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.”