BDCP Benefit-Cost Analysis Is Going Off-Track

I attended the second update on the new BDCP benefit-cost analysis on Thursday.  I was optimistic after the initial meeting in November, but I am not anymore.  In November, I was optimistic because they had finally agreed to do benefit-cost analysis, hired a good economist to lead it, and appeared open to feedback.

After this latest meeting, I am left with the impression that they are not responsive to feedback, and that the analysis is not really directed by the economists or established benefit-cost principles.  It is directed by Jerry Meral, the Governor's chief advisor on the BDCP, who is not fair and impartial, let alone qualified to direct benefit-cost analysis.  He has a clear mission to implement the Governor's vision for the twin tunnels, and he is keeping the consultants on a short leash.  He does not appear to be following key elements of his agency's own benefit-cost guidelines.

In many cases when participants make good suggestions that would make the analysis more consistent with accepted guidelines, the economic consultants defer to the boss (Mr. Meral) or state that it is outside the scope of work.  The scope of work should be really simple, one sentence is sufficient really.  "Conduct a peer-reviewed, independent, benefit-cost analysis of the key elements of the BDCP following recently published guidelines by the Department of Water Resources (2008)."   Mr Meral shouldn't be dictating anything.  He should just send comment letters like everyone else.

[Update 1/29: I just became aware that the scope of work has been posted.  I see nothing in this scope that changes my opinion.  The lengthy scope of work is inconsistent with DWR's own guidelines for this type of analysis, contains no provisions for peer review, and provides draft documents to the water contractors first.]

Here are several areas where I feel the benefit-cost analysis is heading off-track.

Incorrectly Bundling The Tunnels Together With the Habitat

B-C principles are clear on this issue, and the principle is clearly stated in DWR's own rules.  Each of the major components of the BDCP must independently satisfy the benefit-cost test.  Since the big controversy surrounding the BDCP are the proposed tunnels, B-C guidelines clearly indicate that conveyance (i.e. the tunnels) should be analyzed separately.

This element of proper B-C analysis seems to bother people who see BDCP principally as an environmental restoration package.  My initial draft B-C analysis was criticized for ignoring environmental benefits of BDCP, which misses the point.  It was an analysis of the tunnels - not the whole BDCP.

This concern can be avoided by considering a proper range of BDCP alternatives.  These alternatives, including no-tunnel with seismic levee upgrades, and various sizes and configurations of water conveyance (i.e. the NRDC small tunnel proposal) should all be paired with appropriate habitat and operations that meet the requirements of an HCP under the ESA.

All these alternatives would then have roughly equivalent environmental values.  Thus, the environmental values would cancel out when comparing alternatives and allow the resources of the benefit-cost analysis to squarely focus on the critical questions of conveyance.

Unfortunately, Dr. Meral appears to be prescribing an analysis that ties the habitat improvements to building a tunnel.  This is invalid, and his own consultants have even said so by stating that the ESA doesn't require the tunnels, and the habitat investments could be made without the tunnels.

Inadequate Alternatives

This is closely related and somewhat redundant with the above concern.  However, it is so important it needs to be emphasized.

Mr. Meral has made it very clear that they would only be looking at one alternative, the Governor's plan, and comparing it to a no action alternative.  This is a clear source of bias, and is well-known way to game benefit-cost analysis.

At minimum, there should be a strong no-tunnel BDCP scenario (similar to the DPC economic sustainability plan) and a strong small tunnel scenario (similar to the NRDC plan).  The alternatives need not be limited to that, but those two are musts.  If these alternatives are included, then I wouldn't complain if the No Action alternative were dropped entirely from the analysis.

I actually think an analysis of this type would be clearer, faster, and cheaper, because it would largely avoid the morass of non-market environmental valuation and allow clear apples to apples comparisons of conveyance options.

Is the Value of Regulatory Uncertainty Back?  Playing games with the No Action alternative.

This meeting also raised a new red flag for me.  While the consultants are restricted to only consider one alternative to achieve the BDCP goals, it sounds like the consultants have been given the liberty to play games with the No Action Alternative.  I say that because Dr. Sunding kept mentioning that the results are sensitive to the level of water exports in the No Action Alternative, strongly suggesting he is going to lower water supplies in the No Action Alternative below the 4.7maf average, potentially as low as 3maf.  The 4.7maf number is based on the current biological opinions governing operation of the projects, and is consistent with the BDCP's draft EIR documents and the definition of No Action that has been used in every BDCP related presentation I have seen to date.

This is a distortion of how No Action alternatives are typically defined in B-C analysis and in EIRs. The No Action alternative assumes a continuation of current conditions and policies.  A future deviation from current policy would only be considered in rare cases if it is the clear direction and intention of the relevant government agency, in this case, the Department of Water Resources (DWR).  However, DWR is litigating the current biops along with the Delta water exporters, and is on public record in court that they feel they are too restrictive and that higher levels of exports should be allowed.  So it seems to me that the only deviation from a No Action alternative based on the current biological opinions that could be remotely justified is an increase in water exports, not a decrease in water exports, and certainly not to something as low as 3 maf.

I asked Dr. Sunding if this low water export scenario would be part of an additional HCP alternative, and he said no, it would be the No Action alternative.  I wouldn't mind including a no-tunnel alternative with lower water supplies than the current Biops, but such an alternative should be a BDCP alternative (i.e. meeting the requirements of an HCP under the Endangered Species Act), packaged with habitat and levee investments that would generate comparable levels of environmental benefits and seismic risk reduction to water supplies.

With this manipulation of the No Action Alternative, I believe Dr. Sunding is trying to resurrect his value of "regulatory certainty" theory in the form of a super restrictive No Action Alternative.  This hides it by not including regulatory certainty as a separate value category like he did in his July presentation on economic benefits.  However, it effectively embeds the concept inside the valuation of water supplies and seismic risk.

Until this is cleared up, I am taking back my praise from 2 months ago that he has dropped the regulatory certainty argument.  A No Action alternative should be relatively non controversial, but the discussion in this meeting makes me worried that they are going to adopt whatever creative definition of the No Action alternative is necessary to justify the Governor's twin tunnels.

Blowing Up Earthquake Risks

This is now the 4th time I have seen Dr. Sunding present the losses of an earthquake induced Delta collapse that conveniently occurs in 2025, the date the tunnels are assumed to be complete.  Of course, assuming this perfect timing generates the largest possible numbers for his table.

In addition, he always presents the earthquake risk reduction benefits as raw numbers without multiplying by the probability it happens.  The scope of work they developed for the "benefits analysis" last year stated that this would be multiplied by probabilities, but he isn't doing it in presentations.  Why?  Even the exagerrated DRMS estimates placed the probability at about 2% per year.  He also includes 2 and 3 year outages that are thought to be highly improbable.  I applied the DRMS probabilities to his tables and found the present value of earthquake risk reduction to be no more than 5% of the construction cost of the tunnels.

Most irritating to me, Dr. Sunding is assuming that the state will not eliminate the earthquake risk to water exports through seismic levee upgrades.  The probability that this will be done in a No Action, No Tunnel alternative is certainly greater than zero, and I would argue this is far more likely than the 3 maf of exports he is seriously discussing as part of his no action alternative.  Building the tunnels will probably mean that there will be no seismic upgrades of Delta levees which will result in unnecessary enormous losses of lives, property and economic activity in the event of the big earthquake event.  From this broad perspective, I could make an argument that the Earthquake value of the tunnels is negative.

I believe my suggestion that the earthquake risk reduction benefits of the tunnels are negative (in other words it is a cost, not a benefit, since it will result in poor seismic protection for everything else that matters in the Delta) is far less of a stretch than the "regulatory certainty" theory Dr. Sunding has conjured up.

Super Low Discount Rate

The consultants presented a justification for an unusually low discount rate of 2.275%.  One could present equally convincing justification for a 7% discount rate, especially when focused on opportunity costs of state funds rather than today's currently low long-term interest rates that are being manipulated in unprecendented ways by the Federal Reserve.  

Another reasonable approach is to look at the DWR guidelines here.  In January 2008, when DWR issued its guidelines recommending a 6% discount rate, the yield on a 30 year Treasury Bond averaged 4.33%.  BDCP is arguing that todays super-low market interest rates suggest a lower discount rate should be used.  At the end of last week, the 30 year Treasury bond yield was 3.14%, which is only 1.19 percentage points lower than when they released their guidelines endorsing a 6% discount rate.  So I don't see how DWR can make a market interest rate argument for lowering the discount rate by much more than 1 1/4%, which would be a discount rate of 4.75%.

This is an unsettled issue in Economics, and it isn't going to be settled now.  The proper way to handle this is to do a sensitivity analysis that shows the results with a range of values, say 2% to 7%.

A low discount rate is the oldest trick in the book for biasing a B-C analysis in favor of a project, and by adopting a single, super low discount rate, they are just fueling perception of a rigged study.

Concerns With the Non-Market and Recreation Values 

I mentioned two of these in the meeting: the noise and visual pollution of the intakes, and accounting for the lost non-market values of prime farmland.  And it isn't clear to me that BDCP would result in any net gain in recreational values.  After all, the folks who are currently in the Delta recreational business are some of the biggest opponents.

I also have concerns with the benefits transfer approach, but I won't bother with that here.  As discussed above, I believe this is an area of intense controversy.  And it is really unnecessary, because what folks really want is a benefit-cost analysis that focuses on the tunnels.

[5:00 PM, lightly edited for clarity and grammar]

FYI for Governor Brown: Katrina and Sandy killed over a thousand people and destroyed thousands of homes

Governor Brown's state of the state speech invoked the destruction of Katrina and Sandy as the primary justification for his plan for the tunnels.

The primary tragedies of Katrina and Sandy were lost lives and destroyed homes and property.  Katrina killed over a thousand Americans and Sandy killed over a hundred, and caused billions in local property damage.  The state's assessment of a mass flood, Delta earthquake scenario predicts similar levels of fatalities and local property damage.

In both Katrina and Sandy, there were also some significant secondary disruptions on gasoline markets and some other effects that spread outside the affected area.  For a massive Delta flood, there would be similar impacts: the focus has been on disruption to export water supplies, but there would also be costly disruptions of transportation, energy, and local water systems.

In his speech, Governor Brown declared that his plan to protect the state from a Delta flood is to worry about only one of the secondary interests (water exports) at enormous costs while ignoring the lives, homes and businesses that would be destroyed in the very unlikely but catastrophic flood event in the Delta.

Can you imagine if the Governor of Louisiana or President of the U.S. gave a speech that said that the lesson of Katrina is that we need to move oil refineries out of vulnerable areas around the Gulf without mentioning or offering to help the thousands of people who lost their lives and homes in these events?  Jerry Brown just did the equivalent when discussing a Delta flood, and only showing concern for out-of-area interests in his comments and in his action plan (tunnels).    Where is the backlash?  The media is praising him for his visionary rhetoric while ignoring that his actions/plan show a cruel indifference to whether hundreds or thousands of Californians perish in a catastrophic flood.

In this case, Brown's speech is not only insensitive but is bad economics.  The state is now sitting on 2 studies that clearly show that seismic levee improvements are cheaper than the tunnels, and provide more economic benefits because seismic levee upgrades protect water exports from interruption, and also provide additional benefits of protecting in-Delta lives and property, and significant non-water energy and transportation infrastructure.

First Impression of the NRDC Portfolio Delta Plan

 The "new" NRDC proposal is very similar to a compromise based on the 3,000 cfs pipeline proposal Greg Gartrell and Jonas Minton were talking about a lot back in 2009 and 2010.  I thought was the best proposal out there in 2010 and early 2011. 

 

At that time, I thought the small tunnel was necessary for a lifeline water supply in the event of the earthquake.  All I knew about Delta earthquakes and levees was what I read in the newspapers and heard from Dr. Doom.  After working on the DPC Economic Sustainability Plan, I now realize that the earthquake risk to water exports can be reduced by as much or more as building tunnels through the common sense approach of upgrading the levee system, an action which also has enormous non-water benefits.  To their credit, this new portfolio plan doesn't make seismic risk reduction the principal justification for the 3,000 cfs tunnel and the plan does call for significant levee investments.     

I didn't notice any agricultural water agencies on the NRDC water agency support letter.  I don't think their small and still very expensive tunnel, and their portfolio of alternative water supplies provides a lot of value to agriculture, both outside and inside the Delta.  While the 3,000 cfs tunnel has the advantage of being cheaper and thus leaving more money to invest in the rest of the portfolio, I'm not sure a $5-7 billion, 3,000 cfs tunnel with 4 to 4.3 maf of average exports is a good investment compared to a no-tunnel BDCP with potentially more levee and habitat investment. 

Farm water supplies is where I think Bob Pyke's West Delta Intake plan may have an edge over this NRDC/Barry Nelson adaptation of the Gartrell/Minton little tunnel plan, it provides more water to agricultural users who have fewer alternative investment options than urban agencies.  We need further development of both of these conveyance alternatives.

 

Overall, I think the new NRDC portfolio proposal is a welcome development, even if it is mostly repackaged old ideas put forward by an interesting coalition.  It is clearly better than the current BDCP, and it deserves serious consideration. 

 

At the moment, I count three credible alternatives to the current BDCP that are not receiving enough serious consideration: NRDC portfolio plan (little tunnel), DPC economic sustainability plan (no tunnel), and the West Delta Intake concept (big tunnels downstream).  I am pretty sure all of them have lower costs and higher benefits than the current BDCP proposal, and that all of them satisfy the co-equal goals of state law.

 

It's Time For a Serious Study of the West Delta Intake Concept

I admit that I didn't pay much attention the first time I heard Bob Pyke describe the West Delta Intake concept nearly two years ago. 

Then I started talking to local fisherman, boaters and farmers for the DPC Economic Sustainability Plan.  I recall talking to one gent in Lodi who had been fishing the Delta for decades who said, "They should just put the intakes in the Carquinez Straight."  I asked, "Do you know Bob Pyke?"  "Nope."  Over the next few months, I heard some other comments from Delta locals suggesting intakes at the Antioch Bridge, Rio Vista, etc.  "Do you know Bob Pyke?" I asked.  No, they said.  While they claim not to know him, I am pretty convinced Bob stole his idea from some Delta locals while drinking in a local bar.  It involves too much common sense to spring from the mind of a Ph.D.

Seriously, these conversations made me realize that this was a conveyance concept that might get in-Delta support, and I can't recall ever hearing a local say they should just build a little pipe (or a 3,000 cfs tunnel).  West Delta intakes passes the common sense and fairness test of many people who actually live in the estuary.  That's nice I thought, but it isn't a good enough reason to build it.  I still mostly dismissed it as an expensive civil engineers' flight of fancy.

Over the past year, Dr. Pyke has been filling in details to the concept while the BDCP tunnel concept flounders, delivering less water and more cost with each iteration of the BDCP plan.  And the more I learn, the more I think West Delta intakes could be a viable option, and apparantly I am not alone.  At this point, it seems very likely to me that the West Delta concept delivers more benefits at lower cost than the BDCP tunnels.    

In the recent article in the Record, the sub-headline focuses on the potential cost savings, just like most coverage of the fat, seismic-resistant levees we recommended in the Economic Sustainability Plan.  But I think the key to appreciating both the fat levees and West Delta Intakes is to understand that they provide more benefits than the alternatives, rather than focus on the costs.

Of course, this all needs to be studied in detail.  I agree with Larry Ruhstaller in the Record article,

Simply studying the plan can't hurt, Ruhstaller said Friday.

"If there's a fatal flaw, let's find it," he said. "We think there's a lot of fatal flaws" in the governor's plan.

Why should we be looking at this alternative?  Take a quick look at the some of the more significant potential benefits and costs.  It certainly seems promising.  What's the harm in a study?

Potential Benefits of the West Delta Intakes Compared to the Tunnels

1.  More Water Exports.  For years, I have been hearing about the "Big Gulp, Little Sip" approach to the Delta; that we need to take more water in wet years and less in dry years.  That has been a selling point of the tunnels, but it appears that the tunnels aren't able to actually take that big of a gulp.  Bob's design would allow a bigger gulp by having significant storage between the intakes and the aquaducts, and having ten miles of "intakes" along wide channels on Sherman island feeding conveyance tunnels with 15,000 cfs capacity as opposed to 9,000 cfs in the current BDCP plan.  Because the intake location would create water quality issues in dry years, it seems there would be no choice but to take a little sip in dry years. 

Overall, it seems the average level of exports would be higher than the BDCP tunnels.  The failure of the current BDCP to significantly increase water exports in return for a $14 billion investment from water exports is a key reason why BDCP makes no economic sense, especially for farmers.  While the tunnels offer some water quality benefits for exporters, the water supply is more important.  By my rough calculations, average water exports need to get to 6.5 to 7.0 maf before a $14 billion investment in conveyance makes economic sense for water agencies.  We know BDCP can't get to those levels.  The West Delta concept has a shot, and it should be studied.

2.  More Benefits for Fish.  The West Delta "intakes" would be 10 miles of coarse sand and rock levees where water would be pulled in at much lower velocity than the proposed BDCP intakes, which might collectively add up to nearly a mile of screened intakes.  The channels are much larger near Sherman island too, so it intuitively makes sense to me that salmon and other fish would pass by much more easily.  And the design of the plan would put a physical constraint (not a rule that can/will be broken) on dry year water exports, which is said to be critically important to fish.

But I don't know anything about fish, so don't listen to me.  Let's get the biologists to study it.  While DWR has expressed concerns about Delta Smelt in this region, I seem to recall some environmental experts touted by DWR - and high-level Delta Stewardship Council officials saying things like we must accept that we might lose some species in order to improve the overall ecosystem and achive the co-equal goals.  I am not saying that we should let the Smelt go or even that the West Delta concept is harmful to Smelt.  I am saying that concerns about Smelt is not sufficient justification not to study the West Delta concept given that they have continuously studied conveyance concepts that are known to harm endangered species.

3.  Better for in-Delta interests.  There is no arguing this. And yes, they matter.

4.  Better for non-water concerns such as transportation and public safety.  Dr. Pyke's proposal talks about transportation improvements on Sherman Island, but I would make the larger point that his plan would build upon levee upgrades throughout much of the Delta as recommended in the Economic Sustainability Plan.  If you believe that the risk of a major seismic event in the Delta is high enough to demand action, then you must realize that transportation, life loss and other infrastructure and property loss in the event of a Delta quake is a much larger risk than water exports.  Real solutions to seismic risk in the Delta protect all these values, not just water exports, and the BDCP tunnels fail on this criteria.  West Delta intakes aligns the water exporters interests with the rest of the state when it comes to addressing seismic risk.  This is a critical issue that I will write about in the future.  These levee upgrades need to be done regardless of any conveyance solution that may be implemented, but there is a real risk it won't happen if the BDCP tunnel plan goes forward. 

In addition, it offers an advantage over the BDCP tunnels in that it improves all stakeholders relative to the so-called "status quo". That is an attribute with real societal value, and it also has practical value when it comes to navigating lawsuits, politics and getting a conveyance permitted and built. 

Potentially Lower Costs Than the Tunnels

Would the construction costs be lower than the tunnels?  I'm not sure, but it seems unlikely to be significantly higher.

The most obvious saving is that the conveyance tunnels would be less than one-half the length of the BDCP proposal.  That is a large cost saving on tunnels, but the West Delta concept also includes additional costs for new storage.  The reconfiguration of Sherman Island, dredging out the peat, building the 10 miles of permeable sand/rock levees and other improvements will be expensive, but might not be much more than the North Delta intakes and forebay in the BDCP plan, which are also really expensive.  

So what's my preliminary conclusion on the WDIC.  I think there is a significant probability that the concept has higher overall benefits than BDCP tunnels, and it is unlikely to cost more and might have lower costs than BDCP tunnels.  It definitely merits a rigorous study.   

For the details and a better explanation, check out Bob's accessible 13 page description of the concept and why it makes sense here.  He's got a brief addendum floating around to that gives more details on permeable levees too.  I don't have a link to the addendum, but will try to post one later.

Update:  Here is a link to the addendum.

Thoughts on the (Yawn) Governor's Budget Proposal

Well, that was boring.  First time in years that the Governor's budget proposal didn't include huge budget cutting or a major new proposal which makes sense because it is his 3rd budget and he has already laid out much of his policy vision. 

And with Prop. 30 passing and the economy hasn't thrown any major surprises over the last year, the budget is more or less balanced along the lines of last year.  So no need for new slashing, and no new money for major initiatives or restoring old cuts. 

The big story is going to be the weighted student funding formula that would direct most of the new funding to schools with lots of english language learners and poor kids.  That was initially proposed last year, but implementation was contingent on increased overall funding - which meant Prop. 30 passing.  I am a little surprised that opponents of Prop. 30 didn't use the weighted-student funding proposal more in their campaign against the taxes (something like "Jerry Brown's tax increase won't increase funding for all schools, politicians and bureaucrats will choose which schools get the extra funding and some schools will be left out.  Do you trust Sacramento to treat your community fairly...")  I wouldn't be surprised to see Democrats lower the vote thresholds for school parcel taxes to help ease resistance from suburban school districts that will be harmed by the weighted student funding formula.  This issue has huge implications for the Valley, and still has to overcome a lot of resistance, so I will be watching this issue closely.  

People most often ask me about the economic and revenue forecast in the budget.  I think it is a little optimistic, but not unreasonable, and it is important to note that their forecast optimistically assumed the 2% payroll tax cut would be extended for 2013.  That assumption obviously turned out to be wrong, and will have an effect on future forecasts for the May revision.  My initial estimate is that revenues are probably going to be $1-2 billion less than their projections, a little larger than the budget's reserve.