Friday, 23 August 2013

BDCP Officials Continue to Inaccurately Describe Their Economic Study

In recent testimony to the Delta Stewardship Council, Karla Nemeth misrepresented the economic analysis of BDCP, perpetuating confusion over what this report found.  Ms. Nemeth’s statement is typical of the confusing and inaccurate descriptions of this report by various state officials, including Jerry Meral and John Laird.


According to Maven’s notebook meeting summary, Ms. Nemeth explains that BDCP will stabilize water exports at a level of at least 4.7 million acre feet (MAF) annually using the high-outflow scenario.  She then describes the results of the economic analysis as follows,
With BDCP stabilizing existing water supplies with a yield of about 4.7 MAF, our most recent economic analysis demonstrates about a $5 billion economic benefit that is mostly the result of reducing the risk of future shortages.“ 
Given how much the Delta Plan expounds on the subject of risk, I am kind of surprised Phil Isenberg or another member of the Delta Stewardship Council didn’t interject right there to ask Ms. Nemeth if her use of the term risk was consistent with the Delta Plan, especially since she said most of the benefits come from risk reduction.  The Stewardship Council’s Delta Plan goes to great lengths to define risk as probability times consequences, it even has graphics illustrating the concept.  But the BDCP Economic Analysis doesn’t treat a future reduction in water exports without BDCP as a risk with a probability, it treats low probability risks as certainties with 100% probability.  

In fact, the positive result of the BDCP economic analysis is not "the result of reducing the risk of future shortages.”  It is the result of comparing BDCP to an alternative that is extremely bad for the contractors and extremely good for the fish, and then having an analysis that counts the harm to water exporters and ignores the benefits to the fish.  An accurate statement from Ms. Nemeth would state, “With BDCP stabilizing water supplies with a yield of about 4.7 MAF, our most recent economic analysis demonstrates about a $5 billion economic benefit for the water contractors compared to a scenario where tougher environmental regulations reduce average exports to about 3.4 MAF by 2025.

You might think I’m nit-picking, but Ms. Nemeth’s misstatement is about a $10 billion error, meaning that the difference in the value of water supply reliability in the scenario used by the Brattle Group and a risk analysis implied by Ms. Nemeth is likely to be in the neighborhood of $10 billion. 

What is the probability that by 2025, exports would be reduced below 3.5 MAF due to regulations?  While this scenario is the water contractors’ worst nightmare, the probability of this occurring is very very low.  Thus, the value the Brattle Group has assigned to avoiding this outcome should be multiplied by a very low probability, which is the approach they took to valuing the reduction in earthquake risk where they multiplied the loss from a year-long earthquake outage by an assumed 2% annual probability of it occurring.

A journalist recently sent me a link that shows implementation of the State Water Board’s draft flow criteria would reduce water exports to 3.7 MAF to 3.9 MAF (see Appendix B here), and most observers believe the chance that those criteria are implemented is extremely low.  Thus, it seems to me that 3.7 MAF is a reasonable lower bound for future water exports without the BDCP, and this lower bound is even higher than the 3.4 MAF the BDCP used as the basis for comparison in their Economic Analysis.  No wonder Dr. Sunding and BDCP are getting so much flak for making this ridiculous assumption.

If 3.7 MAF is a resonable lower bound on future operations, what is a reasonable upper bound?  Given the barrage of legislation and lawsuits against the current biological opinions and the ESA itself, it seems to me that a reasonable upper bound on future operation would be a return to 2000 - 2005 conditions where water exports exceeded 6 MAF per year.  At the outset of BDCP, many water contractors said their goal was to restore exports to 6.5 MAF.  Thus, I would say a probable range of future outcomes is 3.7 MAF to 6.5 MAF, and the current biological opinions are in the center of that range.

That doesn’t mean that the BDCP doesn’t have some regulatory risk reduction value to the water contractors.  But a proper valuation of that risk would put likely put its value in the millions, not billions of dollars.  It would be similar to the valuation of seismic risk reduction of the tunnels which the BDCP economic analysis values at around $400 million.

Speaking of economic risks, there also other important components of economic risk that the BDCP ignores, especially on the cost side.  What is the risk that the tunnels take more than 10 years to build as assumed in the analysis?  What is the risk that BDCP costs more than currently estimated?  The BDCP warns that their regulatory assurances aren’t guarantees, so what is the regulatory risk that remains even with BDCP?

I remain very confident that BDCP results in a net economic loss for the water agencies’ ratepayers of around $7 billion compared to the status quo.  

About the Author

Ethan Jacob

Author & Editor

I am Ethan Jacob Executive Director of the Center for Business and Policy Research at the University of the Pacific, where I have a joint faculty appointment in the Eberhardt School of Business and the Public Policy Program in the McGeorge School of Law..

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