Beats me!  Let’s see.

California’s Department of Water Resources (“DWR”) argues that BDCP water is a bargain.  I do not find the pitch compelling.  The cost of water is understated.  The BDCP water supply is “non-firm” and not at all comparable to alternatives discussed.  What should be done?  Use a subscription process and find out if federal and state water contractors are willing to enter into contracts to purchase BDCP water. 

BDCP’s $300/AF to $400/AF Water?

DWR states that “with a cost of $13.3 billion, the implicit cost of water of the BDCP ranges from $302/AF to $408/AF.”  I have (approximately) replicated the calculation by amortizing the assumed cost over 50 years at a 3% interest rate divided by average annual yield of water for the high Delta outflow and low Delta outflow scenarios (differences due to rounding?).  There are three reasons why these estimates are too low:

• BDCP cost estimates understated by $2 billion due to the growth in capital costs (adjusted for inflation) between preparation of opinions of probable cost and initiation of construction, timing requirements of cash flows during the construction period, and the cost of debt service reserves
• Ignores the difference in timing between the capital commitment (at the start of construction) versus the start of water deliveries (a decade later)
• Inadequate consideration of project risks

A more reasonable range for the estimated annual cost of BDCP water (inflation adjusted) is $625/AF $890/AF.  And, this cost is before application of debt coverage ratios for capital financing to set water rates that would yield water rates in the range of $840/AF to $1,190/AF.

BDCP Water Is Inferior to Stated Alternatives

DWR also discusses BDCP water as if it were comparable to desalination, recycling and other local projects.  BDCP water is not a reliable water supply.  It is non-firm water.  In contrast, desalination and recycling are reliable water supplies.  In addition, these water sources deliver water at the buyer’s distribution system.  The BDCP water available at Banks and Tracy in Northern California.   Moreover, the project risks (at least for desalination) are vastly different from the BDCP water conveyance facililty.  For desalination projects, the technology has been around for decades (and improving).  Seawater has been desalinated, delivered and used.

The “water yield” of the BDCP is the result of computer modeling

Even if BDCP water were cheaper than these alternatives (and it may not be—see above), BDCP should indeed sell at a significant discount.  BDCP water supply is inferior.

The lack of comparability between BDCP and desalination is stunning.  DWR’s narrative on comparative costs suffers from a severe case of “oversell.”

Find Committed Water Users

Rather than dueling commentary, a productive exercise would be to see if this project has any takers.  Based on the reporting at mavensnotebook.com, the next steps are consultations on cost allocation among state and federal water contractors.  A better approach would be to put together proposed contracts and see who signs up.

There are principles of market mechanisms address controversy in agency decision-making worth consideration:

Define project rights.  The state and federal government could treat the BDCP water conveyance facility as a supplemental project.  The definition of project water available can use DWR’s calculation of BDCP project yield.  A “BDCP unit” would be an apportioned share of project yield and an apportioned share of project costs to defined delivery points (Banks and Tracy).  If DWR issues project debt, pass debt obligations through into a Unit’s financial obligation (this follows approach of the original State Water Project).

If this sounds like the contract structure of the Colorado Big Thompson Project, it should.  What is truly new?  In fact, the Northern Colorado Water Conservancy District (project operator) used this approach for its original project in the 1950s, as well as for the Windy Gap project that represented a supplemental yield to the original project.

Subscription process.  Rather than engaging in “discussions” of cost allocation between and among state and federal contractors, offer units to qualified water users.  Qualified water users could be limited to existing stated and federal contractors or extended to entities that meet defined eligibility criteria.   The BDCP water conveyance project is viable if water users enter into commitments to purchase at least the number of project units available.  (If total offers exceed available units, allocate units on the basis of purchase offers.)  If purchase orders are less than units available, then the project is not viable in its current form.

There are three alternatives in the case of insufficient water user interest:

• Market unsubscribed units to a broader class of water users than originally eligible
• Redesign the project to meet lower demand at prices acceptable to water users expressing an interest
• Abandon the project

Trading BDCP Units.  The BDCP units would be binding contractual commitments of water users.  Allow subsequent trading of units to allow flexibility in project utilization over times as circumstances change.   Further, reward the water users that step up to the BDCP project at inception if this indeed proves an excellent investment.  Over time, these water users can either enjoy the fruits of their wisdom  or enjoy the financial rewards if the economic value of BDCP units appreciates over time.  (The CPT price history suggests that the original founders of the Colorado Big-Thompson project made an excellent investment!)

State and Federal Agencies Critical Role.  State and federal agencies continue their critical roles of defining, constructing and operating the BDCP water conveyance facility.  Using market mechanisms to see if the BDCP water is worth the costs is not revolutionary.  Water agencies have traded SWP Table A contracts and CVP entitlements in California since at least the 1990s.  DWR assembled contracts for the original SWP project with interested water agencies willing to enter into long-term agreements to meet the SWP’s planned size.  While the “implementation problems” are legendary, the original SWP project represented an economic win as shown by water agencies paying millions of dollars to acquire Table A contract amounts, warts and all.

Why solicitation is better.  The solicitation process enables each state and federal contractor to make its own decision.  In contrast, “cost allocation” negotiations will understandably be dominated by how various “groups” should be treated.  The exercise will understandably be co-opted by coalition building.  There will be contractors who may find them coerced into a deal, if there is one.

If a BDCP water deal comes out of a non-sensual process, conflict has a tendency to prevail.  As evidenced by California’s experience with the Peripheral Canal a generation ago, project losers become ballot initiative opponents (more on this in a later post).  With water bonds facing a headwind in today’s economic environment, a divided water user community does not bode well for the prospect of water bond initiatives.

Is BDCP Too Premature for a Water User Solicitation? 

First, if it is too premature for a water user solicitation, how will cost allocation negotiations work?  Either the parties have eoungh information about project yield and costs to make decisions, or they don’t.

Second, one does not need complete and full information to make decisions.  Has there ever been a real deal where this has been the case?  I doubt it.  To the extent that there are major uncertainties remaining, the terms of the offering can have specified outs—e.g, a price schedule not to exceed a defined amount, major milestones achieved no later than defined dates, etc.  Unless there is sufficient interest in the project at this stage, why invest more time and millions of dollars of effort to find out later that “this dog won’t hunt”?

Concluding Thought

California has the opportunity to build on its existing traditions of using market mechanisms.  Putting the BDCP water conveyance project to a “market test” would be another step in the evolution of California water institutions.  An added benefit would be that the market approach outlined above would be transparent and operated under rules known by all.