Wednesday, June 17, 2015

Fourth Quarter Data shows larger drought effect on Farm Jobs

Farm jobs in the San Joaquin Valley declined significantly in the 4th quarter of 2014 compared to the same period in 2013, according to data from the Quarterly Census of Employment and Wages (QCEW) released today.  The QCEW is a census of employer tax filings, and is a very reliable estimate of employment.

The table below shows the total of monthly agricultural employment (both direct farm employment and agricultural labor contractors) across the 8 counties classified as the San Joaquin Valley.  The decline in employment exceeded 2% in each of the last 3 months of the year, in contrast to increases at the beginning of the year.  The annual monthly average shows a loss of 513 jobs, or -0.3%, in contrast to earlier estimates of a modest gain.  When this recent trend is combined with larger water shortages in 2015, it suggests that a significant decrease in agricultural employment should be expected this year.

While agricultural employment now appears to have decreased slightly in 2014, the following should be noted:

  • Farm employment in the Valley remained near an all-time high.
  • Even in the 4th (worst) quarter, the decline in jobs was less than half the consensus prediction by economists in 2014 (yes, that includes me too)
  • Total agricultural wages were up nearly 4% compared to the previous year.
  • Overall employment continues to grow in the San Joaquin Valley, and unemployment has declined to single-digits in most of the Valley, and is significantly lower than its historic average in most of the Valley despite the drought.
In contrast, both farm employment and wages decreased 3-4% during a less severe drought in 2009, which was the basis of predictions of greater losses in 2014.  The leading explanation for the smaller than expected loss in jobs is the shift to higher value crops, and while that is certainly part of the explanation - that shift was already well underway in 2009.  

Year 2014 2013 diff % diff
Jan 179,059 173,054 6,005 3.4%
Feb 177,319 171,692 5,627 3.2%
Mar 167,919 161,119 6,800 4.0%
Apr 198,015 191,217 6,798 3.4%
May 231,878 235,793 -3,915 -1.7%
June 223,892 233,722 -9,830 -4.4%
July 229,603 229,301 302 0.1%
August 239,192 239,456 -264 -0.1%
September 235,671 236,482 -811 -0.3%
October 211,829 216,994 -5,165 -2.4%
November 186,775 190,720 -3,945 -2.1%
December 169,356 177,111 -7,755 -4.6%
Average 204,209 204,722 -513 -0.3%

Thursday, June 11, 2015

How much has Cap and Trade Increased the Price of Gas in California?

My parents are visiting from Ohio, and a favorite topic of conversation on these visits is what is more expensive here than "back home" and how much.

While driving past a gas station with my Dad this weekend he suddenly whistled, "Whoa, it's $2.59 at home, that's the biggest difference I have ever seen.  What's going on?"  I mentioned that we now have AB 32 (cap and trade) covering motor fuels, and that the most quoted studies predicted about a 10 cent increase per gallon, but I haven't studied it in detail.

That conversation led me to conduct some in depth research on Gas Buddy, which generated the following chart comparing California and Ohio.

I looked going back 8 years, and it looks like the historical difference is 25-50 cents per gallon with the gap being larger in the summer.  So far in 2015, it looks the difference has been 50 cents to a dollar with the current difference being about 75 cents a gallon.  Dad was right.

The data is volatile and it is a little premature to draw conclusions, but it looks to me like the AB 32 effect is about 25 cents per gallon.

I seem to recall predictions that a price of about $10 per ton for carbon emission permits would translate into about 10 cents per gallon.  So far in 2015, the carbon price has been $12-13 per ton, so the gas price increase/gap seems higher than expected.  I wonder how the cap and trade revenue being collected by the state compares to the increased amount California drivers are paying for gas.

I am sure there are many people who are properly researching this issue, and we will be hearing a lot about it in the months and years to come. 

Thursday, May 14, 2015

Tulare County Leads the State in Dry Wells, and Agricultural Expansion

ACWA reports on DWR Director Mark Cowin's comments at a drought hearing this week,
Cowin said DWR is implementing a number of water management changes, including a drought barrier in the Delta and temporary urgency changes in operations. He said about 1,900 wells have gone dry in California and over 1,000 of the dry wells are in Tulare County.
Below is a table showing the change in harvested acres between 2013 and 2007 compiled from County crop reports.

change in acres 2013 to 2007
field fruit/nut veg total % ch
Kern -173783 113035 -19324 -80072 -8.7%
Kings -51693 13050 18 -38625 -6.8%
Tulare 101546 72518 -334 173730 20.4%
Fresno -154386 39916 -48240 -162710 -13.8%
Madera -22280 37560 100 15380 5.2%
Merced 46204 10263 1528 57995 10.3%
Stanislaus 50118 56865 12887 119870 27.5%
San Joaquin 24000 49000 -25200 47800 7.6%
Total -180274 392207 -78565 133368 2.5%
-5.9% 21.7% -13.4% 2.5%

Tulare leads growth in total acres, whereas Stanislaus leads growth in percentage terms.  Kern has the greatest growth in fruit/nut which are usually permanent crops.

To what extent is the Valley suffering from a man-made drought?  While it is politically popular to point fingers at the Endangered Species Act, I don't think the Delta Smelt planted those orchards.    

Friday, May 1, 2015

Governor Brown attempts to justify the $15+ billion construction cost of the Delta tunnels. "Yes, this costs money, but compared to what? A stadium? (Water) is the basis of human existence.”

"Compared to what?"

That's actually a good framework for thinking about the wisdom of investing tens of billions of dollars in the Delta Tunnels.  But the Governor needs to define the real trade-offs instead of creating false choices - neither stadiums, civilization or the "fabric of modern California" is at stake - all of which he referenced in yesterday's news conference.

What are valid comparisons?
  • Higher investment in alternative water supplies like stormwater capture, water recycling, and limited use of desalination.
  • Higher investment in water conservation and maintenance such as fixing leaking pipes.
  • Higher investment in Delta levees that simultaneously protect public safety, water supplies, transportation infrastructure, energy infrastructure, and property.  [If the Governor is really worried about a Delta earthquake, why is he only worried about water exports - and not saving lives and this other critical infrastructure too?]
  • Letting a few thousand acres of crops go fallow - and given the tiny water yield of the tunnels - this isn't much of a loss. [Actually, a viable finance mechanism for the tunnels could require ag-urban water reallocation, so there could be less farming with the tunnels than without - especially when the impacts on Delta farming are included.] 
There is plenty of evidence to to show that billions of dollars spent on tunnels are a clear financial loser when compared to all of these alternatives.

It is important to remember that in the original proposal where the tunnels were part of the BDCP - the State's consultants could only economically justify the tunnels by putting an enormous dollar-value on the 50-year permit.  Yesterday, they conceded that the permit was not happening.  Thus, the economic analysis their consultants produced to support the BDCP shows that the tunnels are no longer economically justified.

Of course, spending less on water-related projects is a valid choice too - so it is not entirely unfair to compare the tunnels to non-water related projects.  If the Governor wants to have a discussion about the fabric of civilization, I would suggest that he compare it to spending on education and universities, public safety, or healthcare.  But even if we are going to compare it to unnecessary-sounding projects that also involve lots of concrete, I would be willing to bet the tunnels have a worse return on investment than most stadiums, or even a bullet train.

Wednesday, April 29, 2015

Sacramento Performing Arts Proposal Keeps Growing. Is Arena Fever Affecting the City's Fiscal Discipline?

When asked about the Sacramento Arena's public subsidy, I sometimes mentioned that some of the fiscal risk was indirect: subsidizing an entertainment center makes it harder for a City to say "No" to other long-term financial commitments - whether that is requests for other facilities or employee contracts - as well as deal with its unfunded liabilities.

Not long ago, Sacramento officials were saying they didn't have the money to take on a $10-50 million renovation of the Community Center theater, and at last nights City Council, it appears as if City leaders are now considering a City-financed $200+ million performing arts theater.  I watched part of the presentation to the City Council meetings presentation from the performing arts task force, and saw appeals to civic pride from the task force members while financing discussion was vague and deceptive.  [Although I appreciated Councilman Hansen's comments about not losing sight of a less expensive Plan B, and the operating budgets of local performing arts groups.]

Here are excerpts from a Sac Bee and Capital Public Radio coverage of the optimistic talk in last night's meeting followed by an excerpt from a Bee article just a year and a half ago that was pessimistic about funding the smaller renovation project

A task force exploring the need for a new performing arts center in downtown Sacramento has identified four potential sites for a 2,200-seat theater, but needs up to six more months to figure out how to pay for what would likely be a $200 million project.
During a hearing with the City Council on Tuesday night, task force members said they had determined that replacing the aging Community Center Theater would help the city compete for the musical and performance acts that are beginning to be lured to more modern sites in Davis and Folsom.
Mayor Kevin Johnson and the City Council directed city staff to work with the task force over the next six months to develop financing options, investigate locations that are under consideration, put together design plans for the theater and begin the process of requesting proposals from groups to operate a new theater.
 Garry Maisel, president and CEO of Western Health Advantage and chairman of the theater task force financing committee, said the project’s funding would likely be a “complicated puzzle” of public and private sources. He raised the possibility of a sales tax measure on the 2016 ballot to fund regional arts groups, as well as using state economic development loans or the city’s hotel tax to help cover the costs.Private sources include naming-rights deals, corporate sponsorships and individual donations.
“If you put the pieces together correctly, it will work,” Maisel said.

Read more here:

The Mayor's Performing Arts Theater Task Force director, Richard Rich says a new building would benefit the city more than a renovation of the existing Community Center Theater.
"We can do as little as possible and spend tens-of-millions of dollars to take a deeply-flawed situation and make it slightly less-flawed or we can embrace the renewed spirit that this city has and we can give our citizens a center that reflects their pride in the city."
From a November 2013 article on a less costly renovation,
Some city officials – including the city’s treasurer – caution that it might make fiscal sense to wait to make improvements until millions of dollars from a key revenue source earmarked for the project are available.
A tax placed on hotel rooms would serve as the foundation for the renovation project, but more than $8 million of that revenue is being used annually to pay off debt for the expansion of the Sacramento Convention Center in the mid-1990s. The convention center bonds will retire in 2021.
The $50 million renovation would require annual bond payments of $3 million, city Treasurer Russ Fehr said. The bonds would be backed by the general fund, but the city anticipates using hotel tax money to repay them. While those revenues are expected to increase in the coming years, Fehr said the city should wait until more of the money is available.
The city’s plan to help finance a new downtown sports arena is also playing a role in Fehr’s cautiousness.
Hotel tax revenue would act as security for the bulk of the city’s $258 million contribution to the project, should the primary financing method – revenue generated by parking operations – fall short of projections. The availability of the hotel tax as an arena financing security will also serve as a credit enhancement for the city when it issues bonds for the arena project, Fehr said.
The City Council voted earlier this year to devote $8.5 million from shuttered tax assessment districts to the theater project. City officials hope that naming rights and fundraising efforts will help close the gap, but acknowledge they are well short of being able to finance the entire project without taking on debt.
“For strictly financial reasons, I wouldn’t recommend debt financing (the theater) at this time except for the necessity to proceed due to the disabilities issues,” said Fehr, who will brief the City Council tonight on the theater financing issue. “We can do this at a minimal risk to the general fund, but I think we should wait a while before we do it.”
Councilman Steve Hansen, whose district includes downtown, said he will ask city staff tonight to provide details on what renovations can be made at different funding levels. He said he also wants to explore forming a nonprofit agency to take over operating the theater and raising money for the upgrades, saying such an entity might have better luck in soliciting donations than the city.
Hansen said he wants the City Council to vote on a renovation plan early next year.
“It’s a complex question, and I wish there was a clearer answer,” he said. “I believe ultimately we’ll renovate this theater, but right now, I don’t think anybody has made a strong case for one specific plan.”
Performing arts advocates argue the city should move ahead with the full $50 million renovation plan.
Richard Lewis, the executive producer of the California Musical Theatre, said the $50 million project – which would include improvements to the theater’s seating, restrooms and loading docks – would represent “not a 10-year fix, but a 30- to 50-year fix, in my view.
P.S.  4/30:  Personally, I have bought more tickets at the Community Center theater and Mondavi Center than Kings games, and would enjoy a new theatre in Sacramento. 

However, the City Council's decision to subsidize the Kings' arena means that Sacramento is less able to afford the performing arts project than before, not more.  Developing a viable financial plan may be an insurmountable obstacle for the project, but the tone of the conversation is makes me afraid that arena-fueled economic optimism threatens to cloud the City's overall fiscal planning. 

Friday, April 24, 2015

Does Cheap Community College Create Negative Incentives for High School Students?

With President Obama proposing free community college, perhaps it seems strange to wonder if California's two-year schools are too inexpensive.  California has the lowest CC tuition in the nation by far, and the biggest differential in tuition between 4-year and 2-year schools.  The state provides a strong financial incentive for its high school grads to attend 2-year schools, and they respond in large numbers.

A recent presentation and op-ed by Hans Johnson of PPIC, and my own daughters' graduation from high school has got me thinking about this issue. Johnson's op-ed makes the following observations,
Among the 20 most-populated states, California ranks 19th in the share of recent high school graduates that go to a four-year college — public or private, anywhere in the United States. In 2012, only a third of California high school graduates enrolled in a four-year college within a year of graduating from high school, compared with about half of high school graduates in Massachusetts, Ohio, Florida, Georgia, Indiana, New Jersey, Wisconsin and New York. Among the 50 states, California ranked 47th. 
In contrast, California ranks first out of the 20 most-populated states in the share of recent high school graduates who go to a two-year college (and ranks fifth among all 50 states). State funding reflects this focus, with California’s community colleges commanding an increasing and now majority share of state allocations — 54 percent — to the three public systems (UC, CSU and the community colleges). 
Clearly, community colleges play a very large role in California’s higher education system. The problem? Low completion rates. Substantially less than half of students who enter community colleges with the intent of transferring to a four-year college successfully do so. Research has shown that students are much more likely to earn a bachelor’s degree if they first enroll in a four-year college rather than a community college.
California looks more like the President's proposal than any other state. However, numerous reports show the educational achievement of California's residents - especially young adults under 35 - is falling relative to the rest of the nation and world, threatening the state's future competitiveness.  From California's experience, it isn't clear to me that making college degrees more affordable with financial incentives to start at a community college will lead to better educational outcomes.

Certainly, affordability is a barrier to higher educational achievement, and that is deservedly getting a lot of attention these days.  However, the evidence shows that poor high school preparation is also a strong barrier to college completion.  And as Johnson notes, students who begin in community college are less likely to finish even though their choice makes a bachelors degree more affordable.  I expect that it increases other issues with transfer credits, social and academic transitions, and academic preparation.

The other issue I have noticed this year in my kids' high school that I have not seen anywhere in this discussion is how the incentive to start in community college negatively effects what students do in high school.  I have seen capable high-school students avoid challenging courses and make lackluster efforts in academics, and they admit the reason is that it doesn't matter for admission to the local community college.  Students with ability and financial resources are discouraged from starting at 4-year schools, because you can "get the same thing" for much less cost - both in money and in work.  No need to worry about taking another math class, an AP course, the SAT, or study for the test tomorrow.  Not only does it reduce their learning in high school and preparation for college, it instills bad habits that persist in the future.

Admittedly, these are just some anecdotal observations on a small non-random sample of high-school students inspired by the differing educational climate I have observed in California compared to other states I have lived.  It's a hypothesis, and I have no idea if there is any serious research that shows that a financial incentive to attend community college can have negative effects on high school academic choices and achievements.  And if there is a negative effect, there may be better ways to correct the incentive than increasing community college tuition.

Monday, April 6, 2015

Quick Take on LA Times' Report on Restructuring the Delta Tunnel Plan

Some highlights from Bettina Boxall's extremely interesting and important article.

"Sources familiar with the state discussions said that it is likely the department will separate the habitat restoration component from the tunnel proposal and pursue shorter-term operating permits for the new diversion facilities and existing pumping operations. Although the Bay Delta plan included restoration money, it is unclear how the separate restoration effort would be funded or carried out.

While the changes would not affect construction of the tunnels, they have raised concerns that the restoration work could fall by the wayside. And the revisions, expected to be released in coming weeks, could also make the project less attractive to the urban water and agricultural irrigation districts that have promised to pick up the roughly $15-billion construction tab....

The plan revisions would represent more than just a bureaucratic change. The agricultural and urban water districts that are the major drivers of the long-planned project were betting that a 50-year permit would stabilize delta deliveries that have been restricted by increasingly stringent protections for endangered fish. 

Reverting to shorter-term approvals would leave future water deliveries vulnerable to cuts associated with a change in permit conditions. And that raises questions of whether the project is still worth the money to the districts that have promised to pay for the tunnels. 

"We don't really know what the permitting will be 10 years from now, 15 years from now," said Jeffrey Kightlinger, general manager of the Metropolitan Water District of Southern California, which would cover a portion of the tunnels' cost. "That's the challenge in making sure it's a sound investment. Does it pencil out and still make sense?"

I am in rare agreement with Mr. Kightlinger, this change has huge implications for the economics of the tunnels.  As I have discussed on this blog and a variety of other issues, the value of reducing regulatory uncertainty is the majority of the economic benefit attributed to the tunnels in the BDCP economic studies.  According to this article, the level of regulatory assurance will be massively reduced under the revised plan.

I wrote this blog in 2012 right after Dr. Sunding unveiled the regulatory certainty argument in a BDCP meeting. That post still looks good to me this morning, and it looks like my environmental sources were right on target when they told me the regulatory certainty scenario was not accurate.

The argument was later repackaged by changing the no-tunnel baseline to the "Existing Conveyance Scenario" where exports are assumed to plummet in the future without the tunnels, but remain near current levels with them.  Even with this reframing, the economic benefits of BDCP drop substantially with the impending change to short-term approvals, and risk of significant drops in water deliveries even with the tunnels.

Faced with that heightened risk even with the tunnels, it is reasonable to expect that water agencies will make more investment in expensive, less risky water supply alternatives.  Thus, another economic justification that has been made for the tunnels - that it will avoid the cost of these investments - is also weakened by this change.

The other big change described in Boxall's article is separating the habitat restoration component.  This will really help clarify the economic analysis, as the incorrect packaging of the restoration with the tunnels (restoration does not require the tunnels), was a major analytical shortcoming.

As for environmentalists worries that restoration will fall by the wayside without this packaging, they shouldn't worry.  The BDCP/tunnels were not creating any new funding for habitat restoration, it was diverting public environmental funding from other uses to the BDCP.  Good projects like the Yolo Bypass enhancements do not depend on the BDCP for funding and will go forward anyway with or without the tunnels.  And as we learned with last years water bond, environmental funding is more likely to be approved when it is detached from BDCP.  I would also argue that this is a good time to bring up again my argument for a no-tunnel BDCP, which is a more conventional approach to a Habitat Conservation Plan under the ESA, in which the regulated entities provide new resources for habitat restoration in return for some level of regulatory certainty.  I discussed that in an October 6, 2013 op-ed in the Sacramento Bee (can't find a link), and in this old blog post,

A bit unrelated, but I read an interesting new article last night in Businessweek about Seattle's troubled tunnel project.  The on-line version has fun graphics too and is worth a look by those interested in the Delta tunnels proposal.

Thursday, March 19, 2015

New Data Shows Surprisingly Small Impacts of Drought on Farm Employment

While I have a long record of saying that drought impacts on the economy tend to be overblown, even I was surprised by the minimal drought impacts in the data released this morning.

The Bureau of Labor Statistics' Quarterly Census of Employment and Wages is the most reliable data on employment (it is a census of quarterly tax filings).  Data for the 3rd quarter of 2014 was released this morning, representing the peak season for farm employment when drought impacts should be most evident.  As shown in the table I compiled below, there is virtually no difference in farm employment between 2014 and 2013 in the 3 counties that are thought to be most devastated by the drought. (Jobs are listed under each month in the table, NAICS sector 11 is 99+% agriculture in these counties, the increase in total wages suggest decreased hours is not a big part of the explanation even though the minimum wage increased on July 1, 2014.)

There is more data that needs to be compiled before jumping to conclusions, but I think it is important to get this information out there since the rhetoric on jobs, unemployment and water shortages is heating up again.

In my view, the impacts of drought are much larger in environmental data such as plummeting fish abundance, than in jobs.  I surprised a reporter earlier this week when I said that I thought the drought was a bigger environmental crisis than an economic one, and the recent data about 6 delta smelt found in the recent survey compared to virtually no change in agricultural jobs is an example.

How to explain this?  

As I said, there is more data to sift through, but it is important to recognize that this drought is coming in the midst of a strong expansion period of Valley agriculture.  The total number of acres irrigated and harvested has been growing every year for most of the past decade, even in the face of scarce surface water.  Thus, in the absence of drought, I suspect 2014 employment would have been even higher.  The drought is causing significant fallowing of relatively low value, and non-labor intensive field crops, while new acreage is coming into production by tapping groundwater.  Thus, there are farmers laying people off, I don't think the farmers in news reports are lying.  But clearly, there are others that were hiring.  In other words, the baseline for agriculture activity is rising, as I discussed last spring in this post.  

Friday, March 13, 2015

The Center for Business and Policy Research opened today.

Today, the Business Forecasting Center was renamed the Center for Business and Policy Research and my main office has moved to the Center's second office in Sacramento.  The new name and second locations has been in the works for a while.  It better describes the scope of what we do and gives us a base to build on it.

It also allows the Center to align with new academic programs that the University of the Pacific will be introducing to its Sacramento campus over the next few years in partnership with Pacific's McGeorge School of Law which was the only program on that campus until recently.

See our new website here.

Which California Metro Areas Are Still Below Pre-Recession Employment Levels?

The latest revised payroll data shows big differences across the State's regions.  The tables below show the percentage change in payrolls (seasonally adjusted) since June 2007.

Among the 10 largest metro areas in California, Sacramento is the furthest behind and soon will be the only large metro area still below pre-recession levels.  The good news is that Sacramento is recovering nicely now, but the recovery started about two years late in this region.  However, the biggest outlier is on the positive side not negative.  Silicon Valley and San Francisco is in a league of its own.                                                                                                

Anaheim-Santa Ana-Irvine Metro Div

Bakersfield MSA

Fresno MSA

Los Angeles-Long Beach-Glendale Metro Div

Oakland-Hayward-Berkeley Metro Div

Riverside-San Bernardino-Ontario MSA

Sacramento-Roseville-Arden Arcade MSA

San Diego-Carlsbad MSA

San Francisco-Redwood City-South San Francisco Metro Div

San Jose-Sunnyvale-Santa Clara MSA


Focusing just on the Central Valley, there is a geographical pattern from north to south. The worst recovering areas are in the Sacramento Valley, while the strongest growth has been in the drought-stricken areas of the south Valley.  Stockton and Sacramento metro areas are virtually tied, and both should finally cross this job recovery threshold this summer.  While it has been a painfully slow process, it is actually two years sooner than we were predicting back in 2011.

Yuba City -4.72%
Redding -4.39%
Sacramento -1.45%
Stockton -1.44%
Modesto 0.06%
Chico 0.39%
Visalia 1.48%
Fresno 1.77%
Madera 3.65%
Merced 5.10%
Bakersfield 7.90%
Hanford 9.77%

Tuesday, March 10, 2015

Army Corps of Engineers leaves Lathrop and South Stockton levees out of a draft flood control plan.

The levee planning battles seem to be warming up again.

The Record has an extremely interesting story about the Army Corps of Engineers draft plan for upgrading Stockton area levees.  I have not had a chance to review the draft plan yet, but the article discusses an important issue surrounding RD 17.
The Corps eliminated from consideration any improvements to the San Joaquin River levee that protects Reclamation District 17, a vast area stretching from Weston Ranch to Lathrop. The government’s justification is a Carter-era executive order that forbids levee improvements that might encourage development in floodplains. If the improvements went forward, the population living behind the RD 17 levee could increase by 100,000 people or more, the Corps reports. 
While the Federal Emergency Management Agency does not consider RD 17 to be in a high-risk flood plain, the Corps does — and that’s the problem. “We can’t responsibly invest limited funds in levee improvements in areas that would induce or facilitate growth within an area highly prone to deep flooding,” said Stacy Samuelson, a water resources planner with the Corps. 
On the flip side, tens of thousands of people already live in RD 17, and the area is home to San Joaquin General Hospital, the county jail, Interstate 5 and other important infrastructure. All the more reason to provide better protection, advocates say. “We’re not happy, and we’re going to fight it,” said Dante Nomellini, a Stockton attorney representing the reclamation district. “The problem is there’s no (added) protection for the 43,000 residents and all the investments that are out there now. That’s the craziness of it.”
The other important infrastructure is about to include a nearly $200 million VA clinic to break ground soon next to SJ General.  I certainly believe in protecting floodplains, but there are other planning and public safety principals to consider as well, including the principal to concentrate development around existing infrastructure.

It reminds me of Natomas in the Sacramento area.  Talk about federally funded levee upgrades that will induce or facilitate development.   

Thursday, March 5, 2015

Drexel Closes in Sacramento. What about Warwick?

In recent weeks, many conversations I have had in Sacramento have turned to the University of Warwick's announcement that they are going to establish a campus in south Placer County.  There are a mix of views but I would say the Warwick skeptics slightly outnumber the believers in my informal conversations.

Undoubtedly, today's news that Drexel is closing its Sacramento campus bolsters the skeptical view. After all, Warwick's plan is very similar, and based on the same gift of property, as Drexel's abandoned plan.  And the national higher ed headline this week is that Sweet Briar College in Virginia is closing despite a beautiful campus and a $93 million endowment adds more evidence that private, residential colleges are in financial trouble across the country and supports the view that it would be foolish to consider starting a new one.

Personally, I remain very positive about the potential for higher education growth in Sacramento in spite of the well-documented challenges in the sector.  I think one or more new campuses can succeed in Sacramento or Northern California, even if a hundred small private colleges close in the East and Midwest over the next decade.  And I think Warwick can be very successful in south Placer County, although there is a chance they could pull out like Drexel as their phased plan has several points for them to reevaluate before significant investment is made in the physical campus.

The memory of Drexel's closure is undoubtedly going to create challenges for Warwick's planned start-up phase of offering graduate programs in leased space.  Potential students may be reluctant to enroll in a University that they aren't sure will still be there in 5 years, and given Drexel's history and confusion with troubled for-profits in leased office buildings around the area, those doubts will persist until Warwick can show tangible investment in the campus.

Successful private universities in the Sacramento area will need to have a compelling non-monetary reason to be here, solid and patient financial backing, some visibility and connection with the Bay Area, and have the ability and desire to attract students from outside the local area.  Drexel had no compelling reason to be here and sensibly closed, but I still think Warwick and others have an opportunity to succeed.

Tuesday, February 3, 2015

Treasurer's Report on Delta Tunnels' "Affordability and Financing Considerations"

This report was released in November, but I only managed to take a second look yesterday.  I still don't find it convincing, and it doesn't appear to have done much to quell growing financial doubts about the $25 billion BDCP twin tunnels plan.

The report attempts to estimate whether the twin tunnels' are financially feasible.  In other words, do the water agencies that would pay for the tunnels have the financial capacity to successfully issue and repay its construction bonds?

I have no doubt in the capacity of the urban water agencies to pay their share.  These agencies have tremendous ability to recover their costs through rates and property taxes - even for a bad multi-billion dollar project like the tunnels.  However, these urban agencies are the minority players in the tunnels' financing, the majority of the water and the costs are allocated to agricultural contractors, and most questions about financial capacity have been targeted at these farmers.

The majority of the agricultural water contractors are part of the Federal Central Valley Project (CVP), not the State Water Project.  The executive summary of the Treasurer's report summarizes its findings on the CVP contractors as follows (page 8).
Even if the CVP contractors develop a new credit with a take-or-pay obligation and similar credit features of DWR bonds, it is not clear at this point whether $10.25 billion of bonds (assuming a 50/50 split) in the Base Case could reasonably be issued without a large rate stabilization fund or other credit enhancement or subsidy from the federal government, state government, or SWP contractors.
Not very reassuring.  The first part of the sentence assumes CVP contractors will agree to unfavorable changes from their current contracts, and the second part concludes that subsidies are still likely to be needed even if they do.

Specifically, it assumes CVP contractors will change to a take-or-pay system where they would be obligated to pay debt service for capital costs even in dry years when they receive little water.  It seems unlikely that these farmers would be willing to give up one of the most favorable terms in their current CVP contracts.  It also assumes additional unfavorable provisions to CVP farmers to secure repayment such as "step-up" provisions to pay their neighbors' costs if they default, and the ability to levy property taxes or assessments to guarantee payments.  Finally, it assumes that the CVP contractors will be able to establish a new credit sufficient for a mammoth $10 billion bond issue with a AA rating, even though half of these agencies have no history of issuing muni bonds and thus no credit rating, and even the larger AA rated agencies have relatively small bonds.

And even if CVP contractors agree to all these changes, the Report still casts doubts on the ability of the CVP farmers' to issue the bonds without a large rate stabilization fund (who would pay for this? the financial analysis in the report does not include costs for a rate stabilization fund) or subsidies from federal and state taxpayers or urban ratepayers; even though BDCP proponents have repeatedly denied that any such subsidies would be necessary or acceptable.

In contrast to the caveat-riddled report conclusions, tunnel proponents have been quoting this sentence in the news release  that puts a rosier spin on the results than any sentence I could find in the report itself.
The Treasurer’s report illustrates that the cost of the Delta conveyance facility is within the range of urban and agricultural users’ capacity to pay.
Specifically, the report estimates the cost of water with the tunnels is $213 to $278 per acre foot for Kern and $253 to $301 per af for Westlands, and that the "capacity to pay" of Kern farmers is $277 af and Westlands' farmers capacity to pay is $291 af.  The estimated "capacity to pay" is within the range of costs, so BDCP proponents state that the tunnels are "affordable."  I don't think falling within this range is going to be very reassuring to potential bond investors.  I reviewed the calculations in the report and see a few significant problems:

1. The analysis uses average values.  It does not account for variation in hydrology or markets.
2. Capacity to pay is overestimated. The return to owner/management is implausibly low.
3. Costs are likely underestimated, relying on optimistic assumptions about ratings and bond covenants.

With respect to the first issue, using average values, financing the tunnels requires these farmers to make payments in every year - they can't skip dry years or years when markets are unfavorable.  In a dry year like the current one, the cost per af of water shoots up under take-or-pay contracts, and net revenues drop if you are fallowing land or paying high prices for supplemental water.  The Report correctly notes this risk, and even proposes a solution - a large rate stabilization fund.  But it does not include the costs of establishing such a fund - which would most likely come from increasing the initial amount borrowed - and include the cost of this insurance into the cost of water.

Second, the capacity to pay is overestimated.  To estimate capacity to pay, the Report uses average per acre revenue for 5 years, 2008-12, and subtracts an estimate of per acre costs from UC Cost/Return studies excluding cost for water and a return to owner/management (i.e. profit).  The Report then allows for a miniscule return of $90 to $94 per acre (Figure 20-21, page 37-38), and defines the remaining net revenue as the "capacity to pay for water."  The low value for a return is because the report used 10% of net revenue as an allowance for profit, rather than the more commonly used approach of a percentage of gross.

I don't think there are any farmers out there that would consider $90 per acre a reasonable return, especially when more than half the land is in vegetables or permanent crops.  According to USDA, the rental rate of irrigated cropland in California in 2012 was $340 per acre. My relatives in Michigan and Ohio have rented farmland for almost $200 an acre in the frosty and unirrigated Midwest.  Rental rates are reasonable to use for a return on bare land, but they do not include a return on investment in permanent crops (like the nearly $10,000 acre investment in establishing an orchard) or a return to management effort.  So what is reasonable value?

According to the BEA farm income data, the average net return to farming in Fresno County since 1969 is 25% of gross revenue with a range from 9% to 37%.  Profits have been strong in recent years, with margins over 30% of gross revenue since 2011 and over 20% in every year since 2002.  In light of this, I would argue that 10% of gross revenues would represent the minimum return to ownership/management to use for payment capacity.

Another approach could be a return on investment necessary to attract capital to a business with the risk profile of farming.  An example of this kind of allowance would be the 11-11.5% return on investment the Public Utilities Commission uses in determining allowable rates for investor owned utilities.  A 10% ROI to estimate a fair profit for farmland would be even more than 10% of gross revenue - but I will use the 10% of gross revenues to be conservative.

Using 10% of gross revenue, the return to management in the Report for Kern would increase from $94 acre to $439 acre and increase from $90 acre to $363 acre for Westlands which reduces the net revenue available to pay for water.  $400 per acre is not a lot of profit for running a farm, but it is a little bit higher than the rental rate of land and seems a reasonable estimate of the minimum necessary to keep the land in ag. production which I think is the spirit of the payment capacity calculation.

If you make this adjustment to a minimal profit margin, the calculated payment capacity for Kern drops to $164 af of water, and for Westlands it drops to $192 af.  Both of these values are well below the estimated cost range, and thus one should conclude that farmers do not have the capacity to pay for the tunnels and make a minimal profit.  

Finally, on the cost side, the Report's estimate of costs do not appear to account for any coverage ratio that is common in bond covenants.  Typically, bond covenants would require the debt issuer to ensure that net revenues after operating expenses are at least 1.25x annual debt service payments.  The new credit entity for CVP farmers will not only need revenue in excess of its debt service payments, it will undoubtedly need its own general manager, lawyers, lobbyist, office, etc.  Farmers will have to pay those costs, the costs of establishing and maintaining a rate mitigation account, and keep their annual net revenues at least at 1.25 times the debt service if they have any hope of the credit ratings and borrowing costs assumed in this report.  I haven't made an estimate of all this, but I think it would boost the cost range of water by at least $50 af, maybe closer to $100 af.

The bottom line is that I think a more reasonable estimate of maximum payment capacity for farmers is about $175 af, and their average cost of water will be at least $300 af with the tunnels.  Even for permanent crops, the adjusted maximum payment capacity is about $325 af and the water supply is not nearly reliable enough to shift to 100% permanent crops.

As frustrating as current conditions are to south-of-Delta farmers, they are still very profitable today. If they are paying for the tunnels, they have little chance of being profitable.

Like Hydrowonk Rodney Smith, the Treasurer's Report has left me more convinced than ever that the tunnels are not a doable deal.

P.S.  It should also be emphasized that the Treasurers' report only looks at financial feasibility, it is not a benefit-cost analysis or policy analysis.  The first page of the Report states this clearly,
The report does not address the merits of the BDCP per se or the question of whether the state and other parties involved in the project should proceed with this project.
That hasn't stopped tunnel boosters like the Metropolitan Water District from misrepresenting the report.  Clearly Jeff Kightlinger didn't read the first page of the report when he issued a statement that said "this independent review finds that BDCP is a prudent investment."

This post is too long already, so I recommend this post from the Hydrowonk for a good explanation of why the average cost analysis in this Report does not show that the tunnels are a prudent investment.

Thursday, January 22, 2015

Stockton wins first part of its bankruptcy appeal. Plan implementation begins next month.

According to the Stockton Record, Judge Klein has rejected a stay in the bankruptcy plan implementation, and the City will move forward with implementing the plan in February.  These excerpts from Roger Philips' article in the Record, featuring comments from the Judge, are very informative about his reasoning and what lies ahead.

In announcing his ruling, Klein took into account Stockton’s success at negotiating settlements with all of its creditors other than Franklin before the city’s trial began last May.
“The nature of the plan has involved a lot of hard work and hard-fought matters involving compromise by virtually all of the parties of interest,” Klein said. “My ultimate rationale … was everybody with the exception of Franklin had come to the table and given up quite a bit. They elected not to come to the table and deal, and they chose instead to challenge confirmation and to appeal.” 
In refusing to stay confirmation of Stockton’s plan pending the appeal’s outcome, Klein noted that Franklin’s appeal solely concerns the amount of money the firm will receive. As a result, Klein said, he saw no reason to delay implementation of the bulk of the restructuring plan and no cause to risk scuttling what has already been accomplished. If the case is returned to him by the appellate panel, Klein said, “I think I can (handle it) without tearing up the existing plan and throwing it away and having to abandon all the difficult compromises that were achieved.” 
Klein said the appeal could take as many as five years to resolve, and that to delay Stockton’s exit from bankruptcy over a money issue involving one creditor was against the public interest. The judge also said he does not think it is likely Franklin’s appeal will succeed. “The public interest is served by actually being able to implement a plan upon which people can rely,” Klein said. “When I add up those aspects in the analysis, I’m seeing little likelihood of success on appeal. I’m not seeing significant harm to (Franklin).”
As I have discussed before, Franklin's recovery is extremely low compared to other unsecured creditors - whether they are the other bondholders who settled - or even the retirees who lost health coverage but retained pensions.  So Franklin has some arguments, but there is also the argument that creditors who didn't negotiate and settle and who loaned the city money in 2009 once the downward spiral in the City's economy and finances was extremely obvious should take a larger loss.

The Judge is right, the City needs to be able to move forward.  Franklin is a relatively small creditor, and if they win the right to greater payment on appeal - it would almost certainly amount to less than a million dollars a year.  That would hurt the City's efforts to restore services, but it is not enough to upend the whole plan.  So while there is still some lingering uncertainty regarding the Franklin appeal, it is just going to be a footnote to the bankruptcy story.

The more important questions are how the City will move forward from here financially?  Is there enough revenue in Measure A (and will it be managed properly) so that the City can live up to the promise of 120 more police in Measure B?  Will the City maintain fiscal discipline with future employee contracts and budgets?  How much will the CalPers burden grow in the future?  Can it come up with creative ways to start restoring some of the non-safety services given its budget constraints?  Many challenges still lie ahead for City leaders, but at least Stockton can move forward with more certainty and confidence now.

Friday, November 14, 2014

Franklin Appeals Stockton Bankruptcy Confirmation

Franklin filed an appeal of Stockton's bankruptcy confirmation this week.  I hope that my previous prediction that Stockton's plan would be rejected in Court will continue to be wrong. 
Franklin claims that Judge Klein's ruling included 4 errors:
1. It incorrectly interpreted the Best Interest of Creditors Test.
2. The classification of Creditors was discriminatory and unlawful.  [The City's plan grouped Franklin's claim "class 12" with the retiree health plan claim.]
3. The plan was proposed in Bad Faith.
4.  The City has not adequately disclosed payments and fees related to the case.
I find the second argument most compelling, and it is a big reason why I originally thought the Court would reject the plan.  Of course, I am not a lawyer.  According to Judge Klein, Stockton's classification scheme does not discriminate illegally, and the appellate court may agree.
Below is an excerpt on this topic from Franklin's appeal.
"Disparate And Discriminatory Classification And Treatment. Franklin also established that
the Plan’s classification scheme – in which Franklin’s unsecured claim was classified together with
part of the claims of City retirees (health benefit claims but not pension claims) and separately from
the claims of all of the City’s other bondholders – had only one purpose: to enable the City to avoid
the “cramdown” requirements of section 1129(b)(1) of the Bankruptcy Code. By improperly
gerrymandering Franklin’s unsecured claim into a class whose other members (the retirees) had
committed to vote to accept the Plan due to the promise of unimpaired pensions, the Plan violates the
strictures of section 1122(a) of the Bankruptcy Code. In re Barakat, 99 F.3d 1520, 1525 (9th
Cir. 1996) (plan violates section 1122 where “the classifications are designed to manipulate class
voting”) (quoting In re Holywell Corp., 913 F.2d 873, 880 (11th Cir. 1990)). The Court erred in
concluding otherwise.
The Court also erred in disregarding the disparate treatment of Class 12 claims and creditors
holding Class 12 claims. Specifically, the Court turned a blind eye to the direct linkage under the
Retirees Settlement between the retirees’ recovery in Class 12 and the City’s agreement to leave the
retirees’ pensions unimpaired. While nominally providing a sub-1% recovery to all claims within
Class 12, the Plan actually provides retirees with a recovery of somewhere between 53% and 70%

due to the fact that, as quid pro quo for the sub-1% “settlement” of Retiree Health Benefit Claims,
the City agreed to pay pensions in full. As many cases cited by Franklin establish, that treatment
violates section 1123(a)(4), which requires that claims and creditors in the same class receive the
same treatment. The Court erred by disregarding that authority.
Finally, the Court erred by failing to consider the undeniably unfair discrimination against
Franklin’s unsecured claim. Had the Court properly rejected the City’s gerrymandered classification
and disparate treatment of Franklin’s unsecured claim, it would have concluded that the sub-1%
payment on that claim unfairly discriminated against Franklin in comparison to the Plan’s 50%-70%
payment of retiree claims and 52% to 100% payment of other City bonds, including the wholly unsecured Pension Obligation Bonds. This legal error is likely to lead independently to reversal."