Monday, June 24, 2024

Review of Delta Conveyance Project Benefit-Cost Analysis

My complete review and discussion of the implications from the Department of Water Resource's benefit-cost analysis of the $20 billion Delta Conveyance Project was published online this morning. California is in a cost of living crisis, so it is critical to examine the value of an enormous megaproject that be paid for through higher water bills. Beyond its cost, the DCP also has substantial environmental impacts for Delta communities and both endangered and commercially-valuable fish species. DWR's consultant report falls far short of the objective analysis such an important issue requires.  The executive summary of the review is below.  The full report is about 30 pages, and available at this link

Executive Summary

At its recent estimated cost of $20.1 billion (2023$), the Delta Conveyance Project (DCP) is an enormous financial commitment for water agencies facing increasing constraints on their customers’ ability to pay. The Department of Water Resources (DWR) claims its latest benefit-cost analysis of the DCP (2024 BCA or benefit-cost analysis) supports a decision to build the DCP, because the analysis has a benefit-cost ratio of 2.2. This review finds the benefit-cost ratio is inflated and unreliable. However, before reviewing the numbers and assumptions, it is important to understand how to interpret a benefit-cost analysis and the insights these analyses provide to finance, planning, and decision-making.

A benefit-cost ratio is a tool that ranks alternatives. A benefit-cost ratio below one indicates a bad investment regardless of how alternatives perform, but a benefit-cost ratio above one is only meaningful in comparison to alternatives. The 2024 BCA analysis does not consider any other alternatives, and thus the summative benefit-cost ratio of 2.2 does not indicate it is a good investment. Any water supply alternative would have a high benefit-cost ratio if evaluated under the generous valuations and assumptions of DWR’s 2024 BCA. Nevertheless, the report does provide useful information on the comparative scale of benefit categories that has implications for project finance and long-range planning. Accepting the inflated benefit estimates, there are still three important conclusions that can be drawn from examining the materials provided in the 2024 BCA.

1.For agriculture, the benefit-cost ratio is only 0.39, an estimated 39 cents in benefits for farmers for each $1 in cost.

➢Implication: Farmers will likely opt-out or default. Thus, the DCP should be viewed as an urban only project, and the Metropolitan Water District (MWD) would likely pay 75% of its costs -not 47% as currently planned. Other urban State Water Project water agencies will also likely see their cost shares rise by about 60%.

2.The Seismic reliability benefits are relatively small.

➢Implication: Seismic risk reduction is a poor justification for the DCP, and there are less costly and controversial ways to address the risk.

3.Water supply accounts for almost all of the DCP’s benefits.

➢Implication: MWD (and other State Water Project agencies) should evaluate the DCP like any other water supply project in the context of their long term water planning.

In the critical case of MWD, it should evaluate the DCP as part of its Climate Action Master Plan for Water (CAMP4W) process. CAMP4W is structured around adaptive management with incremental investment decisions made at 5-year intervals. This incremental approach is sensible, because only one of the four future scenarios requires any major development of new water supplies at all, including conservation programs. To address the unlikely event that CAMP4W’s high-demand “Scenario D” turns out to be the future, the plan identifies potential investments, but does not move ahead unless or until specified “signposts” reflecting current conditions warrant such investments.

MWD’s Long-Range Finance Plan – Needs Assessment projects that meeting the water supply needs of the high-demand Scenario D would require $15 billion in capital investment over 20 years that would add 500,000 acre-feet (AF) of new water supply and 250,000 AF of new storage. In comparison, a 75% share in the DCP would supply only 60% of the required water supply and 0% of the required storage for the full Scenario D capital investment. In essence, if MWD chooses to commit financing now to the DCP, it is essentially abandoning its own CAMP4W framework in favor of a premature bet on the unlikely “Scenario D” growth projection, putting the entire projected $15 billion capital investment into a single risky and potentially unnecessary project.

So how does DWR’s benefit-cost analysis for the DCP arrive at a surprising 2.2 benefit-cost ratio for such a questionable investment? This report reviews the details and finds the conclusion is based on a series of unjustified, optimistic assumptions that compound into a grossly inflated valuation of benefits. Specifically, the BCA:

● Inflates urban water supply values by assuming extreme demand growth, including a stunning 2.8 million new households on single-family lots by 2045 in MWD service area. The result is a projection of extreme future water shortages that drives excessive water supply values in their methodology.

● Includes an optimistic (100 year) assessment of project lifespan, resulting in an extended benefit evaluation to year 2144 while applying low capital replacement costs and extremely low (sub-2%) discount rates.

● Ignores largest sources of project risk in its sensitivity analysis: cost escalation, lower water demand, endangered species regulation, lifespan and interest rates.

● Ignores impacts on salmon and other threatened and endangered fish species.

DWR and the Delta conveyance Design and Construction authority (DCA) have compounded the flaws in the BCA with misleading public relations materials. For example, in some of its online materials DWR features an erroneous cost comparison that uses a levelized cost per acre foot costfor the DCP based on a 100-year operating period and sub 2% interest rates and compares it to alternative water supply costs from other studies that used 25-50 year life spans, and interest rates 2-3 times higher. If a levelized cost of DCP water supplies is calculated with comparable time horizons and interest rates that were used for calculating other water supply sources, the DCP water supply costs are $3,000 to $5,000 per acre foot plus conveyance costs from the Delta, higher than other water supply alternatives.

Friday, June 7, 2024

Comment letter on Delta Conveyance Project benefit-cost analysis

On Monday, the Department of Water Resources Director and consultants will be presenting their latest cost-estimate of the delta tunnel and a recently released benefit-cost report to the Metropolitan Water District (MWD).    

Their presentation is posted now, and it is an all positive promotional pitch that does not seriously engage with the financial and environmental issues with the estimated $20 billion project.  The presentation also conceals some of the extreme assumptions that are used to inflate the benefits of the project, and makes a misleading and inaccurate cost comparison of DCP water to alternative supplies.

This afternoon, I sent a letter to the MWD board highlighting some of the shortcomings in the analysis. Link to letter

The letter points out several key issues that are ignored in the presentation.  I hope the critical perspective, helps the board and the public be more informed about the economics of the Delta Conveyance Project.  

Saturday, June 1, 2024

DWR's Delta Conveyance Project Analysis Finds a 0.39 Benefit-Cost Ratio For Agricultural Users. It Won't Be Long Before Even More Agricultural Agencies Are Dropping Out or Filing Lawsuits Against the Project

 A benefit-cost ratio specific to agricultural users is not reported anywhere in the report, but it is pretty easy to calculate from the reports Table 1 and projected water allocationfrom the reports Table 1 and projected water allocation.  

According to Table 1, the water supply and water quality benefits to agricultural users has a present value of $2.36 billion.  Assuming, they receive a share of seismic benefits that is proportional to their share of total water supply and quality benefits (6.4%), they also receive an additional $60 million in seismic reliability benefits for a total of $2.42 billion in benefits.

The benefit-cost analysis also estimates that agricultural users will receive an average water yield of 148,500 af, which is 36.35% of the total projected water yield of 403,000 af. That means that agricultural users would be responsible for 36.35% of the DCPs costs. Excluding the environmental impact cost which would not be paid by water users, agricultural users share of project costs would have a present value of $6.213 billion.  The benefit-cost ratio for agricultural users is 0.39, clearly a terrible investment for agricultural users even when analyzed using the exaggerated values and generous assumptions of the DCP benefit-cost analysis. The analysis assumes 100-year project lifespan, a real discount rate below 2%, and that agricultural water users are willing-to-pay over $460/af for an unreliable water supply on a sustained, long-term basis.  I suspect farmers will use much more conservative assumptions in their personal benefit-cost estimations, and thus in reality agricultural users would be likely to receive far less than 39 cents of benefits for each $1 invested in the DCP.

The implications for the future of the DCP are large.  As more and more agricultural water agencies make the rational choice to opt-out, the remaining cost share and risk for urban water agencies rises.  For Metropolitan Water District that likely means that the 50% cost share they are hoping for will increase to 75% or more.  And with an estimated cost of $20 billion, that increased cost share is an additional $5 billion to a total of $15 billion or more.  MWD is already dealing with declining revenue from water sales, and a $15+ billion capital expenditure on the Delta tunnel is going to be very, very challenging to incorporate into its long-run financial plan.

It also broadens the opposition to the tunnel in political and legal arenas.  Yesterday, a SWP contractor, Tulare Lake Basin Water Storage District, was leading litigation seeking an injunction against exploratory drilling for the DCP according to the Courthouse News Service.  The article states, "The Tulare district in its suit wrote that the delta tunnel project would add costly new infrastructure to state water facilities and potentially affect the cost and amount of water it can buy from the state.”

Sunday, May 19, 2024

Delta Conveyance Facility (DCF) Water Is More Expensive Than Desalination, Not Less As DWR Claims

The Department of Water Resources (DWR) puts out a lot of misleading information around the Delta Conveyance Facility (DCF).  When DWR released its updated construction cost estimate and benefit-cost analysis for the DCF, the featured graphic states that DCF water supplies have costs comparable to conservation programs and less than half the cost of desalination.  Specifically, DWR takes a $1325/af 100-year levelized cost from their DCF benefit-cost analysis out of context, and lays it next to estimates from other studies that make very different assumptions about interest rates, project life and other key inputs.  

DWR's cost comparison is garbage.  You don't have to be an economist or engineer to see why.  Simply compare the basic cost drivers of a desalination plant (the most expensive alternative) and the DCF: capital costs, energy use, and water yield.

Capital Cost:  Recent large scale desalination projects/proposals in southern California (Huntington Beach, Carlsbad) have capital cost estimates of about $1.5 billion in 2023 dollars for about 50,000 acre feet (af) of reliable water supply ($30,000 per annual af).  The DCF is $20 billion for highly variable water yield that is projected to average about 400,000 af ($50,000 per annual af ). (Advantage: Desal)

Time to Build:  Large-scale Desalination, about 5 years.  DCF, about 15 years.  (Advantage: Desal)

Energy Use:  Desalination uses about 5 megawatt hours of electricity per af.  Energy use of the State Water Project are 3-5 megawatt hours per acre foot, depending on final delivery site.  Additional water supplies from the DCF have to be pumped hundreds of miles through the SWP to users whereas Desal plants are located near users.  DCF operations (pushing water through the Delta tunnel) would add energy costs to the SWP total.  The bottom line is that getting water through the DCF and to its end users will have electricity requirements similar to desalination.  They are the most energy intensive water sources in California, desalination forcing water through membranes, whereas DCF water must be pumped hundreds of miles and over mountain ranges.  (Advantage: DCF somewhat lower energy use for some locations, and even for other locations)

As the above make clear, DCF water supply is likely to be more expensive than desalination, not less.  And if DCF is at or above desalination costs, DCF water is way more expensive than conservation, recycling, brackish water desalination, and stormwater capture.  How does DWR get the opposite result?

Taking cost inputs and calculating a levelized cost per acre foot requires a few additional assumptions which need to be consistently applied.  The DCF assumptions from its benefit-cost analysis are wildly different than those used in the reports they are using for comparison.

1. Interest rates:  The DCF estimate is based on a social discount rate that starts at 2% and declines over time.  The cost comparison estimates are based on studies by Pacific Institute, PPIC, and CPUC that base their interest rate on the cost of capital.  I don't have the CPUC report, but the Pacific institute report uses 6% and PPIC 3.5%.  So the comparison studies are using interest rates two to three times higher than the DWR's DCF analysis.

2.  Assumed project lifespan:  The DCF report spreads its cost over 100years.  These other studies spread the project costs over 25 to 50 year time periods.   

If you use an interest rate that is one-half or one-third the level in the comparison study, and spread the project costs over 2-4 times more years than the comparisons, you can make the most expensive water supply look like the least expensive.  

Reasonable people can disagree on the exact values for these interest rate and lifespan assumptions, but consistency is required.  DWR is not doing this.  They are comparing their cost estimates to studies with wildly different assumptions about interest rates and operating lifespan so they can make a graph that claims up is down.

The bottom line is that water agencies evaluating the cost-effectiveness of the DCF should do their own math.  DWR's comparative cost analysis is not credible.
May 20 Addendum:  After posting this, I decided to calculate an estimated a levelized cost with 50 years of operations, the costs, timing and water supply listed in the benefit-cost report, at a 2%, 3.5%, 6% rate.  The 50 year operations and 3.5% and 6% rates make these estimates more comparable to the PPIC and Pacific Institute estimates shown.  If you are going to use this graph for comparison, these are the values you would use (with a big caveat that this is untreated water at the Delta).
2% = $1,971
3.5% = $2,889
6% = $5,089
For a more accurate comparison, you could put $2,889 to $5,089 as the DCP values on the DWR figure below that is the subject of this blog.  However, that is too low because that is the cost of untreated water at the opposite end of the California aquaduct.  I am not sure of exactly what to add on for that, I have heard estimates of up to $600 af to move water from the Delta to SoCal.  At minimum, one would add the cost of 3-5 megawatt hours of electricity per acre foot to the operating costs.  Whatever the additional costs of conveyance, the results are consistent with my initial argument that the DCP is more expensive than desalination, and substantially more expensive than other alternatives.   

Thursday, May 16, 2024

Quick Reaction to Delta Conveyance Benefit-Cost Analysis

Received the B-C analysis about 2 hours ago, and I am getting requests for instant reaction.  Posting here rather than respond to individual messages.  Three quick observations.    

1.  Seismic risk reduction benefits are low.  They are about 2.5% of the project's benefits according to Sunding and quite small relative to costs.  

Sunding's analysis confirms that earthquake risk is not a compelling reason to build the tunnel, a consistent finding over time.  

Can tunnel advocates stop hyping this point.  Even DWR's own analysis shows the tunnel is a lousy way to address earthquakes and flood risk.

2.  The project is all about urban water supply.  It accounts for virtually all the benefits, and urban water agencies (mostly Metropolitan Water District) will be pay the vast majority of costs. 

Urban water agencies, their decision makers and stakeholders need to take a critical eye at these estimates.  The value placed on this urban water seems extremely high.

3. Comparison to 2018 single-tunnel analysis raises questions about whether the benefits are overestimated.  

In 2018, he estimated 850,000 af of annual water yield from a tunnel, and in this analysis is it is 400,000 af.  

In 2018 analysis, urban users valued a larger water supply at $9.9 billion (2018$).

Now, a much smaller amount of water is valued at $33.3 billion to urban users (2023$)

It's a massive increase for less water.

A good chunk of the difference is due to inflation (2023$) and a lower discount rate (2% vs 3%) based on revised federal guidance.  If that 2018 analysis was redone with 2% discount rate and 2023$, that $9.9 billion would nearly double by my back of envelope math, let's call it $20 billion.  So consistency on inflation and discounting covers about half the gap.

But how do we get from $20billion to $33 billion urban water supply value, especially when the new project has a lower increase in water deliveries?  In other words, this report shows 50% more value from 50% less water.  

I will note that the urban water values are based on future urban water demand as estimated in agencies 2020 urban water management plans.  Experience shows those plans consistently overestimate demand growth, and I suspect that piece requires a lot of scrutiny.  He estimates the tunnel will reduce future water shortages in urban areas from 9% to 5%.  However, future urban water shortages are likely to be much lower with an updated or alternative estimate of demand growth.

Please note that this is instant reaction. I have not had time to review carefully.

Wednesday, May 15, 2024

Questions for the release of the Delta Conveyance benefit-cost analysis

This evening, I learned that the long-awaited benefit-cost analysis for the Delta Conveyance Facility (DCF) is being released tomorrow morning.  DWR put out an FAQ in advance of the release last week, but it didn't include any of the questions below - so perhaps someone who is invited can ask them directly.  Dr. Sunding did these analyses in the 2010s for the WaterFix, including an analysis of a single-tunnel option.  His old analysis of a single-tunnel WaterFix suggests the current single-tunnel DCF would fail his own benefit-cost analysis, as I explained in the past here and here, because the DCF water supply benefits are lower and the costs higher than in 2018.  Perhaps this is why we have had to wait so long for this update, it must take a lot of time and creativity to figure out a way to increase the benefits. (Note: This first paragraph was revised 5/16 9:30 AM, the morning after the original post.)

This report is being released over five years after Governor Newsom directed DWR to switch to a single-tunnel plan, and nearly two years after DWR released the details of its preferred project design in the Draft EIR.  The Final EIR was released last year.  
Should benefit-cost analysis be conducted before or after an alternative is selected?

When WaterFix considered switching to a single-tunnel, staged implementation, you produced a benefit-cost analysis for a single-tunnel alternative in a few months.  
Why did it take so long to release this report?  

In your WaterFix benefit-cost analyses in the 2010s, you did not use the same no-tunnel baseline and project description as the EIR, and you did not include any environmental costs.
In this analysis of the DCF, are you being consistent with the EIR baseline and project description?  
If not following the EIR.  Why?  
Does this analysis include environmental costs of the tunnel?

None of the previous analyses you did for the WaterFix were ever submitted to the State Water Board or the Delta Stewardship Council as evidence that the WaterFix was in the public interest.
Why not?  
Will this analysis be added to the current petition before the State Board?  

In your WaterFix benefit-cost analysis, you found that expected economic benefits from earthquake risk reduction due to the tunnels were relatively small.
Are your current findings the same?  If not, why?
Considering the fatalities, infrastructure and property loss from mass levee failure, is a water tunnel the best way for the State to address this risk?
Have you done benefit-cost analysis comparing levee investments to a water tunnel to address earthquakes and flood risk?

The Central Valley Project, which was supposed to pay 45% of the cost of WaterFix, has already decided not to participate in the DCF due to cost.  Several agriculture serving State Water Project agencies are also declining to participate due to costs.
What does your analysis say about whether the remaining agricultural water suppliers can afford their share of the DCF?
Does your analysis predict that agricultural water agencies will stick with the project, or does it predict that more agricultural water users will drop out of the project?

Metropolitan Water District’s sales have declined in recent years, and population has declined in its service area.  Its 10-year financial projection forecasts rates will increase at 3-times the expected rate of inflation over the next decade with flat or declining water sales.  
Does your analysis project increasing or decreasing water demand for MWD?
Have you analyzed its ratepayers and member agencies capacity to pay for the tunnel?

In your other work, you have written a lot about how uncertainty reduces the benefits of investing in a project, including regulatory uncertainty.  There is a lot of uncertainty about how the DCF will be operated, including uncertainty about environmental effects.  Adaptive management is part of the plan.  
Did you reduce your estimates of benefits to account for uncertainty?
Did you account for uncertainty in the estimates of cost?
Last week, DWR released an FAQ document that reserved its only call-out for 4 bullet points describing “benefits of the Delta Conveyance Project will not be quantified in the benefit-cost analysis and yet are also compelling for decisions-makers.”  These comments and questions are regarding these four bullet points in the FAQ.  

Groundwater supplies.  In previous studies of WaterFix benefits and costs, Dr. Sunding explicitly accounted for constrained ground water supplies and limits on groundwater pumping, it significantly increased the value of water supplies to farms. It seems likely that DWR’s statement about this in its FAQ is false and these benefits are quantified in the benefit-cost analysis.
Are constraints on groundwater included in the valuation of water supply benefits?

Job creation.  You have estimated jobs created from tunnel construction, which DWR calls a benefit in its FAQ document describing your report. 
If the costs increased, wouldn’t the jobs increase too? 
Have you ever said that jobs are a measure of costs not benefits with respect to benefit-cost analysis?
If funds were spent on tunnel alternatives instead of DCF, how many jobs would be created? 
When higher water rates reduce household income, how many jobs are lost?
For every dollar spent, do tunnel alternatives create more or fewer jobs than the tunnel?

Increased Operational Flexibility:  Like groundwater benefits, this could be included in the benefit estimates for water supply and water quality.  This issue does raise questions about whether DWR intends to actually operate the tunnels as described in the EIR.  Regarding tunnel operations, the EIR states that “Shifting from south Delta intakes to proposed north Delta intakes has trade-offs and is not expected…” 
Do your benefit estimates reflect flexibility from the project operations in the EIR?

Delta Community Benefits Program:  The program is speculative and undefined.  Funding is expected to be minimal.  Is funding for this undefined program included in the cost estimate? If not, it shouldn’t be mentioned here. 

[5/19 Note: I have seen the report now and it is a lot different than the WaterFix reports, and thus it answered quite a few of these questions. Most importantly, it doesn't change the project description from the EIR, the biggest problem with the old WaterFix reports.  But the new analysis does some new things that are also very questionable.  I'll leave this post up as the blog is a personal journal, but note the date, 5/15.  There will be more analysis, some of it on this blog.]

Monday, February 12, 2024

Income-based Fixed Charge for Electricity? There must be a better way

I support the efforts of lawmakers to put the income-based fixed charge proposal on hold.

I understand the objectives, but it seems to me that income-based fixed charges would have very high administrative costs and the potential for a lot of errors and privacy concerns.  There are other ways to administer a fixed charge, even a progressive one, if that is necessary and desirable.

There are lots of people living in households that are not economic units - roommates and extended family who are multiple taxpaying units with multiple income streams who are on the same electric meter.  There are also some housing units that are not separately metered within a building.  And income varies wildly from year to year and is hard to verify.

It seems you could accomplish most of the same objective in a much simpler way by having a fixed cost that varies by the size of the housing unit (square footage).  While not perfectly correlated with income, variation by size of the unit would still be progressive and much easier to administer.  Square footage is stable from year to year and the information is easy to obtain and verify without being personally intrusive.  

Finally, there is an issue of adding more "means tested" programs that phase-out in the same income bands.  Too many of these well-intentioned programs, usually developed independently, can create high the equivalent of high "marginal tax rates" and benefit "cliffs" for households that can create negative economic incentives and unfair surprises for households. 

Of course, there is a second issue about whether fixed costs make sense at all.  Having a fixed cost on a bill is better aligned with the true cost structure of a utility which includes fixed and variable costs, but recovering all the costs through rates encourage conservation and efficiency from customers.  The incentive for conservation may be secondary to the objective of getting people to switch fuel sources and electrify appliances and vehicles.  Fixed charges that would normally be bad environmentally, may make more sense in that context.