Does Regulatory Assurance for Delta Water Exporters Require the $13 billion Tunnels?

A few weeks ago at the BDCP meeting, I asked this question to David Sunding, the economist hired by the BDCP.  He said it was a really good question, but answered he had analyzed the scenarios he had been given.

His conclusion from that economic benefit analysis was that the tunnels were worth paying for to the water contractors because the BDCP would provide regulatory assurance against further water supply reductions under the ESA, whereas the "no action" alternative did not include assurance against additional water supply cuts if the fish are not recovering.  Based on the value of incremental water supply, improvements in water quality, and seismic risk reduction, the tunnels were not a good investment for water exporters.  Those three benefits were about $5 billion short of the capital costs of the tunnels alone.  It took regulatory assurance, a benefit he valued at $11 billion in one scenario, to put them over the top.  But the tunnels don't get regulatory assurance without the huge habitat program, so how can all that economic benefit be assigned to the tunnels?

In the BDCP most, if not all, of the environmental gains that could result in regulatory assurances for the overall projects are due to the habitat investments, not the tunnels which have uncertain environmental effects.  The BDCP envisions $4 billion in habitat investments paid for by federal and state taxpayers.

So my question is could a similar $4 billion investment in habitat in a "no conveyance" alternative merit a comparable regulatory assurance from the Fish and Wildlife Service?  What about $2 billion?  In a typical HCP, the regulated entity pays for investments in habitat that would not otherwise be made and thus improves the overall survival prospects for the species.  In return for the habitat investment that advances recovery of the species as a whole, the HCP provides incidental take permits and some degree of "No Surprises" assurance that there will be no further regulatory or financial burdens for the regulated entities under the ESA.  In the proposed BDCP, regulated entities are paying for water supply infrastructure and the public is paying for the habitat.  Why would that be more deserving of regulatory assurance, than an HCP without the tunnels where the exporters themselves are paying for a comparable investment in habitat?  

If a $2-4 billion investment in habitat could buy regulatory assurance on the current biological opinions, by my understanding of Dr.Sunding's results, the water contractors would be better off with this "no tunnel" HCP than paying for the tunnels through the current BDCP proposal.

Even more importantly, taxpayers would be much better off if the water agencies paid for the habitat (or at least shared the cost).  In this scenario, the cost of the water bond wouldn't be taking funds away from education and other essential services.  The BDCP would also have a much better chance of success since it wouldn't need the water bond to pass.

In-Delta interests would not be happy with such extensive habitat restoration, but they are supportive of many habitat projects, and would be more accepting of BDCP if it didn't come with the peripheral tunnels.

I am no environmental scientist or ESA lawyer, so I may be missing some reason why a "no conveyance" HCP couldn't work as a BDCP alternative.  But from my economic perspective, it certainly looks like a win for all stakeholders compared to the current BDCP proposal, and a hell of a lot more financially and politically feasible.

Despite the dozens of so-called alternatives, the BDCP has never included a strong no-conveyance alternative.  Is it really too late?

Strong Words Between Assured Guaranty and the City of Stockton

There has been a heated exchange between bond insurer, Assured Guaranty, and the City of Stockton over its bankruptcy filing.  Assured Guaranty insured the City's two riskiest and most ill advised bond sales in 2007, $125 million in pension obligation bonds and $40 million to buy the WAMU building for a new city hall.

I don't have a lot of sympathy for the bond insurer.  Although they weren't the underwriter (that was the risk-loving, now bankrupt, Lehman Brothers), they are certainly part of the Wall Street financial crowd that encouraged cities to issue pension obligation bonds with deceptive sales tactics that downplayed the risk.  Pension obligation bonds were routinely sold as if they were refinancing debts (exchanging liabilities) when they were really high-risk investing on margin.

The Wall Street bankers came to the City of Stockton in 2006 and literally told them that selling pension obligation bonds were a low-risk strategy that was a better choice than their budget balancing alternatives such as painful cuts to employee salaries, retiree benefits or layoffs.  When the risky bet blew up in Stockton's face (the value of the Bond proceeds were invested right before the market crash of 2007, leaving Stockton with both its fixed bond liability and a huge investment loss), the Wall Street bond traders and insurers are now demanding that Stockton make further cuts to its employee costs and services rather than reducing what they are owed by a cent.  The City has cut over 30% of its employees, slashed the pay of remaining employees by 10-30%, is taking promised health care benefits from its retirees, and is enduring a crime wave after slashing its police force.

Assured Guaranty says in this statement that they are being treated unfairly, as if all the City didn't also have contracts with its employees and retirees (at the time it insured risky bonds) and an on-going obligation to provide essential services to its citizens.  No bond insurers were at the City Council meeting to explain why honoring the obligation to pay them was a higher priority than honoring obligations to provide health insurance for cancer stricken retirees, or provide adequate police on crime-ridden streets. In the face of the real human struggles going on in Stockton, Assured Guaranty's anonymous statement is cold and cowardly.  I recommend that their senior management and shareholders attend the next City Council meeting to read it in person to the Council and the citizens of Stockton and explain why it is "unfair" for them to take a loss that is proportional to others.

The City and its leaders are certainly responsible for most of their own problems. They didn't have to sell those bonds in 2007, write unsustainable employee contracts, or make a host of other poor financial decisions prior to the recession.  I don't think cities should default on bonds. But the City, its employees, citizens and retirees are suffering serious consequences, and Wall Street clearly encouraged and was a partner to many of the City's risky bets. The future of an important American city is at stake, and the federal government isn't coming to bail them out like when the bankers got in trouble. Thus, I understand and support City Manager Bob Deis' response to the statement printed in the Stockton Record.

City Manager Bob Deis called Assured's statement arrogant.  The city will ask a bankruptcy judge to make records from the three-month mediation public so the world can see how Assured conducted itself behind closed doors, Deis said. 

Most galling, Deis said, was Assured's suggestion that Stockton should take more from its employees, like the city's understaffed Police Department. Crime in Stockton is rampant, he said. "They literally want anarchy in the streets." Deis said. "They don't care. They just want to get paid."

To what extent is Wall Street responsible for Stockton's bankruptcy?

It has been said by many, including me, that no one has enough fingers and toes to point at the people who are responsible for the poor and risky decisions that put Stockton into it's mess.  It is true, and that is just looking at twenty years of City officials.  But what about Wall Street and the investors who financed the City's toxic bond sales?  Are they responsible too?

By far, the largest of Stockton's bond issues and its most disasterous is a $125 million pension obligation bond issued in 2007.  In the 2012-13 pendency budget, the City is not paying $6 million in debt service on these bonds, by far its largest single default.  And this particular bond is backloaded, meaning the payments will rise significantly in future years when more of the principal is due.  The original underwriter of that bond was Lehman Brothers, who collected handsome underwriting fees, after selling the idea to Stockton's city management and ultimately the City Council.

See this 2006 story in the Stockton Record from the special City Council meeting in which former Stockton CFO Mark Moses and Lehman Brothers representatives made their pitch to the City Council to approve the sale of the pension bonds.  I have clipped my two favorite paragraphs from the article, but recommend you read the whole thing.

Now is a good time to address the city's retirement debt because the interest rate the city would have to pay on a bond is lower than the rate of return CalPERS expects to make on its investments, Moses said. Taxpayers could save as much as $4.7 million over 30 years by paying interest on a bond instead of watching its debt increase unchecked, he said.

Alternatively, the city could contribute more money each year to its retirement funds, cut benefits or hope to either earn more on its investments or to see its retirees die sooner, said Rob Larkins of the investment firm Lehman Bros., which presented options to the council Thursday. He said he would not recommend that the city try to increase death rates.  

Update: 2:36 P.M. I just listened to Mr. Larkin's 2006 presentation, and the death rate comment wasn't really as significant as in the article. What is very significant is the way he presented the deal. He said "really it is just exchanging a pension liability for a bond liability." That isn't true. The only way to really change the pension liability is to change the benefits themselves, the liability are the promised benefits.  The amount that is "unfunded" is determined by the value of the investments with CalPers and their expected returns. If the bond proceeds were given to employees themselves (perhaps to fund a IRA or 401k type retirement account), and the employees gave up pension benefits (all or a proportional share) in return, then it would be a true exchange of liabilities. The city reduces its risk, and the employees/retirees have more. Instead, the city is depositing the bond proceeds with CalPers to invest and hoping it earns a rate of return higher than their interest costs. It is very simply investing in the stock market with borrowed money. And to make matters worse, the City used a backloaded bond that deferred principal payments. Thus, it was like taking a cash out, interest only mortgage on your house to gamble in the stock market.

Josh Barro explained it well in this Bloomberg piece,

 And a national lesson: Nobody, anywhere, should ever issue pension obligation bonds! Let’s think for a moment about what these really are. They are commonly described as a way of exchanging a pension liability for a bond liability. But really, when a city issues pension obligation bonds, it gets a bond liability and keeps its pension liability -- plus it gains an asset that offsets the bond liability. Typically, the jurisdiction invests the bond proceeds in an equity-heavy portfolio, which may lose value, but the bond liability remains fixed.
If that sounds a lot like buying stock on margin to you, that’s because it is.
In general, pension obligation bonds are sold as a free lunch. That was the idea in Stockton: The bonds bear interest at 5.46 percent while the city was expected to achieve investment returns of 7.75 percent. As such, issuing bonds was supposed to “reduce” the cost of pensions.
But that carry isn’t free. In exchange for a lower average cost, cities that choose pension obligation bonds take on a lot of risk: If the market underperforms, the assets can shrink and become smaller than the bond liability. It’s taxpayers’ responsibility to cover those gaps when they arise, so it’s a big problem that the gaps tend to coincide with weak economic performance and weak tax receipts.
When pension obligation bonds go south, the result is often tax increases and service cutbacks. Stockton shows how, in a worst-case scenario, pension obligation bonding gone wrong can combine with other factors to land you in bankruptcy.

Sacramento distressed mortgage rate drops below 10%

It's a bit of a milestone, the % of mortgages that are either in foreclosure process (2.64%) or 90 days delinquent (7.13%) has fallen below 10% in the Sacramento Metro area for the first time since the housing crisis hit.  (See Sac Bee note on the new Corelogic data).

This combined rate peaked at over 15% in 2010 in Sacramento (peaked around 20% in Stockton/Modesto/Merced), so that is significant progress.  At the current rate of decline, it will be down to 5% in 2014, and that is when I think we will start to see a more normal market with rising home values.

Historically, the normal delinquency rate is about 2% (and historically most delinquencies can be successfully resolved when people actually have equity in their homes).

What will happen to Stockton Marina in municipal bankruptcy?

Tonight, Stockton City Council will likely approve a "pendency" budget that will serve as the City's budget during bankruptcy.  The City will likely be officially file for bankruptcy protection tomorrow.

Already, the City has missed payments on 3 bonds, and as a result have already lost 3 parking garages and an 8 story office building (former WAMU building) slated to be the new city hall to creditors.  The pendency budget for 2012-13 completely eliminates debt service payment on several additional bonds and loans; the largest being nearly $6 million due in the next fiscal year on over $130 million in Pension Obligation Bonds that were sold in 2007.  The largest single budget cut is slashing $7 million in retiree healthcare subsidies with full elimination next year.

Now that the City has lost the parking garages and office building, it is particularly interesting to see that happens to any other City owned real estate that has some revenue generating potential for its creditors.  The immediate things to come to mind are the waterfront entertainment venues: arena, marina, and ballpark; all of which are losing money but do generate a revenue stream.

The proposed 2012-13 pendency budget states, "eliminate appropriation for payment of debt service on the State Department of Boating and Waterways Marina loan - $685,000."  However, when it comes to other waterfront entertainment venues (like the arena and ballpark), the city is reducing but not eliminating the general fund operating subsidy.  Thus, the City seems to have signaled that it is more willing to give up the marina than the other waterfront venues.

The State is not seen by Stockton City officials as being particularly helpful with its budget woes due to swiping redevelopment funds, realignment, inaction on pension reform (the City uses CalPers and does not have its own pension fund like San Jose), imposing the AB 506 process on bankruptcy, and sending the Comptroller in for an audit that costs the City time and money.  Add that to the burdens of the Delta Plan (both real and perceived), and I doubt anyone at City Hall feels particularly terrible about defaulting on a loan to a State Agency relative to all the other painful cuts.

Because of bankruptcy protection, Boating and Waterways will not be able to take immediate possession of the marina in the way Wells Fargo sued for the parking garages and office building after default.  I expect the City should continue to operate the marina through the bankruptcy period.

But it will be very interesting to see how Boating and Waterways approaches the loan default, and who will be operating the marina long-term.  DBW is in a tough spot.  Maybe it is another opportunity for American Lands and Leisure which recently took over operations at Brannan Island State Recreation Area.

Is BDCP a good deal for water agencies? Jason Peltier and David Sunding disagree

In the first part of the BDCP meeting on Wednesday, Jason Peltier of Westlands Water District, the water agency that may have the most at stake in the BDCP, said,

"[The BDCP is] a crappy path for us. This is a crapshoot. Unacceptable... We can't finance it.”

However, in the closing presentation of the meeting, Dr. David Sunding, an economist and principal at the Brattle Group hired by the state Resources Agency, said,

"I think it's really beyond serious debate at this point that the benefits of BDCP to the agencies ... exceed the cost," 

Now that is a disagreement.  It's natural to suspect Mr. Peltier is posturing to negotiate a better deal, and there may be some of that, but I think he is right.

Dr. Sunding went through a presentation that had sophisticated analysis of the usual categories of benefits attributed to the tunnels, a)water supply, b) water quality, and c)seismic risk reduction.  All together, these three added up to about 50 cents of benefits for every $1 in costs to the agencies (using the realistic seismic risk scenario, not the worst case).  So how did he figure that the benefits exceeded the costs for the agencies?

It came from a new category of benefit that was not in his original scope of work with DWR: the value of eliminating regulatory uncertainty.  He put forward a scenario where regulatory assurance was more valuable than all the rest of the benefits combined. $11 billion in one scenario. And he argued that regulatory assurance was the main objective of the agencies in the BDCP process, and a normal component of HCPs under the ESA.  He is right about that.  But environmental lawyers tell me that there are significant limits on the legal assurances in HCPs, and there are serious doubts about whether the BDCP can deliver much regulatory assurance at all due, in part, to enormous uncertainty about the environmental effects of the tunnels.

Thus,Dr. Sunding's conclusion should have been worded "It's beyond serious debate at this point that strong regulatory assurances are required for the benefits of the BDCP to the water agencies to exceed the cost to the water agencies." If he said that, I would agree, and that is very important information for the people negotiating BDCP.  It isn't just posturing, the water agencies really need the assurance in order to seriously consider a $13 billion investment in infrastructure.

With words like "crapshoot", Mr. Peltier is clearly not very impressed with the regulatory assurance in the BDCP.   Apparantly, not many other people are either. I asked a small sample of objective scientists, lawyers, and environmentalists outside the Delta if strong regulatory assurances would or could be part of the BDCP. The responses were "Not a chance", "No way", and "Sunding analyzed a project that is rejected by the regulatory agencies." Maybe there are experts who disagree, but it is clear that Sunding touched on a very controversial topic in the BDCP.  I am pretty sure that any project that might offer some level of regulatory assurance will have lower exports, and thus lower water supply values, than the scenarios he modeled.

I look forward to further debate of the concept of regulatory uncertainty, how much can be provided, and how it should be valued (I'm not buying the $11 billion estimate, more on that later).  But it is important to realize that regulatory assurance isn't very important for statewide benefit-cost analysis.  The regulatory assurance isn't a statewide benefit, it is shifting risk from the exporting water agencies to the environment and everyone else who will have to pay if the tunnels don't work for fish.

The good news is we finally have a rational discussion and debate about economics, and some reliable numbers out in public.  It's about time.  While I disagree with a few parts (mostly with the scenarios he has been given to evaluate), for the most part, I think Dr. Sunding's quantitative estimates are very reliable, and they inform the planning process. Benefit-cost isn't just a pass/fail test at the end of the process. BDCP would have been much better off if they had hired him years ago.

Does American Land and Leisure Know About Covered Actions? (updated 6/21)

Opened the Wall Street Journal this morning, and to my surprise, there was Brannan Island State Recreation Area on page 3 (pictures at link, article behind paywall).

The article about American Land and Leisure (ALL)1 taking over operations for Brannan Island provides enough grist for a series of blog posts.  I will spare you that, but offer a few quick thoughts/observations:

1.  It seems to me that this concession agreement is clearly a covered action that will eventually require a consistency determination with the Stewardship Council's Delta Plan.  [Update: It seems I was wrong about this.  Please click through to comments to read an explanation for why it is not a covered action from Dan Ray of the DSC.] 

2.  If ALL is more successful than state parks at operating Brannan (meaning they don't lose money, take care of the resource, and visitors are satisfied), will that make the realization of the ambitious State Parks plan for the Delta (which includes adding 4 new parks) more likely or less likely?

3.  From the article, it appears that State Parks is guaranteed some payment from ALL (maximum of fixed bid or a percentage) regardless of whether or not they turn a profit at Brannan Island.  If the state can get that kind of return on a park where costs were double revenue, the implications for the system are interesting.

4.  Most importantly, I am very glad the park isn't closing.

Funny for me to see this well written article written by Max Taves, as I have had a few recent conversations with him about Stockton bankruptcy and the regional economy.  I'll have to ask him about his impressions of the Delta.

The Delta Plan Approach to Fiscal Responsibility

Capital Project	Cost	Benefit Cost Analysis Required?
Conveyance	$14 billion	No
Habitat Restoration	$4 billion	No
PL 84-99 Levee Upgrades	$0.5 billion	Yes

Is the Metropolitan Water District Going to Pay 25% or 75% of the Cost of a Delta Tunnel?

The working assumption of BDCP is that water contractors will pay for tunnel conveyance in proportion to their share of Delta exports.  For Metropolitan Water District, that would be about 25% of the cost, and that is the share they say they expect to pay in their public statements.

However, the financing chapter (8) of the BDCP (page 8-89) declares that conveyance is financially feasible, because the per capita cost of construction is smaller than some recent capital projects built by smaller urban water agencies.  They divide the conveyance cost by the 25 million people who are served by agencies that derive at least part of their water supply from the SWP and CVP to come up with a per capita cost of $508.  This is less on a per capita basis than, for example, San Francisco's Hetch Hetchy aquaduct improvements.  However, it is important to note that Metropolitan represents 75% of the population in this per capita calculation, much higher than their 25% share of Delta water exports and the 25% cost share that they have pledged to pay.  There are many reasons why this per-capita cost comparison is irrelevant, but it has been used by the Southern California Water Commitee, and now it is prominent in the BDCP's own argument for financial feasibility.  At minimum, the per capita cost shouldn't be used at all unless Metropolitan really is supporting a per capita financial plan, which means they will pay 75% of the cost.

As discussed in earlier posts, assuming water exports were to increase by 1.2 maf with a canal (a big if for environmental reasons) as stated in the draft BDCP, the annual capital and operating costs of $1.2 billion in the draft BDCP imply this new water will cost $1,000 af - just to get the untreated water to the pumps near Tracy.  That is very expensive and financially marginal for urban users, and clearly infeasible for agricultural users who receive most Delta water.  [Yes, canal proponents use an average cost of nearly $200af averaged over all Delta exports - including those they will still receive without a canal.  This is a common error made by utilities and boosters of infrastructure mega-projects to promote investments that are not in the best interest of their captive ratepayers.  And the latest rumors are that half this amount of additional water is the best case scenario, putting the marginal cost at a minimum of $2,000 af.]

The reality is that Metropolitan will actually have to pay something close to the 75% cost share implied by the per capita cost comparison for the project to have any chance at being financially feasible.  Even that may not be enough.  Their ratepayers could probably stretch to make the payments (hence making it technically feasible), but it surely isn't a good deal for their ratepayers who have lower cost options.  Most importntly, it is not what Metropolitan has been telling their customers and their board that they are going to pay.

First Impression of the new PPIC water economics report

It's good.  Really, I mean it.

They have brought in some very solid new economists that were not part of their earlier reports, and they acknowledge that some key facts have changed since their 2008/2010 report endorsing a peripheral canal that I have criticized so much over the years.  Most importantly, these facts include the ever increasing cost of new conveyance, as well as better understanding of the real costs of earthquake interruptions, and an increasing understanding that urban water demand is declining due to the combination of conservation and slower growth.

This report contains no statement that a peripheral canal or tunnel is the best choice for California's economy, a statement that has been made in previous PPIC reports written by the smaller UC-Davis based group.  In fact, it even has a more accurate statement of the what the previous PPIC/Davis studies actually found  (see page 15).

Past PPIC research has shown that a peripheral canal would be the best option to meet the "coequal goals" of water supply reliability and ecosystem health (Lund et al. 2010) Today, options have multiplied—from a canal to a tunnel to two tunnels—and cost estimates have increased significantly. In 2008, official estimates for new above-ground conveyance ranged from $4 billion to $9 billion (California Department of Water Resources 2008). By 2012, as attention has shifted to building tunnels, cost estimates have increased to roughly $14 billion—not including the costs of financing and added operational expenses. With cost estimates growing, the question arises: Are the benefits of new conveyance great enough to justify the expense?

They are describing their previous report as evaluating the co-equal goals, not cost-benefit analysis, which is how one correctly determines if a canal/tunnel is the best economic choice.  This is an important point.  In a blog post last fall, I discussed the conflicts between the co-equal goals and cost-benefit analysis as analytical frameworks.

I am focusing on this one issue, because the Delta conveyance question is the single most important policy choice facing California at the moment, and PPIC is generally cited as the independent, academic support for building it. 

The vast majority of the report isn't about the conveyance at all, and I generally agree with the discussion and recommendations surrounding these other issues.  I particularly liked that the report led off with some much needed perspective on the importance of water to the California economy, and some optimistic comments about our ability to manage future water scarcity.  Cutting down on the crisis talk greatly improves the quality of discussion on California water issues.

Update June 1:  Buried in footnote 40, the author's confirm that they have not done the analysis to conclude that conveyance is the best economic choice, and that it requires cost-benefit analysis.  Specifically, it says.  "To determine which strategy is best for the economy, the net costs of new conveyance need to be compared to the net costs of implementing alternatives with reduced exports."  Footnote 41 is pretty darn interesting too, and corrects a lingering error in the 2008 PPIC report that said ending Delta exports would cost over 100,000 jobs.  Glad to see it.

Why not a 4 day school week?

California stateworkers may be going to a 4-day workweek (with 9.5 hour days, 38 hours per week) as a proposal to save 5% in costs of state compensation.

With schools also facing budget cuts, why not a 4-day school week?  Except instead of longer school days, I would propose a longer school year with 3 day weekends.

The traditional calendar is 36 weeks x 5 days = 180 days  Why not 42 weeks x 4 days = 168 days? 

Some school districts around the country have gone to 4 day weeks with longer school days - similar to the state worker proposal - in order to save money on fuel and utilities for buses and heating buildings, etc.  I oppose that concept. 

But I bet students would actually learn more with a shorter summer break and 3 day weekends throughout the year. 

As a parent facing school budget cuts, and dreading the too long summer break with bored children, this idea sounds really good to me now.

California DOF revises 2050 population projection down by 8.5 million. Huge Implications for Water, Transportation, and Budget Planning

California DOF makes the state's official population projections.  The DOF forecasts have been notoriously aggressive in the past.  Until this week, the most recent DOF forecast was issued in 2007 and projected the state population at 59.5 million in 2050.  This week, DOF released new projections that estimate a population of 51 million in 2050. 

I am pleasantly surprised by the extent of the downward revision, and very pleased to see that the State's official growth projection is now much more realistic and fits well with our own modeling.  My research associate has just returned from a meeting about these projections for San Joaquin Valley counties, and came away really impressed with the improvements the DOF demographers are making to their models.  Kudos to them, it will really help the state improve planning and decision making.

For example, it is critical to things like estimating future water demand, a topic near and dear to many of the readers of this blog.  This 15% cut in future population projection is a big deal.  That's 15% less water demand - regardless of what you assume about efficiency improvements - and 15% fewer ratepayer/taxpayerss to tap for future debt payments - whether those are revenue bonds issued to pay for conveyance or a a general obligation water bond.

Way back in 2008, the very first thing I criticized in the PPIC/Davis analysis of the peripheral canal, was the population forecast used to estimate future urban water demand.  Their model used the absurdly high figure of 65 million, when DOF's own high forecast was 59.5 million, and most private forecasters and extrapolation of U.S. Census 2040 estimates were coming in around 54-55 million in 2008.  That was before the Great Recession, and I think the new DOF estimate of 51 million is pretty realistic now.

To their credit, the PPIC team has made some adjusments and they are thinking more constructively about the implications of slower growth and conservation, and I suspect some modeling of this will be evident in their new book on water economics.  I particularly liked this passage in a recent blog post,
  

The prospect of a long-term plateau or decline in water use in California is fundamentally positive for the politics of water in California (although it has some negative implications for utility finance). No longer should policymakers fear vast inevitable growth in long-term water use, with apocalyptic zero-sum consequences. California can have growth and prosperity without continued increases in water use. Water conflicts need not become increasingly severe and debilitating. 

[Edited on 5/12 to correct some very poor grammar.  I shouldn read these posts a second time before clicking publish.  My apologies to the English majors who suffer through my blog posts.]

Will Water Contractors' Have a Maloof Moment on the BDCP?

Over the past month, the Sacramento arena deal collapsed when the Sacramento Kings' owners, the Maloofs, backed out of the deal.  Many people were incredulous at the Maloofs flip-flop, as they have been saying they needed a new, modern arena for years.  The Maloofs killed the deal because they realized that the a new arena wouldn't generate enough new revenue compared to their imperfect current facility to justify the new debt.  While City officials are upset with the Maloofs, city taxpayers should not be.  The Maloofs may have accidentally saved the City of Sacramento from a financial fiasco as well.

I think we may be headed towards a similar moment with some of the water contractors and the BDCP deal.  The agricultural contractors are most likely to play the role of the Maloofs and wake up to the financial reality.  According to the draft BDCP, the marginal cost of new water the contractors get out of the tunnel is going to be $1,000 af ($1.2 billion in debt service and new operation cost for an average of 1.2 maf of new water).  Environmental deficiencies with the draft BDCP could mean even less new water, driving the marginal cost of new water supplies even higher for the contractors.  If you prefer to look at averages (spreading the $1.2 billion over all 6 maf), all the water delivered through the tunnel will cost about $200 af more.  Without the BDCP, the contractors would still receive the vast majority of that water, that's why the marginal cost for incremental water supplies is the most important number for decision making. 

I have heard farmers in the Valley talk about the burden of paying $200 af for supplemental water in 2009 to keep their almond orchards alive while railing against the Delta Smelt.  How can they seriously support a plan that would raise their water costs of all their water (not just the supplemental supplies) to this level in wet and dry years?  The BDCP is a solution to the Delta Smelt problem that will cost Valley farmers far more than the Smelt and Salmon biological opinions ever will.

With so much political effort expended to get the BDCP and a potential tunnel/canal to this point, it's promoters are not going to let it die easily.  The public officials, including water agency directors, and some environmental groups pushing the project are not the ones who will pay the costs, and like Mayor Johnson and the arena, the public officials will not be the ones to back out of the deal.  It will be the farmers, who like the Maloofs, take a step back, look at the numbers and come to their financial senses.

New Forecast Is Out

Our April economic outlook was just published (yes, I know it is May 1).

CALIFORNIA AND METRO FORECAST:  April 2012

California remains on the path of slow recovery according to the latest projection from the Business Forecasting Center at the University of the Pacific.  For 2012 and 2013, real gross state product is forecast to grow at an average 2.5% rate for both 2012 and 2013, and jobs will increase at a 1.5% pace.  In 2014 and beyond, the pace of recovery will gradually accelerate as housing and construction begin making a positive contribution to the economy.

California’s unemployment rate is currently 11.0%, and is projected to remain in double digits through the last quarter of 2013.  Housing starts are projected to grow modestly to 54,000 in 2012 with most growth in coastal multi-family construction while single-family homebuilding remains near historic lows.

The regional outlook predicts that 2012 is the first year of economic recovery in the hard hit Central Valley.  More details here

My take on the Sacramento Kings' Arena Debacle

Yikes, it seems the blog took a month of vacation.  Time to wake it back up.  I wrote this commentary on the Kings' arena for our forecast publication about a week ago.  With the arena deal dying again last Friday, the perspective is still timely, and it's good blog material.

  

Sacramento Arena Deal Collapses in Spectacular Fashion

It’s been hard to avert our eyes from the train wreck that is the Sacramento Arena deal, especially since the Business Forecasting Center just opened a satellite office in Sacramento and one of our professional colleagues, Chris Thornberg of Beacon Economics, took center stage as a consultant to the owners of the NBA’s Sacramento Kings.  Thornberg questioned the revenue projections underlying the arena financing assumptions, and questioned the City’s financing plan and whether the deal was in the best interest of the City.  The focus on the public benefit from the City’s financing plan was odd for a consultant of the Kings.  Presumably, the Kings would want to persuade the City to increase their Arena subsidy, and it is hard to see how highlighting the City’s financial risk and weak economy helps persuade the City to improve the deal for the Kings.  One plausible explanation for the Sacramento bashing tactic is that the Maloofs are trying to persuade the NBA that Sacramento is an unviable market so the league will approve relocation to another city.  The Maloofs flip-flop and Thornberg’s harsh criticism of Sacramento elected officials led to a heated public war of words, including dueling op-eds in the Sacramento Bee between Thornberg and City Manager John Shirey.

Underlying the drama are objective economic and financial calculations.  Are the revenue and economic projections realistic?  Is it a good business deal for the Sacramento Kings?  Is it a good deal for the City, or a looming financial disaster?  An even more fundamental question is whether a new arena generates enough new economic value to justify a $391 million investment, regardless of who pays for it. 

From the Kings’ financial perspective, the new downtown City-owned arena must be compared to their current team-owned arena in Natomas, and realistic future alternatives including relocation or even renovation of the current arena.  The Kings are reported to be profitable, unlike most of their NBA peers playing in larger, more modern arenas.  The Kings would contribute about $70 million in new arena construction costs, plus agree to a 5% ticket surcharge that would send several million dollars a year back to the City.  Even assuming a conservative $20 million annual revenue boost from a new arena, the Kings could support these direct costs.  However, there are a host of additional provisions that likely make it a poor financial deal for the Kings.  In addition to the direct arena costs, the Kings’ owners would no longer receive revenue from non-basketball events at the current arena like they do currently at the team-owned Power Balance Arena.  The deal also locks them into the Sacramento market for another thirty years in addition to a host of other smaller concerns.  The Kings’ best strategy would seem to be to stay in the existing arena for a while, explore its renovation, while waiting to see if Sacramento or another city makes a more favorable offer as the economy and municipal finances improve.

What about the City?  Is the proposed arena deal a financial disaster?  It is definitely a fiscal risk, but whether it is a potential disaster depends on your perspective and the civic value you place on an arena.  Compared to other publically-financed arena deals over the past twenty years, the deal is more protective for taxpayers than many.  While the City pays about 60% of direct development costs, the City’s real contribution is significantly less than 50% when revenues from a 5% ticket surcharge, profit sharing with arena operator AEG, and other terms are included.  Although the economic development benefits of an arena are badly overstated, it will bring some new net dollars to the region and the Arena is clearly a civic amenity of some value.  Despite these positive aspects to the deal, it is still a significant public subsidy and considerable risk for a City that is in the midst of a serious budget crisis.  The positive cash flow from parking facilities is an asset the City of Sacramento has to get it through the crisis that many similar cities lack.  Financing the arena could involve a 50-year lease on parking facilities to fund an arena whose economic life will likely be less than fifty years.  Some of those parking assets are in key locations, and committing them to a parking lease for fifty years could entail significant opportunity costs.  The same can be said for selling city-owned land such as the 100 acres in Natomas adjacent to the current arena.  The City’s finance plan clearly adds new burdens to the municipal budget, even though some arena costs will be “backfilled” with ticket surcharges and other tax revenue.  Some public expenditure for an arena can be justified - all civic assets have costs - but the Mayor and City Council have clearly pushed the City's side of the deal to its boundary, especially considering the minimal contributions from the surrounding cities and the clear unwillingness of taxpayers to support a dedicated arena tax in the past.
The Mayor has worked hard to retain the Kings and has come up with the best proposal he could, one that pushes the City to its financial limit, and yet still doesn’t appear to be a better deal for the Kings than the alternatives, including the status quo.  The inevitable conclusion is that, like most sports arenas in medium to small markets, a $391 million arena in downtown Sacramento simply doesn’t generate enough new value to equal its cost.  No amount of financial engineering is likely to change that.  The new arena is simply infeasible without an owner and/or a City that is both wealthy and passionate enough about pro basketball in Sacramento to overlook significant financial risks.  Judging from recent events, both sides seem to have an abundance of passion, but a shortage of wealth.