Friday, August 23, 2013

BDCP Officials Continue to Inaccurately Describe Their Economic Study

In recent testimony to the Delta Stewardship Council, Karla Nemeth misrepresented the economic analysis of BDCP, perpetuating confusion over what this report found.  Ms. Nemeth's statement is typical of the confusing and inaccurate descriptions of this report by various state officials, including Jerry Meral and John Laird.

According to Maven's notebook meeting summary, Ms. Nemeth explains that BDCP will stabilize water exports at a level of at least 4.7 million acre feet (MAF) annually using the high-outflow scenario.  She then describes the results of the economic analysis as follows,
With BDCP stabilizing existing water supplies with a yield of about 4.7 MAF, our most recent economic analysis demonstrates about a $5 billion economic benefit that is mostly the result of reducing the risk of future shortages." 
Given how much the Delta Plan expounds on the subject of risk, I am kind of surprised Phil Isenberg or another member of the Delta Stewardship Council didn't interject right there to ask Ms. Nemeth if her use of the term risk was consistent with the Delta Plan, especially since she said most of the benefits come from risk reduction.  The Stewardship Council's Delta Plan goes to great lengths to define risk as probability times consequences, it even has graphics illustrating the concept.  But the BDCP Economic Analysis doesn't treat a future reduction in water exports without BDCP as a risk with a probability, it treats low probability risks as certainties with 100% probability.  

In fact, the positive result of the BDCP economic analysis is not "the result of reducing the risk of future shortages."  It is the result of comparing BDCP to an alternative that is extremely bad for the contractors and extremely good for the fish, and then having an analysis that counts the harm to water exporters and ignores the benefits to the fish.  An accurate statement from Ms. Nemeth would state, "With BDCP stabilizing water supplies with a yield of about 4.7 MAF, our most recent economic analysis demonstrates about a $5 billion economic benefit for the water contractors compared to a scenario where tougher environmental regulations reduce average exports to about 3.4 MAF by 2025."

You might think I'm nit-picking, but Ms. Nemeth's misstatement is about a $10 billion error, meaning that the difference in the value of water supply reliability in the scenario used by the Brattle Group and a risk analysis implied by Ms. Nemeth is likely to be in the neighborhood of $10 billion. 

What is the probability that by 2025, exports would be reduced below 3.5 MAF due to regulations?  While this scenario is the water contractors' worst nightmare, the probability of this occurring is very very low.  Thus, the value the Brattle Group has assigned to avoiding this outcome should be multiplied by a very low probability, which is the approach they took to valuing the reduction in earthquake risk where they multiplied the loss from a year-long earthquake outage by an assumed 2% annual probability of it occurring.

A journalist recently sent me a link that shows implementation of the State Water Board's draft flow criteria would reduce water exports to 3.7 MAF to 3.9 MAF (see Appendix B here), and most observers believe the chance that those criteria are implemented is extremely low.  Thus, it seems to me that 3.7 MAF is a reasonable lower bound for future water exports without the BDCP, and this lower bound is even higher than the 3.4 MAF the BDCP used as the basis for comparison in their Economic Analysis.  No wonder Dr. Sunding and BDCP are getting so much flak for making this ridiculous assumption.

If 3.7 MAF is a resonable lower bound on future operations, what is a reasonable upper bound?  Given the barrage of legislation and lawsuits against the current biological opinions and the ESA itself, it seems to me that a reasonable upper bound on future operation would be a return to 2000 - 2005 conditions where water exports exceeded 6 MAF per year.  At the outset of BDCP, many water contractors said their goal was to restore exports to 6.5 MAF.  Thus, I would say a probable range of future outcomes is 3.7 MAF to 6.5 MAF, and the current biological opinions are in the center of that range.

That doesn't mean that the BDCP doesn't have some regulatory risk reduction value to the water contractors.  But a proper valuation of that risk would put likely put its value in the millions, not billions of dollars.  It would be similar to the valuation of seismic risk reduction of the tunnels which the BDCP economic analysis values at around $400 million.

Speaking of economic risks, there also other important components of economic risk that the BDCP ignores, especially on the cost side.  What is the risk that the tunnels take more than 10 years to build as assumed in the analysis?  What is the risk that BDCP costs more than currently estimated?  The BDCP warns that their regulatory assurances aren't guarantees, so what is the regulatory risk that remains even with BDCP?

I remain very confident that BDCP results in a net economic loss for the water agencies' ratepayers of around $7 billion compared to the status quo.  

Thursday, August 22, 2013

Stockton MSA tops the U.S. in home price appreciation according to FHFA

On page 48 of this morning's release of the FHFA home price index for the second quarter is the following list of areas with the fastest home price appreciation in the U.S. over the past 12 months.

National MSAs, 1 year home price appreciation ranking.
1. Stockton-Lodi, CA 19.40% 

2.  Phoenix-Mesa-Scottsdale, AZ 18.47% 

3.  Las Vegas-Henderson-Paradise, NV 17.59% 

4. Bend-Redmond, OR 16.73% 

5. Modesto, CA 16.01% 

6.  Sacramento--Roseville--Arden-Arcade, CA 15.45% 

7.  Vallejo-Fairfield, CA 15.42% 

8.  Reno, NV 15.09% 

9.  Madera, CA 14.78% 

10. Oakland-Hayward-Berkeley, CA 14.56% 

Of course, virtually all of these cities topped the price deprecation lists if you go a few years back.  For example, the Q4 2008 release showed Stockton at 291 out of 292 metro areas with -41% change in home values over 1 year. (Merced was last with -49% change in that release.)  Even people like me who felt local property values had dropped too far should be mildly surprised and slightly impressed to see the Stockton MSA at #1 on this list.

Wednesday, August 7, 2013

The BDCP Economic Impact Study

Between a family vacation and the University of the Pacific network meltdown (entering day 5 of no email), I am in both physical and virtual isolation.  I did see the press release and a few news articles about the release of the BDCP's statewide economic impact report.

A few quick thoughts.  This is not a valid benefit-cost analysis.  Without even getting into some of the deficiencies in the calculation details (e.g. overestimates future water demand, discount rate is too low, etc.), it suffers from three fatal structural flaws.  While the consultants are very capable economists, their report contains these flaws and ridiculous assumptions for the simple reason that the Delta tunnels can not be economically justified without them.  Below is my summary of the three big structural flaws.

1.  The $15 billion Delta tunnels must be subject to a separate analysis.  BDCP invalidly ties environmental restoration projects together with the tunnels into a bundle, although these conservation projects could be pursued without the tunnels. The principles of benefit-cost analysis, and the state's own guidelines are crystal clear here, the tunnels must be justified independently.  

2.  The BDCP analysis compares the project to a single ridiculous alternative, where export water supplies are cut another 25% below the current restrictions in the biological opinions.  While this might be an extreme scenario to bracket the analysis, and some environmental groups support such restrictions, it is disingenuous to portray it as the most likely outcome in the absence in the BDCP.  This is particularly true since the water contractors and the state Department of Water Resources are suing that the current biological opinions are too restrictive and unjustified by science, and they even won the last skirmish in court on this issue.  The Department of Water Resources can only argue that this is the most likely outcome if they think that the science and law supports an additional 25% cut in water exports, a position that is in direct conflict with the stance they have taken in federal court for years.  BDCP has to take this contradictory position to economically rationalize the tunnels since spending $15 billion on tunnels that don't increase water supply rather obviously doesn't make economic sense.

The EIR (environmental impact report) uses a completely different no-action alternative, a continuation of the current biological opinions, which can be justified.  Using this more realistic baseline as the basis for comparison, the tunnels fail the benefit-cost test by a wide margin.  I demonstrated this last summer, and the state's consultant, Dr. Sunding acknowledged this in response to a question at the Metropolitan Water District.

In addition to an alternative that continues current regulations, the tunnels should also be analyzed against a set of no-tunnel BDCP alternatives.  These would include options focused on seismic levee upgrades, as the Delta Protection Commission has advocated, and would include a version of the delta corridors plan which is the through-delta alternative discussed in the EIR.  These no-tunnel alternatives would be BDCP alternatives, meaning they would convey the same regulatory assurances to the contractors under the Endangered Species Act as the state's preferred project with the tunnels.  They would contain the environmental restoration elements of BDCP, so the environmental benefits of restoration would cancel each other out, and the benefit-cost analysis would focus squarely on the tunnels.

3.  The BDCP economic impact analysis does not place an economic value on the most important environmental impacts, particularly the endangered and threatened fish species that are driving the entire conflict.  This issue is critically important here, because the BDCP economic analysis uses a no-tunnel alternative that is an environmental activists dream, it is very likely to be more beneficial to the fish than the BDCP plan.  The BDCP statewide economic impact analysis makes an assumption to boost water supplies to increase water supply benefits, but does not account for the environmental cost on the other side of the ledger.

Valuing the environment is a sticky and controversial issue, but it is an issue that must be addressed.  You can't just waive your hands and ignore the economic value of recovering fish populations like this recent BDCP economic report.  In this context, I think the best approach is to define alternatives that are expected to deliver roughly equivalent environmental benefits.  Fortunately, this is possible to do for the tunnels, since the BDCP EIR analysis basically says that the tunnels alone provide no net benefit for fish relative to the current biological opinions.  In other words, ignoring the environmental effects could be justified if the current biological opinions are used as the baseline for comparison, as they are in the EIR.  Following the structure of the EIR is also highly desirable to maintain consistency across the various reports.  That is the approach that I took in the benefit-cost white paper I put out last summer.  The bottom line is that if the BDCP is going to use a baseline alternative that is more protective of fish than the tunnels, it is imperative that the value of those fisheries is explicitly included when they weigh benefits and costs.