in the project through transfers, he said.

There are five north-of-Delta contractors that will not directly benefit from the project, so they are excluded; their percentage of Table A would be spread among the other beneficiaries over the 97.2% and that’s where Metropolitan’s share of 47% comes from.

The bonds will have a 40-year term.  They have run an analysis using a 4%, 6%, and 8%; 4% is the base case because that’s where market interest rates are approximately right now; the other interest rates are shown to give the board some sense of impact of increasing interest rates, he said.  Capital costs are debt financed, and O&M costs are paid as incurred.

Mr. Breaux said that the white paper also addresses alternative financing options, such as the Water Infrastructure Finance Innovation Act or WIFIA, and the Water Infrastructure Loan Act or WILA, which is currently proposed legislation.  He said they will continue to monitor these programs; however, for this paper, they assumed using revenue bonds issued by the Department of Water Resources.

In the event WIFIA or WILA were used, they would mostly have the benefit of locking in the interest rates at a level that is close to 3% for a portion or possibly all the project costs,” he said.  “So clearly it would be beneficial if that would come to pass, and so we’ll continue to watch legislation to see where it goes.”

QUESTION 2: What is the financing plan?

The total capital costs for both construction and mitigation is $16.7 billion.  The costs would be split between the Central Valley Project and the State Water Project; the Central Valley Project share at 45% would be $7.5 billion; the State Water Project share at 55% would be $9.2 billion; Metropolitan Water District share at 26% would be $4.3 billion.

We have inflated those costs from the 2014 numbers that were previously used using a 3% factor, so this in 2017 dollars what we expect the project to cost,” Mr. Breaux noted.

He then walked through the financing process.  The finance plan has the Department of Water Resources issuing bonds to fund the State Water Project contractor’s share of $9.2 billion.  “So when they want to do some construction, they issue revenue bonds; the bond investors in turn buy those bonds and those bond proceeds go to the Department of Water Resources.  They use those to pay construction costs, and State Water Project contractors then receive on their statement of charges the amounts for both capital repayment and payment of interest.  It goes back to DWR, and that’s what they use to repay bond investors.

Because of the size of the amount of debt that will be issued, the Department of Water Resources has initiated a validation action that would affect the marketability of their bonds, Mr. Breaux said.  He explained that it is a judicial proceeding to affirm a public agency’s authority over finance matters, such as the issuance of bonds; it’s a common practice for projects of this size.  “The Department of Water Resources has filed a validation with the Sacramento County Superior Court and until that’s decided, which could take several years, the marketability of their bonds will be affected, because of the uncertainty around that validation proceeding,” he said.

Mr. Breaux said that they want to maintain the collection of debt service for the Cal Water Fix project on the statement of charges during the validation action, so he explained how the interim structure would work.

The Department of Water Resources would issue a revenue bond, but instead of to the bond investor, the Finance JPA would actually buy that bond in what’s called a private placement,” he said.  “The Finance JPA in turn, would issue its JPA revenue bonds to bond investors.  Those proceeds from the bond investors would go back to the Finance JPA and we’d use those proceeds to purchase the bond from the Department of Water Resources.  Those bond proceeds then go to DWR, they are able to pay the cost of construction and continue to put that amount on the statement of charges and collect it from the State Water Project contractors, and they’ll use that to make the debt service payment on the bond.  The Finance JPA holds and then the JPA would use that to make payments to the bond investors.”

Mr. Breaux said this is a very important structure to put in place.  “One of the risks identified in the white paper is SWP contractor default,” he said.  “The use of the finance JPA preserves all the protections already built in the SWP contracts, obligating the contractors to make payments and if necessary, compels the contractor to levy taxes or assessments in the event of nonpayment.  They also have debt service reserve funds and a 25% coverage requirement on debt service that gives an additional security to the structure.  And in the unlikely event that the validation action determines the Department of Water Resources does not have the authority to finance the project, the process would be established leading to a potential conveyance of interest of the project to the finance JPA or some other designee.”

There are numerous agreements are being drafted and negotiated among the State Water Project and the Central Valley Project contractors, the proposed finance JPA, and the Department of Water Resources.  He noted that processes and commitments will be included in these agreements to reduce financial risk and uncertainties.  “These agreements will be summarized in detail for the board’s consideration at the time it is asked to render decisions on the California Water Fix,” he said.  “Suffice it to say there’s a lot of drafting of agreements going on right now, and that will continue for the next 30 days or so.”

Director Steiner noted that in the white paper, there is a reference about gap funding.  “The way it looks like the gap funding works is it talks about willing contractors who presently might be willing to finance preconstruction costs and start as soon as September, and it looks like those would be reimbursed from the first payments that are made and first purchased by DWR …  as to the gap funding, that would be reimbursed from DWR from what the JPA pays to DWR to buy those bonds?

Gary Breaux answered that between now and the end of this accounting year, DWR has identified some funds that they plan to use for that, but there is the need about halfway through 2018 to be able to have some additional funding to keep things moving forward.  “So to the extent there are contractors who are willing to put money up for that out of this first bond issue, just like you have an arrow going to construction costs, you’d also have an arrow going back to repay not only the gap funding for the next 6 months or the first 6 months of 2018, but also the money that was put forward for the EIR process, some 7 years ago, as that’s also meant to be reimbursed out of the first bond issue, back to the various contractors who put that money up.”

Director Vasquez asked if other agencies have already approved paying for the project.  Mr. Breaux said that the agencies are in the process of reviewing it, but he didn’t think any had approved it as of yet.

No one has committed as of yet,” said Roger Patterson.  “All of the agencies that have been involved for the last 11 years, and everyone has put up their proportionate share of the funding, there’s about $260 million that has gotten us to this point.  All of those agencies are making their decisions on the same time frame.  It’s rightfully been identified what if we have some that say no, then how would you adjust the shares in the project amongst the others, and we’re giving some thought to that, but so far, no one has said no, other than the Bureau of Reclamation said they are not going to make investments for their senior water right holders and the refuges, but they are offering that to the other CVP contractors, so at this point, it’s still 55/45.  Everyone is making the decision on the same general timeline.”

There is a lot of talk about who’s in, who’s out, but we won’t know that until when the time comes for each agency to make its own decision,” said Jeff Kightlinger.  “There will be some making decisions before us, they’ll be some making decisions after us, but what we are going to be posing to the board and what staff will be presenting is a choice to come in and do our share, and that’s all.  This isn’t some open ended, we may be doing 100%, we don’t really know, we’re not asking the board to do that.  … The only decision before the board, are you willing to fund your share of the project?  To the extent there’s side deals, someone offering us their share, all that would come back to the board for a subsequent decision, if the board were interested in that.

Director Abdo said, “We’ve been told that this decision is going to be made at the end of September on the off meeting, and what I’m wondering is if we could have a little more time, especially to put it onto a regular board agenda so that it’s not on the off Tuesday, and also it would give me time at least to talk to some of the stakeholders in my city who have had questions … it’s August, and a lot of people are out of town.”

Director Steiner expressed concerns about those agencies that might want to opt out of the project, but still want to receive their Table A amounts through the old system.  Roger Patterson said they can’t opt out of the project in that way.  “What they could do is say, if we could find a partner, we would be willing to transfer some benefit for some money for those, and those are the things that we would bring back, but right now, our assumption is that all of our state water contractors at some level would be participating in the project,” he said.  “No opt out.  It would be if you wanted to keep the cost down and willing to give up reliability, then you have to find a partner to do that deal with.”

Mr. Patterson noted however that the Central Valley project is giving their contractors the first chance to opt into the project.  “Those that don’t opt in to the project will not have access to using the tunnels on the CVP side, so that’s the principle that they’ve adopted,” he said.

So the principle of this permanent ability to give away some of your Table A or temporary ability that’s discussed in the white paper, would only be available to the SWP, but on the CVP side, they’re in or they’re out,” said Director Steiner.

On the Central Valley Project side, you could have an investor that later, another CVP contractor could ask to acquire some of their shares and that could be allowable, subject to approval of the owner of the facility, so that’s the way they are looking at doing it,” Mr. Patterson said.  “We do Table A transfers now between SWP contractors, something very similar to that is what various state water contractors might choose to do.”

QUESTION: What impact does the California Water Fix have on costs and water rates?

Mr. Breaux then presented a slide showing a finer breakdown of the costs, noting that the costs have been inflated to 2017 dollars.  “The operating costs have been inflated as well,” he said.  “These are the operating costs that would be in effect once the project is fully operational, but we wanted to at least bring those up to 2017 dollars.”

He then presented a chart showing capital financing and O&M costs for the $9.2 billion State Water Project share using a 4% rate of interest.  He noted that the actual debt that is represented on the chart is closer to $12.8 billion.  “In determining how much debt’s going to be needed, we have been inflating the capital costs throughout the construction period as they are expended, so what’s represented here is actually $12.8 billion in debt,” Mr. Breaux explained.  “Then we also have the operations and maintenance costs also being inflated at 3% per year, and so in the year of completion, you’re looking at a total payment for the State Water Project of $703 million.  Now if we want to present-value that back to today’s value, we used a 3% factor, so that’s where the $438 million comes from.”

Mr. Breaux said they have assumed no deferral of principal and interest.  “As these bonds are issued for the 40 year term, they will start to bear interest and that will be paid each year as start to amortize the principal and the debt.  Given the lengthy term of this, this also assumes that amendments are made to SWP contracts and that is extended out to 2085, so that would also presumably take place before we’re actually issuing debt out this far.”

Mr. Breaux then presented a table showing the cost impact at 4%, 6%, and 8%.  At 4% interest rate, Metropolitan’s $207 million would require a 13% rate increase if it were to happen all in one year.  “We anticipate these will be annual rate increases of about a little less than a percent over the 15 year construction period until all the bonds have been issued, and the average costs per acre-foot, $122 per acre-foot spread over a 1.7 MAF of assumed sales,” he said.

With the project being about 95% capital, if interest rate increases to 6% and 8%, that results in an overall rate increase up to 6%, 17% or 1.1 % per year, and 8% would be 21%, 1.4% per year.  “These calculations are important, I want to make sure everyone is tracking.  You can see again, the $207 million divided by the 1.7 MAF is how we arrive at the cost impacts and such where we get the $122, $157 or $196 per acre-foot, depending on the interest rate.”

Mr. Breaux then presented a chart of Metropolitan’s ten year financial forecast, noting that the financial forecast was part of the annual budget adopted by the board in April of 2016.

At that time, we were assuming a 6.135% rate of interest, and construction really starting in the 2017 to 2018 time period,” he said.  “What this shows certainly is for any of the cases, they stay within our current financial forecast for the ten years.  Clearly over the full construction period, the 8% scenario is going to come out higher than the MWD forecast from two years ago, a year and a half ago, 6% is pretty much in line with what we were showing then, and the base case will of course be lower if rates stay that low.”

QUESTION: What is the cost of project alternatives?

The last question addresses what it would cost to replace the annual average water supply improvement of 337,000 acre-feet, which would be the 26% share of the improvement of the Water Fix if it doesn’t move forward,” Mr. Breaux said.  “This analysis is not meant to indicate that the California Water Fix replaces the need for local projects, such as recycling, groundwater recovery, or desalination.  Local resources and conservation are expected to make up an increasing greater share of the region’s overall water portfolio, and in fact, our Integrated Resources Plan calls for its imported State Water Project supplies to be stabilized and for the future demands to be met with a combination of local supplies and conservation.”

Mr. Breaux then walked through the calculation of the marginal cost of the California Water Fix.  “The estimated average incremental Water Fix supply would be 1.3 MAF, and this is for the most part not having that supply continue to degrade in the future,” he said.  “Our 26% share of that would be 337,000 acre-feet.  Again we’ve talked about the annual costs of $207 million.  The annual cost divided by the 337,000 AF gives you $613 dollars per acre-foot at the south Delta pumps.”

Moving the water down to the Metropolitan service area adds $227 per acre-foot for a total of $840 per-acre foot; this cost includes the costs of power for transportation and variable treatment costs.  “With that, that gives us something that we can reasonably compare to other types of projects that if we’re trying to, in effect replace this lost supply with other projects if we don’t move forward,” he said.

The $840 per acre-foot compares very favorably to projects that have already been built or are to be built,” said Mr. Breaux.  “It’s also worth noting that many of the projects that you see here, many of the more cost-effective projects have already been done, so the costs will probably be higher in the future for similar projects.”

He noted that as a wholesale water provider, Metropolitan does not have a direct connection to retail customers or their water bills, but staff has performed a simple analysis on an approximate household impact for the Board to get a sense of what that would be.  “For this calculation, we’re using our residential water use, taking 70% of that, because that’s what on average what that amounts to and for the total water sold.  We have 6.2 million occupied households, so the household impact calculation would be the annual costs, 70% of that, divided by the 6.2 million households divided by 12 and so this is where we derive the household impacts of almost $2 in the base case up to $3 for the 8% interest case.

He then presented a slide comparing the California Water Fix to two different types of local resource programs, one with a recycling focus and the other with a desalination focus.  “For the recycled focus, the estimated costs contained in the recently completed feasibility study for the regional recycled water project was used with an estimated cost of $1610 per acre-foot, and for the desalination focus, the projected 2017 unit cost for Carlsbad Desal Plant of $2412 was used to do some of these calculations, and it’s worth noting that to replace the 337,000 acre-feet, if the California Water Fix does not move forward, it would require doing two plants the size that are being considered for the Carson Plant, or up to 6.5 times the amount that the Carlsbad produces, so it’d take a lot of these to replace the amount of water that the Water Fix will get for us.”

Mr. Breaux emphasized that this analysis is not meant to suggest the California Water Fix replaces the recycling focus or desalination focus, but from an affordability standpoint, they think it compares very favorably to other types of projects.

IN CONCLUSION …

The California Water Fix is certainly consistent with the Board principles that the costs follow water and beneficiaries pay,” Mr. Breaux said.  “The finance plan utilizes the existing State Water Project contracts, structure and a Finance JPA.  Cost impacts are consistent with our 10 year financial forecast, and we think the California Water Fix compares favorably to the costs of other alternative supply projects.

General Manager Jeff Kightlinger than reviewed the next steps for the decision process.  They have been collecting questions and comments about things that need to be further addressed; they will prepare answers in writing and will distribute that to the board, and again have a staff presentation.  It would be a synthesis of these first three special workshops, but include the new issues and questions and comments that they’ve heard.  “We’ll put all that before the Board, take a look at our IRP and see how this fits in with all the rest of our planning, and then have the Board ask whatever questions they want.  We’ll have our various experts such as Roger and Steve and Gary here, and we’ll take whatever time the Board wants to do, and so that’s the game plan for the 26th, subject to change by the chairman and the … and the Board.”

Chair Randy Record notes that scheduling the vote for the off-Tuesday gives the whole day, so they can take whatever time is needed.  “That’s 6 weeks from now.  I don’t want to start putting it off at this point; if we decide we need to put it off, we’ll make that decision during the board meeting in September, but I would ask the board to anticipate that we’re going to keep that September 26th date, so keep working on it and get questions in. … “

Director Larry McKenney said, “I’m always pointing out to people that we’re going to both capital and O&M on the state project for another at least 17 more years, whether we get any water out of it or not, so to me it’s an investment to improve our system.  I think that we ought to look at the costs presented here with that view in mind, recognizing that about the time that these costs are projected to ramp up, we’re going to be finishing up with payment of the previous SWP costs, we’re going to be stopping paying for that debt, we’re also be finishing up and stopping paying on our DVL debt, so this is just the next generation of investment, and I think we ought to think of this investment in that economic context for us.”

My ultimate read of this whole document is that projected costs for us to make this investment is such a smart choice and is so reasonable, that we should make our decision now, and then if after that, some of the other participants drop out, in a future decision making process, we could easily afford to look at picking up more of the project and making it bigger,” continued Director McKenney.  “I think it would be even better for us, so I don’t think that we should be too worried about waiting for everybody else to decide, I think everybody else is going to wait for us.”

Director Murray noted that although a lot of information has been prepared, almost up until today, a number of questions pertaining to the costs and how those costs would be allocated has not been available to them.  “There are agencies on this board that have anywhere from tens of thousands of consumers to millions of consumers.  LA happens to be one of those agencies that has millions.  And along with that goes the kind of governmental structure and interaction that you would normally associate with the second largest city in the nation.  I know government doesn’t move swiftly. … so I think it’s all well and good to say I don’t want to put this off, here we are, let’s get going, but that’s not how it works in a lot of places.  There are mayors, there are city councils, there are neighborhood councils, there is a wide range of constituents that make up the fabric of how these large cities operate, and even some that are not all that large operate in very similar ways … we need to prepare ourselves now to say, all things considered, that 26th is not realistic.”

Director Steiner noted that in the EIR, there was 186,000 acre-feet given as the incremental supplement so why the difference between 1.3 MAF  and 186,000?

Roger Patterson said he doesn’t like this metric very much, but what it is is the smaller number is comparing what we have today.  “We’ve always viewed this as project to secure over time the kind of reliability for what we have today.  The analysis that was in white paper #2 tried to do a with and without, and not just pulling things out of the air but actually based on information that we have picked up over time from the various regulators, and then you do have to add a little bit of professional judgment, if you will, so all we did with the 1.3 MAF is looked at the range we had without the project, looked at the range of supply with the project, and just took the midpoint of the two.  It could be higher, it could be lower, but that’s the midpoint of the two.  So that’s really what that is, so it was 3.5 to 3.9, 4.7 to 5.3, so it’s the midpoint of those two, that’s what that is.”

Director Steiner noted that there were going to be a lot of things to vote on at the meeting on the 26th, not only yes or no on the project, but a financial JPA package and a construction JPA package.   “That’s just really a lot to digest and to work together with our agencies, we have agencies that we have to answer to for San Diego and they have to answer its agencies, and those agencies like the City of San Diego will have to answer to its city council, so I recognize it’s been a long time, I recognize this is a lot of information, and these white papers have gone a long way towards answering a lot of the questions, and certainly, but it really needs some digesting.  So I agree that we really need to think about whether a little more time will let us be able to digest this a little better.”

Director Abdo asked about the costs per user of the project.  “Every single one of our agencies sets our own water rates, and the percentage of Met water that’s in that water rate and goes to each individual ratepayer is different in each of our agencies, so are you talking about an average of everybody, all 19 million people, as if the cost would go directly on them exactly whatever it is … is there a way to calculate how much it’s going to cost San Diego ratepayers versus Orange County versus all the other agencies?

Yes, it’s an average, so that $2 is an average across the entire service area, so if you’re agency actually buys zero water from Met, the cost to the household would be 0,” said Jeff Kightlinger.  “If your agency gets 100% of your water from Metropolitan, the cost would be $4 per month per household.

FOR MORE INFORMATION …

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