Dr. Michael says the California Water Fix is worse than the status quo: ‘An extremely costly solution with limited benefits is really worse than managing through the constraints in the current situation’
In October of 2016, Dr. David Sunding gave a presentation to the Imported Water Committee of the San Diego County Water Authority regarding his benefit-cost analysis of the California Water Fix project. 
Dr. Sunding defended his analysis of the project, calling it ‘essentially like an insurance policy’ to prevent erosion of existing water supplies. Looking to hear the opposite side of the argument, Dr. Jeff Michael from the University of the Pacific, was invited to speak at the December committee meeting.
Here’s what he had to say.
Dr. Jeff Michael began with a spoiler alert: “If you are familiar with my work, I’m opposed to the WaterFix and I came to that conclusion by looking at the analysis 5 or 6 years ago,” he said. “I appreciate the invitation to explain my reasoning to you. You may or may not agree with it today but I think it’s good to hear all sides of these things.”
Dr. Michael said he would be talking about the Bay Delta Conservation Plan benefit-cost analyses done by both himself and Dr. Sunding a few years ago; provide comments on Dr. Sunding’s recent presentation to the San Diego County Water Authority board; and then give an overview of the updated benefit-cost analysis that was released in August of 2016. “I take a statewide perspective so while it’s not a presentation of what this means to San Diego, I think there’s a lot that you can take out of the larger discussion that’s pretty relevant to you and has some implication for the decisions that are facing this board.”
Dr. Michael completed his first benefit-cost report on the BDCP in July 2012. Prior to that, he was the principal investigator for the Delta Protection Commission on the Economic Sustainability Plan that was focused on impacts to the Delta. “One of the comments that we received from the peer review board from the Delta Stewardship Council was, ‘this isn’t a benefit-cost analysis; we need a benefit-cost analysis of this project,’” he said. “So when it came around to the summer of 2012, nobody had done that sort of analysis in the state. I felt like I’d learned enough by, through the other projects that I had worked on to take a reasonable first pass at a benefit-cost analysis. That’s where this discussion started that’s been going on for a few years. So in 2012 I took a look at the BDCP and looked at the tunnels independently. I pulled them out of the BDCP to focus specifically on those and a statewide analysis based on the EIR/EIS.”
Working for the state, Dr. Sunding did some benefit-cost work in 2013 as a BDCP formal proposal. His proposal looked at it more from a water agency’s perspective and moved away from the EIR/EIS no tunnel baseline to a different baseline. “A major part of the justification was that the Bay Delta Conservation Plan was an HCP under Section 10 of the agency of the ESA and had no surprises or regulatory assurances in it for the agencies, which to some extent justified assuming that things won’t change with the WaterFix but they could change without it. And that’s not present anymore,” said Dr. Michael.
“That baseline change really increased the water yield,” said Dr. Michael, presenting a slide showing a comparison between his analysis and Dr. Sunding’s. He acknowledged it’s a lot of numbers, but he wanted to point out two things: “First, the difference between my analysis and the BDCP one back in 2012/2013 is basically all due to the top line – that export water supply and the assumption about what is the water yield of the project. This is why when David and I talk about this and have talked about it over the years, we say that even though the bottom lines are different, we actually agree about much, much more than we disagree on. In fact, the disagreement was mostly about this one issue about water yield.”
“The second thing that I want to draw your attention to is the bottom line, the benefit-cost ratio,” Dr. Michael said. “Back under the Bay Delta Conservation Plan, my benefit-cost ratio is about a .5 and Dr. Sunding’s is about 1.4. Now the proposal has changed to the WaterFix and I think that the WaterFix is unambiguously a worse project for water agencies than what the BDCP was.”
“If you look at the benefit-cost ratios that we have now, mine has gone down, which reflects the fact that the proposal has gotten worse, but Dr. Sunding’s benefit-cost ratio is about the same, in fact, it might even be a touch higher, despite the fact the proposal has gotten worse. So, there’s been some changes to his analysis.”
Dr. Michael then addressed Dr. Sunding’s presentation to the Board in October. He noted that a draft analysis came to light through a public records request. “The news stories were that the draft analysis had assumed a taxpayer subsidy for what was about 30% of the construction cost of the project; pick up some costs that would be otherwise be allocated to agricultural users,” he said. “The bottom line of the analysis is even with the taxpayers’ subsidy we found that the benefits were short of the allocated costs for agricultural agencies. But, when you pooled everything together, his conclusions was that in the aggregate, benefits were greater than the costs after the subsidy is removed from the costs because of the high urban values.”
Dr. Michael said the only significant change is that in Dr. Sunding’s presentation in October, it’s been said that there will be no subsidy. “But this 30% of allocated costs, several billion dollars, has just sort of been defined as outside the scope,” he said. “It’s still removed from the cost and nobody’s been identified that would pay that cost. So what I would say to your agency is in the absence of taxpayer funding or any credible plan there, I would just assume that a portion of the costs could come back to your ratepayers or any ratepayers of Metropolitan because they’re the most supportive agency of the project. They have the most financial capacity in order to recover costs from their ratepayers.”
What are the benefits of 70% of a tunnel? “If you’re only going to look at 70% of the costs, I would argue that the benefits are zero,” said Dr. Michael. “In order to validly look at this, you need to pull in all of the costs unless you have a commitment to something like a taxpayer subsidy and then from a statewide or a policy perspective, that’s still part of the cost. Somebody is paying that.”
Dr. Michael then presented a graph, noting that Dr. Sunding had presented a similar graph that looked at dollars per acre-foot with project yield. He pointed out that there’s so much uncertainty about the project yield. The blue line is the information that Dr. Sunding presented to the Board in October; the red line is a calculation of cost per acre-foot as calculated by Dr. Smith of Stratecon. “There’s a stark difference in these calculations from two different economists about what the cost per acre-foot and how it varies by yield,” he said. “Part of it is that in the blue line, that 30% is missing and all of that is included in the redline. But there’s also, I think, some different assumptions related to financing, interest rates, cost of bond issuance and some of those other issues.”
Dr. Michael then turned to the baseline issue, which was basically the entirety of their disagreement on the BDCP analysis. “There’s been a lot of debate about what’s the right baseline to look at to compare the WaterFix to what the world without the WaterFix look like,” he said. “In my analysis, I’ve used the EIR/EIS which is consistent with the petition to the State Water Board for the project and the biological opinions. I’ve looked at the official documents and the proposal and I think that’s the baseline that we need to look at.”
“I know that some water agencies have disagreed and argued that this alternative baseline has been an apples-to-apples comparison because it imposes the same operating restrictions on the south Delta pumps as would be in place under the WaterFix and then just adds the tunnels to the picture,” he continued. “I really disagree that that’s the proper apples-to-apples comparison. The policy for the state is co-equal goals of water supply reliability and the Delta ecosystem. So, I think when you’re looking at the value of the water supply reliability element, the tunnels, the thing that you need to hold constant is the performance of the ecosystem, not the engineering or operating constraints on one set of pumps in the system. What you need to look at is a world with and without the tunnels that has similar environmental performance. And this is the finding in the EIR/EIS and the petition. You have to remember that those restrictions on the south Delta pumps – they’re part of the tunnels.”
The tunnels are not beneficial for the environment in and of themselves; they kill fish and they degrade water quality in the Delta, said Dr. Michael. “The environmental benefit that offsets that is that with the new point of diversion, there is the ability to reduce reliance on the existing diversions and the problems that come with it,” he said. “I believe for a variety of reasons that the proper baseline is the EIR/EIS – I think it’s actually better. It keeps the environmental impacts on an apples-to-apples basis. It’s consistent with the analysis that we have and we have to consider what the environmental effects are.”
Dr. Michael said the second reason he prefers not to adopt the other baseline is that he thinks it’s folly to speculate about future regulations and the direction of policy from federal agencies decades from now. “We’ve certainly seen things take some unexpected twists and turns and these could come home to have an impact in the Delta,” he said.
He acknowledged that some have tried to derive the value of agricultural water from land prices in the Valley, but he doesn’t think that’s the best approach. “I’ve looked at farmland rental rates, which I think is a little more stable and a little more reliable approach,” he said. “There’s a lot embedded into the prices of farmland and I think it produces a somewhat higher value than is appropriate. Also, I believe this analysis inflates the urban values, exaggerates scarcity, and a lot of things that the Water Authority staff has already identified as problems, including not fully accounting for alternative water supply investments that are likely to be made are in the plans of a lot of the agencies within this region. It also includes some real aggressive assumptions about the population growth and other demand drivers in this region.”
Dr. Michael then turned to address the updated benefit-cost analysis he did in August of 2016. He noted that it was important to update the analysis because Water Fix has changed; it is no longer a habitat conservation plan. The current Water Fix is just the tunnels; it doesn’t include the regulatory assurances or the no surprises clause, so it doesn’t have that value for the water agencies. It is also does not have the commitment to do environmental or habitat restoration.
The WaterFix is now looking to be permitted under the ESA, Section 7. “It’s basically a lower environmental standard, which is not to jeopardize the existence of endangered species vs. overall improvement,” he said. “So this change actually makes the analysis a lot simpler too.”
Dr. Michael noted that water yields have come down since the BDCP in addition to losing the habitat conservation plan benefits, and construction costs were updated to reflect a time estimate from 10 years to 15 years in the new documents. “These new assumptions have been incorporated using a similar framework but incorporating this new information,” he said. “Key assumptions in it using the EIR/EIS which has an annual average of 225,000 acre-feet of yield from the with and without tunnels that comes directly from the biological assessment of the WaterFix, the plan’s official documents. These are the assumptions made about a 15 year construction timeline, 100 year useful life as is assumed in the reports. A discount rate of 3.5% is a fairly safe assumption.”
Dr. Michael said he looked at two scenarios. One is optimistic from the standpoint of the economics of the tunnels. “In that, I’ve used the values of water from these earlier assessments from BDCP, not the yields of water but the valuation of water,” he said. “For the base assessment, I’ve used valuation of the water supplies that comes from the California State Water Plan and derives from the California Department of Food and Ag and other sources.”
Dr. Michael noted that even his base scenario still includes some pro-tunnel biases. “If I were to work through a pessimistic scenario, I would consider things like the risk of cost escalation … there’s certainly some risk that that could occur with a project of this scale and size,” he said. “Some areas of social costs, like impacts on Delta recreational economies and some upstream areas, are not included in this analysis. Some areas of environmental costs … , in the testimony and the analysis that is being put before the Water Board, there’s a lot of risk of algal blooms … Construction impacts on the environment aren’t included. My analysis assumes no technological improvements in alternative water supplies and conservation. That’s a conservative assumption, but I’m relatively confident that technology will continue to improve. If you build a desal. plant, 30 years from now it will probably have better and more advanced technology than the one that you’ve recently completed. And I’ve bumped up the value of Delta water exports. And I’ve used 100 year time horizons.”
For Dr. Michael’s base scenario, he used 225,000 acre-field for yield. For the value of ag water, he used a $150 per acre-foot, which was derived from the rental rate of irrigated and unirrigated agricultural land. “The rental rate for irrigated land in the valley is over $400 per acre now compared to unirrigated land, which rents for $25 to an acre,” he explained. “It implies the value of agricultural water. I’ve rounded up to about a $150 an acre-foot. This was pretty comparable to what you’ll see out of reports out of UC Davis and others that look at the value of agricultural water on average.”
For the value of urban water, Dr. Michael looked at a table from the California Water Plan that estimates the cost of alternative water supplies and the potential supply in the future. “If you use that table and calculate a weighted average of those municipal alternatives, you get $633 per acre-foot,” he said. “For my base scenario though, I used $800 an acre-foot and a bit higher value to be conservative.”
Dr. Michael’s optimistic scenario was derived from the BDCP analysis with the faster population growth, fewer alternatives developed, and greater situations of water scarcity in the future that generate an average value of $785 across urban and agriculture. “The value to urban areas is well over $1000 an acre foot,” he said. “I’m using about $367 per acre-foot on average for what’s exported from the Delta in the base scenario, but a higher value of $785 in the optimistic scenario that comes from the BDCP reports. Present value of that over 100 years is $2.8 billion for the optimistic scenario and $1.4 billion for the base scenario.”
For seismic risk reduction, Dr. Michael derived the number from the BDCP report, which determined an average annual value of seismic risk reduction benefit to be $27 million to the export water agencies for the present value of a little over $400 million over 100 years. He noted that it surprises people because it isn’t the biggest and greatest economic risk, so how does one explain that it isn’t worth tens of billions of dollars. “My explanation of this is to point out a few things,” he said. “One is that the tunnels are not full insurance against this disaster. You’re only protecting 50 percent of your exports. In contrast to a seismically resistant levee system which would protect you 100 percent of your exports from this risk, the event is relatively low probability. It’s catastrophic, but it is a low probability event, so an expectant value we’re multiplying that by a low probability each year.”
Don’t underestimate the ability of the state to manage a shortage of this size, noted Dr. Michael, noting that a worst case scenario of a year-long outage would be a loss of 2.5 million acre-feet. He pointed out that in the recent drought, California managed through an 11 million acre-foot shortage of surface water supplies statewide during that year.
“With the current drought, the loss of surface water supply was four times higher than the loss that would be experienced in this Delta event,” he said. “Now it certainly was costly and painful for water agencies and individuals and farms across the state, but we also know that it didn’t destroy the California economy; it grew robustly. Some of these disasters scenarios for the California economy and a Delta solution just don’t stand up into the evidence that we have of our ability to manage through water shortages that I think are more severe.”
“The base scenario actually subscribes zero value to the seismic risk reduction benefit,” continued Dr. Michael. “This comes from having more of a holistic perspective and what the implications are of a massive flood that takes out hundreds of thousands of acres in a community. Most of the loss here is not water exports and some evidence that actually, if you look at it from a statewide perspective, I think there’s strong reason to believe that the WaterFix will actually increase the flood risk within the Delta and the potential harmful impacts to the larger state economy, especially within the Delta region itself. So personally, I actually think we should put a negative value on this, but there’s zero in this analysis.”
Regarding water quality, Dr. Michael said he used the analysis from Dr. Sunding, but he hasn’t analyzed it. “It’s one of the more valuable water benefits to water agencies, but the total benefit, even in the optimistic case, is less than $5 billion because of the low water yields,” he said. “I think that it’s more like a $3 billion benefit for an investment in excess of $10 billion in present value terms. The cost just to the exporters in present value terms is $12.3 billion from the construction costs and O&M, so from my perspective from the case of the water agencies, cost exceeds benefits by more than $7 billion in the base scenario. It maybe a little bit different if more of that water were to go to urban rather than ag, but that’s not the current proposal.”
There are other costs to consider when looking at it from a statewide perspective, Dr Micahel said. There are costs to third parties who aren’t water agencies in the Delta, such as impacts to agriculture, both through water quality impacts and loss of land due to construction; transportation impacts in the Delta, and municipal water quality impacts in the Delta as well.
“It’s important to consider all these things,” he said. “If you roll them up, it’s probably less than a billion dollars. So that’s really important to those communities; that’s a significant sum for the Delta County, that is why they’re very opposed to the project. From a statewide benefit cost ratio, we need to account for it, but it doesn’t tip the balance.”
The environmental costs and benefits have to be considered explicitly, said Dr. Michael. In the Water Fix’s EIR/EIS and biological assessment, there are no claims of environmental benefits to species, just that it won’t harm them, he said. “Now if we were to use the declining baseline scenario that Dr. Sunding did, it, he doesn’t look at the environmental cost and benefits, but that declining baseline is something that would be more protective of water quality in the Delta and more protective of species than the current proposal. So if you’re going to use that baseline, you have to come back on the environmental side of the ledger and account for the cost. Using the EIR/EIS baseline and basically following their findings, I explored some way to estimate some costs, but they were sort of tenuous, so I decided to just put in a zero for that.”
So, putting it all together, what is the end result? “Our estimate of statewide net benefits for the base scenario is negative $10 billion for the project as described in the EIR/EIS for benefit cost ratio of 0.23,” he said. “Using the higher values of water in the optimistic scenario that assume higher urban values and higher urban storages in the future, it gets a bit better at negative $7.8 billion, but it’s still 0.4.”
Dr. Michael said that his conclusion is that the Water Fix is objectively worse than the status quo. “I know people aren’t happy with the status quo, and an argument you often hear for the Water Fix is that the status quo is unacceptable, and we all agree with that,” he said. “That doesn’t mean that you can’t propose a solution that’s worse than the status quo, so an extremely costly solution with limited benefits is really worse than managing through the constraints in the current situation.”
Dr. Michael reminded that he did not include a pessimistic scenario that considers cost overruns and other things. “What does this mean for project financing and for agencies? I think it’s highly likely if not inevitable that agricultural agencies are going to opt out of this project eventually when time comes to truly call the question,” he said. “There’s been some discussion of having a subscribed capacity financing approach, or people could sign up for the increment. The issue is that when agencies start opting out, then this argument about what the baseline is doesn’t become an academic argument between economists anymore; it becomes an important argument about that increment and what that’s going to be.”
“I think the agencies that opt out are not going to embrace this declining baseline scenario, and I think are likely to argue for a more optimistic scenario,” Dr. Michael continued. “So I don’t think that’s a real viable financing option. In my view there, I think there’s pretty clear evidence that this project’s not feasible without a large taxpayer subsidy. I have not seen any analysis to convince me otherwise.”
“That’s all I have for prepared comments today, and I’m happy to answer questions,” he concluded.
DISCUSSION PERIOD
Director Fern Steiner asks if there was analysis done that has determined the costs of doing seismic upgrades to the Delta levees?
Dr. Michael said that in the Economic Sustainability Plan work that he did for the Delta Protection Commission in 2011 put the cost at $2-4 billion for seismic levee upgrades in the Delta. “There’s some debate about how extensive you would need to do that in order to get a level of protection that you would want, but that’s an estimate that I believe is credible it’s based on some work that’s already been done on the Jones track for levees with a wide 50 foot crown on them. We have invoices for that so we know what they pay for those projects and it’s based on the thought of putting in comparable upgrades in other places in the central and south delta that are critical.”
“But an important thing to note about that is that, you know there’s a huge number of beneficiaries from that,” Dr. Michael continued. “It’s not just water agencies; obviously the communities that are right in the delta itself there’s a lot of interest there including transportation and energy interests, so all have interest in the stability of the system in the local communities so there’s a broad base that could be drawn upon to do those upgrades. That’s a policy direction that I would advocate that I think is more beneficial for the state to address. There’s a whole host of risks, including the risk to export water supplies but also to public safety and energy and other considerations in that region.”
Director Fern Steiner asked, “The Bay Delta is not only a water area but we have natural gas, we have a big transportation hub as well as agricultural, so is there some assumption on the $2-4 billion for the levee fix, that those also would participate and wouldn’t just be water agencies that would be doing these enhancements to the levees?”
Dr. Michael admitted he hasn’t proposed any sort of cost allocation for that, although some work on that is being done by the Delta Protection Committee looking at a system for assessing the beneficiaries. “In my view, I can’t see water agencies being responsible for more than 20% of those costs and possibly less given all the other interests that are out there. Any higher level assessment would be pretty hard to justify under the laws that govern cost allocations for these sorts of things but I can’t tell you what that would be. Certainly, these other beneficiaries would have to be responsible to pay a significant amount and potential for state federal funding.”
Director Yen Tu asked, “The biggest difference between your analysis and Dr. Sunding’s analysis is the export of water, and is that because of the assumption that with no regulatory certainty, the production of water will be extremely less?”
Dr. Michael replied, “I think we’re both taking the water fix operations as they’ve been proposed. The difference is that our view of the without tunnel baseline, where I use what’s in the EIR/EIS, and he’s used what’s been called a declining baseline, which is certainly plausible … but it shows him the baseline and fixes it there, and that increases the water yield. … In both cases we’re doing a simplified assumption where we’re taking that yield and applying it from the beginning of operations going forward. And obviously, when you’re looking so far out into the future, there’s a lot of uncertainty what that will be. That’s why I think there is some value in looking these sort of charts that look at cost of potential yields, which are situations. But yes, that is the biggest difference. There’s also, in terms of what I’m presenting now – I mean, I’m including all the costs. I haven’t assumed to take 30% of billions of dollars of cost out and assume that some other entity will cover that other than the federal water contractors.”
For more information …
- To listen to the audio of this presentation, click here.
- To view Dr. Jeff Michael’s full power point presentation, click here.
- For Dr. Rod Smith’s memo re: costs of California Water Fix, click here.
Related post …
Click here to read more articles about the California Water Fix posted on Maven’s Notebook.
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