First Impression of the new PPIC water economics report

It's good.  Really, I mean it.

They have brought in some very solid new economists that were not part of their earlier reports, and they acknowledge that some key facts have changed since their 2008/2010 report endorsing a peripheral canal that I have criticized so much over the years.  Most importantly, these facts include the ever increasing cost of new conveyance, as well as better understanding of the real costs of earthquake interruptions, and an increasing understanding that urban water demand is declining due to the combination of conservation and slower growth.

This report contains no statement that a peripheral canal or tunnel is the best choice for California's economy, a statement that has been made in previous PPIC reports written by the smaller UC-Davis based group.  In fact, it even has a more accurate statement of the what the previous PPIC/Davis studies actually found  (see page 15).

Past PPIC research has shown that a peripheral canal would be the best option to meet the "coequal goals" of water supply reliability and ecosystem health (Lund et al. 2010) Today, options have multiplied—from a canal to a tunnel to two tunnels—and cost estimates have increased significantly. In 2008, official estimates for new above-ground conveyance ranged from $4 billion to $9 billion (California Department of Water Resources 2008). By 2012, as attention has shifted to building tunnels, cost estimates have increased to roughly $14 billion—not including the costs of financing and added operational expenses. With cost estimates growing, the question arises: Are the benefits of new conveyance great enough to justify the expense?

They are describing their previous report as evaluating the co-equal goals, not cost-benefit analysis, which is how one correctly determines if a canal/tunnel is the best economic choice.  This is an important point.  In a blog post last fall, I discussed the conflicts between the co-equal goals and cost-benefit analysis as analytical frameworks.

I am focusing on this one issue, because the Delta conveyance question is the single most important policy choice facing California at the moment, and PPIC is generally cited as the independent, academic support for building it. 

The vast majority of the report isn't about the conveyance at all, and I generally agree with the discussion and recommendations surrounding these other issues.  I particularly liked that the report led off with some much needed perspective on the importance of water to the California economy, and some optimistic comments about our ability to manage future water scarcity.  Cutting down on the crisis talk greatly improves the quality of discussion on California water issues.

Update June 1:  Buried in footnote 40, the author's confirm that they have not done the analysis to conclude that conveyance is the best economic choice, and that it requires cost-benefit analysis.  Specifically, it says.  "To determine which strategy is best for the economy, the net costs of new conveyance need to be compared to the net costs of implementing alternatives with reduced exports."  Footnote 41 is pretty darn interesting too, and corrects a lingering error in the 2008 PPIC report that said ending Delta exports would cost over 100,000 jobs.  Glad to see it.

Why not a 4 day school week?

California stateworkers may be going to a 4-day workweek (with 9.5 hour days, 38 hours per week) as a proposal to save 5% in costs of state compensation.

With schools also facing budget cuts, why not a 4-day school week?  Except instead of longer school days, I would propose a longer school year with 3 day weekends.

The traditional calendar is 36 weeks x 5 days = 180 days  Why not 42 weeks x 4 days = 168 days? 

Some school districts around the country have gone to 4 day weeks with longer school days - similar to the state worker proposal - in order to save money on fuel and utilities for buses and heating buildings, etc.  I oppose that concept. 

But I bet students would actually learn more with a shorter summer break and 3 day weekends throughout the year. 

As a parent facing school budget cuts, and dreading the too long summer break with bored children, this idea sounds really good to me now.

California DOF revises 2050 population projection down by 8.5 million. Huge Implications for Water, Transportation, and Budget Planning

California DOF makes the state's official population projections.  The DOF forecasts have been notoriously aggressive in the past.  Until this week, the most recent DOF forecast was issued in 2007 and projected the state population at 59.5 million in 2050.  This week, DOF released new projections that estimate a population of 51 million in 2050. 

I am pleasantly surprised by the extent of the downward revision, and very pleased to see that the State's official growth projection is now much more realistic and fits well with our own modeling.  My research associate has just returned from a meeting about these projections for San Joaquin Valley counties, and came away really impressed with the improvements the DOF demographers are making to their models.  Kudos to them, it will really help the state improve planning and decision making.

For example, it is critical to things like estimating future water demand, a topic near and dear to many of the readers of this blog.  This 15% cut in future population projection is a big deal.  That's 15% less water demand - regardless of what you assume about efficiency improvements - and 15% fewer ratepayer/taxpayerss to tap for future debt payments - whether those are revenue bonds issued to pay for conveyance or a a general obligation water bond.

Way back in 2008, the very first thing I criticized in the PPIC/Davis analysis of the peripheral canal, was the population forecast used to estimate future urban water demand.  Their model used the absurdly high figure of 65 million, when DOF's own high forecast was 59.5 million, and most private forecasters and extrapolation of U.S. Census 2040 estimates were coming in around 54-55 million in 2008.  That was before the Great Recession, and I think the new DOF estimate of 51 million is pretty realistic now.

To their credit, the PPIC team has made some adjusments and they are thinking more constructively about the implications of slower growth and conservation, and I suspect some modeling of this will be evident in their new book on water economics.  I particularly liked this passage in a recent blog post,
  

The prospect of a long-term plateau or decline in water use in California is fundamentally positive for the politics of water in California (although it has some negative implications for utility finance). No longer should policymakers fear vast inevitable growth in long-term water use, with apocalyptic zero-sum consequences. California can have growth and prosperity without continued increases in water use. Water conflicts need not become increasingly severe and debilitating. 

[Edited on 5/12 to correct some very poor grammar.  I shouldn read these posts a second time before clicking publish.  My apologies to the English majors who suffer through my blog posts.]

Will Water Contractors' Have a Maloof Moment on the BDCP?

Over the past month, the Sacramento arena deal collapsed when the Sacramento Kings' owners, the Maloofs, backed out of the deal.  Many people were incredulous at the Maloofs flip-flop, as they have been saying they needed a new, modern arena for years.  The Maloofs killed the deal because they realized that the a new arena wouldn't generate enough new revenue compared to their imperfect current facility to justify the new debt.  While City officials are upset with the Maloofs, city taxpayers should not be.  The Maloofs may have accidentally saved the City of Sacramento from a financial fiasco as well.

I think we may be headed towards a similar moment with some of the water contractors and the BDCP deal.  The agricultural contractors are most likely to play the role of the Maloofs and wake up to the financial reality.  According to the draft BDCP, the marginal cost of new water the contractors get out of the tunnel is going to be $1,000 af ($1.2 billion in debt service and new operation cost for an average of 1.2 maf of new water).  Environmental deficiencies with the draft BDCP could mean even less new water, driving the marginal cost of new water supplies even higher for the contractors.  If you prefer to look at averages (spreading the $1.2 billion over all 6 maf), all the water delivered through the tunnel will cost about $200 af more.  Without the BDCP, the contractors would still receive the vast majority of that water, that's why the marginal cost for incremental water supplies is the most important number for decision making. 

I have heard farmers in the Valley talk about the burden of paying $200 af for supplemental water in 2009 to keep their almond orchards alive while railing against the Delta Smelt.  How can they seriously support a plan that would raise their water costs of all their water (not just the supplemental supplies) to this level in wet and dry years?  The BDCP is a solution to the Delta Smelt problem that will cost Valley farmers far more than the Smelt and Salmon biological opinions ever will.

With so much political effort expended to get the BDCP and a potential tunnel/canal to this point, it's promoters are not going to let it die easily.  The public officials, including water agency directors, and some environmental groups pushing the project are not the ones who will pay the costs, and like Mayor Johnson and the arena, the public officials will not be the ones to back out of the deal.  It will be the farmers, who like the Maloofs, take a step back, look at the numbers and come to their financial senses.

New Forecast Is Out

Our April economic outlook was just published (yes, I know it is May 1).

CALIFORNIA AND METRO FORECAST:  April 2012

California remains on the path of slow recovery according to the latest projection from the Business Forecasting Center at the University of the Pacific.  For 2012 and 2013, real gross state product is forecast to grow at an average 2.5% rate for both 2012 and 2013, and jobs will increase at a 1.5% pace.  In 2014 and beyond, the pace of recovery will gradually accelerate as housing and construction begin making a positive contribution to the economy.

California’s unemployment rate is currently 11.0%, and is projected to remain in double digits through the last quarter of 2013.  Housing starts are projected to grow modestly to 54,000 in 2012 with most growth in coastal multi-family construction while single-family homebuilding remains near historic lows.

The regional outlook predicts that 2012 is the first year of economic recovery in the hard hit Central Valley.  More details here

My take on the Sacramento Kings' Arena Debacle

Yikes, it seems the blog took a month of vacation.  Time to wake it back up.  I wrote this commentary on the Kings' arena for our forecast publication about a week ago.  With the arena deal dying again last Friday, the perspective is still timely, and it's good blog material.

  

Sacramento Arena Deal Collapses in Spectacular Fashion

It’s been hard to avert our eyes from the train wreck that is the Sacramento Arena deal, especially since the Business Forecasting Center just opened a satellite office in Sacramento and one of our professional colleagues, Chris Thornberg of Beacon Economics, took center stage as a consultant to the owners of the NBA’s Sacramento Kings.  Thornberg questioned the revenue projections underlying the arena financing assumptions, and questioned the City’s financing plan and whether the deal was in the best interest of the City.  The focus on the public benefit from the City’s financing plan was odd for a consultant of the Kings.  Presumably, the Kings would want to persuade the City to increase their Arena subsidy, and it is hard to see how highlighting the City’s financial risk and weak economy helps persuade the City to improve the deal for the Kings.  One plausible explanation for the Sacramento bashing tactic is that the Maloofs are trying to persuade the NBA that Sacramento is an unviable market so the league will approve relocation to another city.  The Maloofs flip-flop and Thornberg’s harsh criticism of Sacramento elected officials led to a heated public war of words, including dueling op-eds in the Sacramento Bee between Thornberg and City Manager John Shirey.

Underlying the drama are objective economic and financial calculations.  Are the revenue and economic projections realistic?  Is it a good business deal for the Sacramento Kings?  Is it a good deal for the City, or a looming financial disaster?  An even more fundamental question is whether a new arena generates enough new economic value to justify a $391 million investment, regardless of who pays for it. 

From the Kings’ financial perspective, the new downtown City-owned arena must be compared to their current team-owned arena in Natomas, and realistic future alternatives including relocation or even renovation of the current arena.  The Kings are reported to be profitable, unlike most of their NBA peers playing in larger, more modern arenas.  The Kings would contribute about $70 million in new arena construction costs, plus agree to a 5% ticket surcharge that would send several million dollars a year back to the City.  Even assuming a conservative $20 million annual revenue boost from a new arena, the Kings could support these direct costs.  However, there are a host of additional provisions that likely make it a poor financial deal for the Kings.  In addition to the direct arena costs, the Kings’ owners would no longer receive revenue from non-basketball events at the current arena like they do currently at the team-owned Power Balance Arena.  The deal also locks them into the Sacramento market for another thirty years in addition to a host of other smaller concerns.  The Kings’ best strategy would seem to be to stay in the existing arena for a while, explore its renovation, while waiting to see if Sacramento or another city makes a more favorable offer as the economy and municipal finances improve.

What about the City?  Is the proposed arena deal a financial disaster?  It is definitely a fiscal risk, but whether it is a potential disaster depends on your perspective and the civic value you place on an arena.  Compared to other publically-financed arena deals over the past twenty years, the deal is more protective for taxpayers than many.  While the City pays about 60% of direct development costs, the City’s real contribution is significantly less than 50% when revenues from a 5% ticket surcharge, profit sharing with arena operator AEG, and other terms are included.  Although the economic development benefits of an arena are badly overstated, it will bring some new net dollars to the region and the Arena is clearly a civic amenity of some value.  Despite these positive aspects to the deal, it is still a significant public subsidy and considerable risk for a City that is in the midst of a serious budget crisis.  The positive cash flow from parking facilities is an asset the City of Sacramento has to get it through the crisis that many similar cities lack.  Financing the arena could involve a 50-year lease on parking facilities to fund an arena whose economic life will likely be less than fifty years.  Some of those parking assets are in key locations, and committing them to a parking lease for fifty years could entail significant opportunity costs.  The same can be said for selling city-owned land such as the 100 acres in Natomas adjacent to the current arena.  The City’s finance plan clearly adds new burdens to the municipal budget, even though some arena costs will be “backfilled” with ticket surcharges and other tax revenue.  Some public expenditure for an arena can be justified - all civic assets have costs - but the Mayor and City Council have clearly pushed the City's side of the deal to its boundary, especially considering the minimal contributions from the surrounding cities and the clear unwillingness of taxpayers to support a dedicated arena tax in the past.
The Mayor has worked hard to retain the Kings and has come up with the best proposal he could, one that pushes the City to its financial limit, and yet still doesn’t appear to be a better deal for the Kings than the alternatives, including the status quo.  The inevitable conclusion is that, like most sports arenas in medium to small markets, a $391 million arena in downtown Sacramento simply doesn’t generate enough new value to equal its cost.  No amount of financial engineering is likely to change that.  The new arena is simply infeasible without an owner and/or a City that is both wealthy and passionate enough about pro basketball in Sacramento to overlook significant financial risks.  Judging from recent events, both sides seem to have an abundance of passion, but a shortage of wealth.