Thursday, March 13, 2014

New PPIC Report on the Cost of Water From the Tunnels

After a quick initial read, my impression of the new PPIC report, Paying For Water, is mostly positive.  It provides a good overview of funding options and challenges in key areas.

Of course, I am always interested in what the PPIC has to say about the Delta tunnels.  There is only a brief discussion of the tunnels on page 26-27, and it correctly focuses on the major challenge of agricultural users affording the tunnels without endorsing or rejecting the tunnel proposal.  However, I do not believe it accurately characterizes the cost of water through the tunnels, and it incorrectly attributes a per acre foot cost estimate to Dr. Rodney Smith (of Hydrowonk fame).
BDCP puts the implicit additional water supply cost of new conveyance, based on current cost estimates, at $302 to $408 per acre-foot at the Delta.39 Additional costs would accrue for transmission, treatment (for urban users), and distribution, which could add as much as several hundred dollars to the price paid by urban water users. Others that have examined BDCP put the likely cost much higher, with estimates ranging from $500 to $1,000 per acre-foot. fn40
Footnote 40 attributes the $500-$1000 per acre-foot estimate to Dr. Smith's blog post, but this is what Dr. Smith actually said in that blog post.
Over the past couple of weeks, I have heard about alternatives to the no BDCP scenario defined by DWR.  What proves true will have a substantial impact on the cost of BDCP water.  Under alternative “no tunnel” scenarios, the best case for the cost of BDCP water would be well over $1,000/AF for a non-firm water supply.  There are some scenarios where the BDCP investment may yield even a lower water supply.  In those circumstances, the BDCP investment in tunnels would become the “bridge to nowhere” in waterworld.
I don't know how Dr. Smith's very clear and bold statement can be interpreted as $500-$1000 af.  I have joined Dr. Smith in estimating the cost of BDCP water as well over $1,000 af., and would be over $2,000af in very plausible scenarios.

The PPIC's brief discussion of the tunnels' cost continues...  
Still, for most urban water users, Delta exports in this price range would remain competitive with most other new sources of supplies. In contrast, this price increase could be prohibitive for many agricultural activities. Among the many open questions is whether water users could agree to a cost-sharing formula with lower payments by agriculture, potentially in exchange for lower reliability, or to a smaller project (lowering both future exports and costs, and using the savings to develop more local supplies in urban areas).

This is a reasonable assessment if you think the costs are under $1,000 af.  My take is a little different, and simply reflects my view that the costs are higher. 

For urban agencies, I believe the costs are on the high-end of their current alternatives.  So it is affordable but marginal investment for urban agencies if you assume a proportional cost distribution with farms.  But the costs are absurd/nonsensical/crazy (I have used all these adjectives) for agriculture, and the majority of the water exported from the Delta is used by agriculture.  Any attempt to shift the costs from agriculture to urban users make the tunnels a very bad investment for the urban users as well.  And the PPIC's other suggestion, that the cost shift be done in exchange for lower reliability for agricultural water supplies - has significant economic and social implications in a dry year like this - the financing plan for the tunnels could be the real "man-made" drought for the Valley.

Tuesday, March 4, 2014

New Temperance Flat Feasibility Study Claims Salmon Benefits and Delta Earthquake Risk Reduction Justify the New Dam and a Big Taxpayer Subsidy

I spent a good part of the afternoon reviewing the new feasibility study for the Temperance Flat dam and compared it to the one released in 2008.  The Bureau of Reclamation's claimed benefit-cost ratio in the new feasibility study is much higher than the one from 2008 that infamously found a B-C ratio of 1.0 to 1.06 despite the fact that the estimated water yield is lower.

Some observations about the benefit-cost estimates.

1.  Estimated construction costs of the dam dropped by nearly $1 billion (new estimate is about $2.5 billion compared to original of about $3.5b), even though the current estimate is in 2013 dollars and the old one was in 2006 dollars.  I am told the cost reduction is attributed to a change in the hydroelectric mitigation required.  Apparantly, it isn't true that estimated construction costs always go up.

2.  The new feasibility study justifies the dam for its ecosystem benefits to salmon.  It values the ecosystem benefits 2-10 times higher than the water supply benefits.  In addition to economically justifying the dam, this finding also is convenient for justifying a much higher taxpayer subsidy of the dam than proposed in 2008 (more on that later).  These multi-billion dollar ecosystem benefits (annual benefit estimates ranged up to $500m per year) result from the report's estimate that the dam will increase long-run average abundance of salmon from between -0.7% and 4.9% per year.  I'm not a biologist, but that doesn't seem like a huge benefit to me for a river that is projected to have relatively small salmon populations.  This recasting of the dam as a salmon project is very surprising to me as I am not aware of any environmental groups or fishery experts pushing Temperance Flat dam as a priority, and there are even some environmental groups who are opposed.

3.  The report is quite honest that the traditional water supply, flood control, hydropower, and recreation benefits that are associated with dams are not nearly high enough to justify the construction costs of this project.  And that's even after the report inflates these traditional benefits...

4.  In the "best" scenario, the report estimates $19 million in annual agricultural water supply benefits from an average increase to ag. water supply of 41,000 af.  That's a healthy $461 af in current dollars, a value that is about 3 times higher than typically used for incremental ag water in benefit-cost assessments.  Given the special role of agriculture as the economic base of the Valley, I have sometimes argued for using a more generous economic development measure that includes multiplier effects.  Like many of these assessments, this feasibility study also calculates the economic development value in a separate section.  In Table 5-12, the report estimates this annual value at $10.8 million for agriculture, which seems about right for 41,000 af of annual yield.  The strange thing is that this economic development value is lower than the value used in the benefit-cost estimate, and it is usually the other way around.  This seems to confirm my suspicion that the $19 million value associated with ag. water supply reliability is an error.  Bottom line, the agriculture water supply benefits are overestimated by a factor of 2-3, at least $10 million per year.  [Update:  I have now seen the technical appendix, and it turns out that this huge agricultural value results because the model they are using allocates the majority of new agricultural water produced by Temperance Flat to recharge groundwater where it has a much higher economic value than growing crops. This is an interesting finding and if it accurately measures the value of recharging groundwater and/or the external cost of pumping groundwater on other users of the aquifer, it makes a powerful argument for regulation of groundwater.]

5.  Delta earthquake and flood protection benefits.  The feasibility study estimates $25 million in annual benefits from emergency water supplies Temperance Flat would provide in the event of a catastrophic Delta flood.  This benefit is inflated due to ridiculous assumptions about levee failure probabilities among other issues.  As a point of comparison that shows the foolishness of this number, it is almost identical to the risk-reduction benefits the BDCP estimates for the Delta tunnels which are thought to preserve several million acre feet of water exports in the case of these catastrophic events.  [The BDCP estimates 50 years of this benefit has a present value of $364m to $460m, use the present value formula to solve for the annualized value and it is in the neighborhood of $25 million annually.  This Temperance Flat study allocates over $400m of construction costs to taxpayers due to this benefit.]   

6.  The benefit-cost analysis uses annual costs and benefits.  It annualizes capital costs over 100 years with a 3.75% discount rate.  That is a very generous assumption, and it understates the annual costs.

Some observations about the proposed cost allocation for Temperance Flat.

1.  Only 26% of the cost of the dam would be allocated to water users (12% ag, 14% municipal/industrial).  In contrast, the 2008 study of the dam allocated the majority of costs to water users.

2.  About 73% of the cost of the dam would be paid by federal and state taxpayers.  The 73% allocation can be broken down into three general categories of claimed public benefits: 49% ecosystem, 8% recreation/flood control, and 17% emergency water supply benefits from a Delta flood (see #5 above).  This 73% share is only direct construction costs, and does not count the subsidy in the Bureau's 0% financing of agricultural users contribution.

So that is about $1.25 billion in taxpayer dollars towards dam construction for claimed salmon benefits (direct costs, this doesn't count interest costs on the water bond that would finance the state's share).  I wonder what a salmon expert would do if you gave them $1.25 billion of taxpayer funds and said spend this to improve salmon habitat.  

In addition, it allocates 17% of the dam's costs (nearly $500 million) to state/federal taxpayers due to the Delta flood risk reduction benefits (see #5 above).  Taxpayers might prefer to spend $500 million in Delta risk reduction would be better spent directly on Delta levees themselves - providing flood protection benefits for water supplies and protecting property, other infrastructure and lives in the Delta. 

Some observations about financial feasibility calculations for water users.
Unlike BDCP, this report correctly proposes a cost allocation before making any conclusions about financial feasibility. 

1.  Agricultural water supply is allocated $264 million of construction costs.  Assuming 40 year repayment period with no interest, and operating costs comes to $8.7 million per year.  The report estimates the cost of the incremental water supply to the agricultural users is $212 af.  That's a hefty cost for agricultural water, and note that this is the cost even with the Reclamation's generous no-interest financing and taxpayers picking up 73% of the estimated construction cost of the dam.

2.   Municipal and industrial water supply is allocated $362 million of construction costs.  The report assumes a 40 year repayment of capital costs and 5.37% interest.  Principal, interest, and operating costs come to $27.4 million annually, and the incremental water supply cost to M&I users is $1,305 per acre foot. That's a pretty expensive municipal and industrial water supply, even with taxpayers picking up 73% of the estimated cost of the dam.

Overall, it's not a very convincing feasibility study, and I don't believe it provides strong economic justification for Temperance Flat dam.  It's disappointing, because I believe in the value and need for storage and I would like to be able to support storage projects in the Valley.  But there are better uses of taxpayer dollars for these and other purposes, and the water it is still an expensive option for water users even with the large taxpayer subsidies.  

Monday, March 3, 2014

What's the value of water to agriculture?

Over the past month, lots of people have been emailing me the $1,100-$1,200 per acre foot price for price irrigation water is selling for in a Kern County auction.  It is indeed an incredible price for agricultural water.  It shows that this drought is very severe and likely will impact some high-value permanent crops, and it tells us what orchard owners are willing to pay for one year to keep an orchard alive when they have few other alternatives.

But what does this data point tell us about the value of water to agriculture in California?  What is the value of agricultural water that should be used for major policy analysis - such as evaluating infrastructure investments such as Delta tunnels, new reservoirs, alternative agricultural water supply investments (like solar powered groundwater desal), or intra-regional conveyance to facilitate more local transfers between Valley farmers?

I would caution people from over-interpreting the $1,100 per acre foot price.  In fact, the same article in the Bakersfield Californian that reported the $1,100af auction, also reported this...
Buena Vista plans to use part of the proceeds from the auction to pay for a land fallowing program within its district. It has offered to pay farmers $400 per acre not to farm this year to reduce demand on the aquifer.
It had hoped to be able to fallow 4,000 to 5,000 acres.
The district ended up getting applications for 11,000 acres, Etchechury said.
After weeding through all the applications, he said, it looks like about 7,500 acres are eligible for the fallowing program, which could cost the district $3 million.
Thus, in the same county where farmers are willing to pay $1,100 per acre foot, a 50,000 acre water district on the west side of the Valley has 7,500 acres (about 15% of the district) accepting $400 per acre to forgo planting. Assuming 3-4 feet of water to grow a crop, this second data point suggests the marginal value of water in agriculture on the west side of Kern County is about $125 per acre foot.  [Data on irrigated land rental rates from the California Department of Food and Agriculture (see page 2) imply a similar value.  CDFA reports irrigated cropland rents for an average of $340 per acre in 2012, and non-irrigated land rents for $40 an acre, a difference of $300 per acre.]

This $1,000 af difference in agriculture water values in the same year in the same area shows large gains could come from local trades, and that there would be considerable value to infrastructure and market institutions to support local, intra-county and intra-basin trades between farmers.  It seems that these sorts of investments could make a lot more financial sense for the San Joaquin Valley than the $15 billion tunnels under the Delta.