Wednesday, April 27, 2011

New Metropolitan Water District Presentation on Delta Costs

I was looking for recent MWD cost analysis on a canal, and found this Powerpoint presentation from a MWD committee meeting that was today.  At the risk of reading too much into a Powerpoint without hearing the presentation, I found several parts very interesting compared to what I saw from MWD last year. 
1.  I have not seen any water contractors talking about incremental (marginal) costs of Delta conveyance before (see slide 36).  That is a very positive development.  Note that the incremental, capital only costs of a tunnel are a whopping $518/af.  Based on the other slides, it is reasonable to add another 10-15% on top of that for operating and mitigation costs, and $250-$300 per af (according to the slide) to move the water from the pumps.  That puts the incremental cost of the water provided by the Delta conveyance to MWD at $800-$900 per af.  They may be willing to pay that, but it is definitely pushing the limits, and they won't be able to pitch in more money for habitat or cross-subsidize ag. users at those levels.

2.  MWD is only allocating proportional costs to itself, thus these would be the same costs that would apply to agricultural contractors.  It's hard to see how ag could pay these costs.

3.  The presentation makes the small tunnels look pretty bad, especially the cut and fill idea.  As a non-engineer, I wonder why 2 tunnels are necessary for 3,000 or 6,000 cfs?  That would be a question I would ask if I were sitting in the room instead of reading Powerpoint on the internet, as I have heard conflicting information on this.

4.  Will the BDCP backtrack to the original East surface canal because of the tunnel costs?  I would expect that question to be on the mind of any MWD board members watching this presentation, especially when they start seeing the costs displayed in incremental/marginal terms instead of average costs.

Update  4:10 P.M.:

I have gotten a half dozen email comments from smart people today on this post.  Use the comments, don't send me email.  That way everyone can benefit from your wisdom. 

Sunday, April 24, 2011

Cost-Benefit Analysis, Rep. McClintock, and the PPIC

Some readers have asked for elaboration on the McClintock/PPIC comparison in the last post.  Tom McClintock wrote this in a recent article in the Sacramento Bee.
as chairman of the House Subcommittee on Water and Power I have announced that all projects – including the Auburn dam – will first be evaluated under a uniform cost-benefit analysis that establishes the amortized cost of construction, and annual operations and maintenance balanced against the value of water, hydroelectricity, recreational leases and flood control protection afforded by these projects.
I like that McClintock is focused on cost-benefit analysis, and I especially like that he is emphasizing the importance of a uniform approach to it.  However, his description of cost-benefit analysis is not correct.  Cost-benefit analysis does not amortize costs into the future and compare them to future benefits.  This approach ignores the time to build, and is problematic when benefits are not smooth.  The correct way to do cost-benefit analysis is to estimate the full path of costs and benefits and discount them back to a single present value.  This is fundamental.  Consult any textbook, government guideline for confirmation.  Even Wikipedia has it right,
Benefits and costs are often expressed in money terms, and are adjusted for the time value of money, so that all flows of benefits and flows of project costs over time (which tend to occur at different points in time) are expressed on a common basis in terms of their “present value.”
If a project has a short build time and a smooth time series of costs and benefits, it isn't a big difference mathematically.  However, if it is a big project with a long build time before benefits appear and those benefits aren't smooth over time (i.e. dams, peripheral canal around the Delta), the error heavily biases the analysis towards making the investment.

So why does McClintock have me thinking about the influential PPIC water reports?

There are two key analysis by the PPIC/Davis group, both originally published in the 2008 Comparing Futures report.  In the one analysis, they evaluate whether a peripheral canal should be built around the Delta, a project long desired by water exporters.  In the other analysis, they evaluate whether Delta levees should be upgraded or repaired after a flood, investments strongly supported by Delta interests.

The PPIC/Davis team does not apply a uniform approach to evaluating these investment decisions. 

When it comes to Delta levee investments, they use the correct present value framework and even account for the lack of benefits during the construction period.  I have no problem with the framework they utilize here.   They conclude that in most cases, investing in and repairing levees is not economically efficient.  Their conclusions depend on the values they assign to benefits, costs, and flood probabilities, and those have values have been challenged by many, but that is outside this discussion of the framework.

When it comes to evaluating the peripheral canal, the PPIC/Davis group uses the incorrect, McClintock style approach that amortizes costs forward to the future for comparison to future benefits.  It is a much easier standard.  The approach ignores a 10-25 year build period when costs are incurred and no benefits are received.  And then, they choose a very distant future year to evaluate benefits (they say 2050, but their 2050 water demand looks more like 2080 or 2100) when benefits of a canal are estimated to be very high, ignoring the fact that benefits will be much smaller at first.

I can forgive Congressman McClintock and staff for not knowing the difference.  After all, ordinary voters are familiar with amortization, not discounted present value; and he is talking about a concept and not making calculations.  But the PPIC group certainly should know the difference, are making influential calculations, should apply a uniform approach.  Instead, they set up an inconsistent framework to evaluate these two investment alternatives, and thereby severely biased their analysis in favor of a peripheral canal before they even input a single number into the models. 

Is this splitting hairs?  Is it a big deal quantitatively? 

Consider a simple example, based on current cost estimates for alternative conveyance, and benefits of a conveyance as calculated in the 2008 PPIC report. 

Assumptions: 50 year analysis period, 5% real interest rate, peripheral conveyance costs $15 billion and takes 15 years to build so $1 billion in costs in years 1-15, operating costs $200 million annually from years 16-50, benefits of the conveyance are $2 billion 50 years from now, increasing by $50 million per year to reflect the growing demand and growing risk of through-delta water supply interuptions from flood.  In other words, I set the benefits at $350 million in year 16, and increased them in a linear fashion to $2 billion 50 years from now.


Incorrect PPIC/McClintock analysis:  Amortized capital costs are $817 million + $200 million operating costs = $1.017 billion in costs in year 50.  Benefits in year 50 are $2 billion.  Costs are about 50% of benefits.  Build it.

Correct Cost-Benefit analysis (present discount value):  Present value of costs = $12.937 billion.  Present value of benefits = $7.402 billion.  Costs are about 175% of benefits.  Do not build.

That is a very large difference, and it shows the substantial bias introduced by the PPIC/Davis team's incorrect approach.  Of course, you can legitimately argue about the assumed numbers in the example, the point is to show that the error is potentially very important quantitatively in addition to showing bias. 

In summary, the PPIC's analysis of a peripheral canal uses an incorrect framework that is heavily biased towards supporting a peripheral canal.  Importantly, the framework is inconsistent with the much tougher standard they framework they use for evaluating Delta levee investments.  The inconsistency demonstrates substantial bias towards the agenda of Delta water exporters and against in-Delta interests.

Postscript:  Several other posts on this blog demonstrate the PPIC bias in other ways, most notably in the parameters selected for their model (water recycling costs 3x too high, desalination costs 2x too high, vastly understating conservation gains and overstating population growth, etc.)   In this post from over a year ago, I stated

The economic analysis in Comparing Futures suffers from 3 fatal flaws.
1. Grossly overstates future urban water demand and the cost of alternative water supplies.
2. Does not value environmental services or even the market values of recreation and fishing.
3. Ignores established scientific methods for evaluating investments over time which skews their analysis to favor big capital projects like canals.
The post went on to talk about the first 2 flaws, but left an explanation of the last flaw for a future post.  This post finally gets around to it, 15 months late.  I thank Rep. McClintock for providing the inspiration.

Wednesday, April 20, 2011

Some Observations on Water

It's been over a month since I posted anything significant on water. Time has been short.  There is plenty to blog about so here are a few quick observations.

1. Tom McClintock keeps talking about benefit-cost analysis.  It's interesting to compare McClintock's approach to BCA to the PPIC/Davis way of evaluating investments in conveyance vs. levees. They are both wrong, but at least McClintock is consistent.

2.  The hearing in Fresno was actually not as one sided as I expected (perhaps my expectations have just gotten so low).  There were lots of references to our jobs reports, and it is always nice to see people using the information.

3.  Westlands is now saying the 2009 water shortage impacts on Valley agriculture were equal to or smaller than estimates I have made.  Yes, it's true.  I saw it in comments from Tom Birmingham and two declarations they submitted to Judge Wanger in the salmon case before they decided to drop their request for an injunction against the salmon biop since the issue is moot at the moment.  Maybe they should hire me for some consulting.

4.  The good, bad, and confusing in the Stewardship Council draft plans deserve comment.  But they issue a new draft plan before I can finish reading the last one.
5.  I have been learning about Delta levees.  I have been quiet on this subject since I am not an engineer.  But if Jay Lund can do economics, maybe I can talk about levees. 

One example of what I have learned can be seen by comparing Figure 12 in the executive summary of the DRMS report to DWR's Flood Safe maps from 2008.  This is important because that bright red island seen near Stockton in DRMS Figure 12 (>7% annual flood probability) is the same island outside the 200-year flood protection according to DWR's Flood Safe Assessment.  For those of you not from Stockton, that island is known as Brookside, was developed 20 years ago, has the most modern levees in the Delta, and is where most of the million dollar homes are in the city.  It looks like this one mistake skews the DRMS cost assessment by over a billion dollars (they are assuming an island with billions in real estate and business sales floods every 10-15 years). 

6.  I'm trying to control an overwhelming urge to scream/blog every time Tom Philp posts something.  I got over it with Michael Boccadero and Mike Wade comments, so let's hope it works for Philp too.

7.   I wonder what the Pacific Legal Foundation (PLF) thinks about Delta lawyers winning "takings" cases against the Department of Water Resources.

Depressing (deceptive?) Fact of the Day

From today's Sac Bee article on folks lining up to work for McDonalds. 

McDonald's and other fast-food chains, once a first job for teenagers, appear to be turning into an employer of more adults: The average age of a fast-food worker is 29.5, up from 22 in 2000, according to the U.S. Census Bureau.

An optimistic view of this is that perhaps fast food jobs have gotten better, higher pay and benefits, and are therefore retaining workers.  But, I took a quick look at the data and saw no evidence that relative fast food wages had grown.

So, I am inclined to think that the pessimistic angle in the article is right, it's a sign of a lousy economy.  Look of the picture of the 59 year old man interviewing for a job at McDonalds after a "long ride in auto sales."

Tuesday, April 19, 2011

New California and Metro Forecast Released

The quarterly update to our 5 year state and northern California metro forecast has been released. The short-term forecast for the state and most metro areas besides Sacramento has slightly improved, but the longer range forecast is little changed.
* California recovers pre-recession job levels in 2015
* double digit unemployment through the end of 2013
* Bay area leading recovery, while Sacramento is at the end.

For more details, see the forecast webpage.

Tuesday, April 5, 2011

Mendota High Wins State Chess Championship

Congratulations to Mendota High students for this tremendous achievement.

It isn't just chess players with achievement, as the Mendota school district has boosted it's API score by about 100 points since 2006.

2010 Census data show a population of 11,019 in Mendota City, a 39.6% increase over the 2000 Census, and four times faster than the 10% growth in the state of California, and more than double the 16.4% growth rate of Fresno County.  Mendota's housing vacancy rate was 5.2% in the 2010 Census, less than the 8.3% vacancy rate in Fresno County and the 8.0% vacancy rate in California.

These are all very remarkable achievements and surprising statistics given the economic challenges Mendota has been facing and the multitude of press reports that have suggested that this town has dried up and blown away because of the Delta Smelt.