Thursday, November 29, 2012

Initial Thoughts on the latest BDCP Economic Analysis Presentation

I attended David Sunding's presentation at the BDCP Finance Working Group Meeting this morning, and some people have asked me to blog my reactions.

Overall, I would say he did very well, and the presentation reflects substantial improvement for the Economic Analysis of the BDCP.  It was certainly much improved over the June presentation, and I commend David for the enormous amount of work he has completed, and his clear and professional presentation and answers to the many questions.  It wasn't perfect, and I have a few new concerns, but they are outweighed by the improvements.

Notable improvements since the last time include:

·         The discussion of the arguably fictional regulatory certainty benefit was minimal, and the enormous estimates of its value were nowhere to be seen.

·         Also gone was the conclusion statement that the BDCP is clearly worthwhile to the water agencies since that depended on the regulatory certainty benefit.  [Update: I should note that he did not give any bottom line conclusions, for or against.]   

·         And most notably, the BDCP is now saying that they are going to do a complete statewide benefit-cost analysis after refusing for years. 
While the regulatory certainty benefit was gone, there were two other notable changes in the benefits analysis that concern me because they are blowing up the benefits estimates to help justify the tunnels.  These are 1) increasing the time horizon and 2) lowering the discount rate.  Both would draw significant complaints in a peer review, and are notably inconsistent with the approach used in the California High-Speed Rail benefit-cost analysis.  I believe the HSR comparison is critically important because these are the 2 controversial mega infrastructure projects on the state's policy agenda, and they should be analyzed consistently. 

Time Horizon:  Rather than estimating benefits of conveyance only up to 2050 (28 years of operations), Dr. Sunding is now extending the benefits to infinity (yes forever).  While cutting off at 2050 was too short, extending the benefits analysis to infinity is erring in the opposite direction.

Here is what the CA HSR B-C analysis says about the same issue (p.8). 

Benefits and costs are typically evaluated for a period that includes the construction period and an operations period ranging from 20-50 years after the initial project investments are completed. Given the permanence and relatively extended design life of high-speed rail investments, longer operating periods, and thus, evaluation periods are applicable.

For the CA HSR BCA, the evaluation period includes the relevant (post-design) construction period during which capital expenditures are undertaken through 2080...
which is approximately 47 years beyond project completion for the scenario with the longest construction period.
I support the use of a relatively long 50 year time span after project completion, but extending benefits to infinity in an infrastructure B-C analysis seems nuts.  However, it wouldn't make much of a difference if the discount rate weren't so low, which brings me to the second issue.

Discount Rate:  Dr. Sunding is using a 2.275% discount rate, justified by a recent Army Corps statement that I haven't seen and current, historically low interest rates.  This is down from the 3% discount rate used in his initial estimates this summer.  While I am sympathetic to using something lower than the traditional 7% rate, this 2.275% assumption could get hammered in a peer-review, even if it has been approved by a federal government agency. 

Current interest rates on bonds are being extraordinarily influenced by unprecedented Fed intervention and the lingering effects of a global financial crisis.  I don't think you can argue that low U.S. treasury rates in the current market signal that somehow the social rate of time preference or the opportunity cost of public funding (discount rate) has dramatically declined.  And what are the appropriate interest rates to guide the discount rate selection?  While Federal Treasury borrowing rates are historically low, credit is still extraordinarily tight, and many individuals, businesses and state and local governments are finding it difficult to borrow at any interest rate.  The appropriate opportunity costs for the BDCP is connected to who is bearing those opportunity costs, and the federal government has made it pretty clear that they are not paying for the BDCP.  Many of the costs are going to be passed through directly to households through rate increases, not added to the Federal debt, so I could make an argument that real interest rates on personal loans (even credit cards) are as relevant as the current rate on Treasuries.  Other BDCP costs are slated for the California General Fund through a General Obligation Water Bond.  I don't think the opportunity costs of utilizing the state general fund are at historic lows.  If anything, the opportunity cost of state funding is at a historic high, and the state hasn't even sold billions of already voter approved bonds due to market and budget conditions - even though interest rates are historically low.  California is a state that needed a temporary tax increase (Prop 30) to pass to avoid cutting 3 additional weeks off the school year, is releasing criminals early, and cutting public health and other key services due to lack of funds.  Given that the Governor has defined school days as the margin in the state budget, I could argue that the social return on investment for time in school would be the appropriate discount rate (opportunity cost).   

Probably more relevant is the other mega-project financed with a combination of general fund dollars and other sources, high-speed rail.  CA HSR used a 7% real discount rate for their benefit-cost analysis (p. 6).  HSR actually used 4% in their initial draft B-C analysis, but moved it up to 7% in the final draft in response to criticism in the peer review.  So, I would suggest that if HSR couldn't get a 4% discount rate past peer review when interest rates were equally low in 2011-12, his 2.275% assumption is going to be a tough sell.  Personally, I think 7% is probably too high, and would have recommend running both the HSR and BDCP B-C studies using 3% and 6% discount rates.  Dr. Sunding should perform some sensitivity analysis and prove that his results are robust to the HSR assumptions about time horizons and discount rates, and aren't just the result of assuming an infinitely lived project and a super low discount rate.

I am also still a little concerned about his approach to the seismic risk.  However, I will note that he toned down the rhetoric about this since the summer, and signaled some openness to considering alternative ways to reduce the consequences of a seismic event.  So this area of concern is also more positive and I have hope something good will eventually emerge.  I don't think there is any doubt that his analysis will show that the earthquake benefits are much less important to justifying the project than water supply benefits.  In fact, it already does.

As always, the criticisms take more space than the compliments, so I should note that I think his work in the critical urban water supply and several other areas is outstanding.  I think some of the folks in the audience do not appreciate what is involved here.  While I have wanted to smack him occasionally over the years (the feeling is mutual I'm sure), I have a lot of respect for Dave Sunding and remain convinced he is the best choice to lead this very important job.

Really, the biggest key to his benefit-cost analysis of the tunnels is defining a good no-tunnel alternative instead of a comparing the tunnel alternatives to a crappy, no-action, status-quo strawman.  The no-tunnel alternative has to be a BDCP option, meaning that it includes the necessary habitat and through-Delta flows and water operations to satisfy the ESA.  I see no reason why a no-tunnel alternative can't have comparable "regulatory assurance" benefits, environmental benefits, and even the potential water supply benefits from the "decision tree" as a tunnel alternative.  Finally, at least one no-tunnel BDCP alternative, and arguably even the tunnel BDCP alternatives, should include significant seismic levee upgrades. 

Tuesday, November 27, 2012

BDCP Blog Falsely Claims UC-Davis Report Models the BDCP, and UC-Davis Researchers Edit the Misleading Blog Post

Recently, the California Water Blog made a post that salinity effects on Delta agriculture from a proposed peripheral tunnel is a dog that doesn't bark. I wasn't going to respond until the Department of Water Resources' "BDCP blog" weighed in with this approving post, showing that the results of this study will indeed be misconstrued as I feared.

My biggest complaint about the California Water Blog is that it left out the crucially important detail that they modeled a tunnel that is significantly smaller than the BDCP proposal while including a large diagram of conveyance clipped from the BDCP to suggest that they did.

And then the BDCP blog, written by DWR staff, falsely titles their blog post "Salinity Effect of BDCP on Delta Farming Minimal, Researchers Say."

However, I revisited the California Water Blog this morning to clip a quote, and I am happy to report that they recently added the following paragraph to the body of their original post and deleted the BDCP diagram. (confirmed in the Google cache version dated 11/20).
The study did not consider the specific changes in the state’s proposed Bay Delta Conservation Plan, which includes the governor’s “preferred alternative” to tunnel exported water under the Delta. The modeled tunnel operated under 1981—2000 water conditions with a capacity of 7,500 cubic feet per second – enough to transport up to 59 percent of average annual exports (4.9 million acre-feet), with the remainder continuing to be pulled through Delta channels to the export pumps.

The fact that the diagram was included and this paragraph was omitted from the original blog post does not absolve DWR and the BDCP blog for misreporting this information. The description of the small tunnel scenario is clearly stated on page 35 of the full report which was released 10 months ago.  If BDCP is really about science and facts, shouldn't we expect them to read and accurately describe the reports they cite rather than reinterpret them through a political lens. 

The edits do not totally let the UC-Davis researchers off the hook either for what a colleague of mine describes as "feeding the animals."  They left this important detail out of the summary of the original report as well.  That summary discusses current policy proposals without explaining the differences between their scenario and the proposals.  And while the BDCP is now moving towards reducing the capacity of the intakes and lower levels of water delivery (details to be released soon), at the time the PPIC report was released and the research was done, the leading BDCP proposal was clearly for a 15,000 cfs facility and 5.9 maf of average exports, and had been for several years.  I complained about it in a post on this blog the day after the report was released in January.
Before anyone reads the summary of the new PPIC report and concludes that Delta residents don't have much to fear in the BDCP or the Delta Plan, they should understand exactly what the PPIC has modeled. When it comes to the big issues of water quality and habitat, it looks more like the recommendations of the Delta Protection Commission's Economic Sustainability Plan than the BDCP.

1. They assume water exports through a dual conveyance system will average 4.9 maf per year (see page 36 and 40) matching the 1980-2000 period. This is barely any increase over the constraints on through Delta pumping under the Biop. So, yes, under those operating assumptions dual conveyance would have a relatively small impact on Delta water quality. But does anyone really think that exporters will pay billions for conveyance that delivers 4.9 maf? My understanding is exporters have made it pretty clear that they won't, and draft BDCP documents and the superficial discussions of finance suggest substantially higher exports of 6 maf or possibly more. On page 40 they do note that some exporters are seeking 6 maf, but that is not what they modeled in their report...
Finally, the California Water Blog post states that the DPC Economic Sustainability Plan and an earlier PPIC report had much higher estimates of losses (the 2008 PPIC report actually estimated hundreds of millions of dollars in losses).  However, the peripheral canal endorsed by the PPIC in their 2008 report was an isolated conveyance facility (not dual conveyance) that diverted 6 maf of water from the north Delta; double the quantity conveyed around the Delta through a facility in this latest report.  And the DPC Economic Sustainability Plan report that I led looked at the actual BDCP proposal at that time, the 15,000 cfs tunnels with 5.9 maf of average exports.  The differences in approach between our report and PPIC are much more than this though, but I will save that for a future post that explains the differences, and the advantages of our approach.

If the BDCP doesn't actually significantly affect Delta salinity, these differences in economic modeling are irrelevant.  The surprising discovery in the PPIC report results from the suprising result of their hydro-dynamic modeling, not any advanced economics.  No change in salinity obviously means no economic impact from salinity changes, this is clearly stated in the DPC Economic Sustainability Plan. 

Thus, I wish the PPIC would write some blogs explaining their hydro-dynamic results in plain English since this is their most important and surprising result.  While I have no reason to doubt the results, I would like to better understand how it is possible to take 3 maf out of the Sacramento River without a larger impact, and I would be interested how their results change if more were diverted through the tunnels, if the results depend on or assume any change in upstream operations and flows, etc.

While they are at it, they should allow comments on their blog, so they can be conveniently alerted to parts that confuse people or even the occasional error or omission.  In this case, there is a good chance that some simple blog comments would have prevented Ms. Vogel at the BDCP Blog from making her mistake.  And how can they be the California Water Blog without the validation of a Mike Wade comment?

[Note: Original post edited to mention the BDCP diagram.]