Ringside: Politics and the Cost for Water Infrastructure

When it comes to building water supply infrastructure, even if regulations are streamlined and litigation is contained, there are massive costs. Quantifying these variables is something we have focused on a great deal, most recently “The Economics of the Delta Tunnel.” In that and other reports we’ve offered a highly simplified cost/benefit equation: divide the total capital cost of a water supply project by the expected average annual yield in acre feet.

While this ratio is an excellent way to begin to compare the cost-effectiveness of various water supply project options, it omits a result of great practical value, which is the ultimate wholesale and retail costs per acre foot that the project will eventually yield. We have steered clear of this depth of analysis because it introduces a great deal of added subjectivity, and almost always denies recipients of the estimate access to a coherent description of every variable that was considered and the assumptions behind each of them. But there is one level of detail we can add without going off the deep end, and that is the expected financing cost per acre foot. Here are the two equations:

Capital cost per acre foot = total capital cost divided by expected annual yield in acre feet.

Financing cost per acre foot = annual payment on construction bond divided by expected annual yield in acre feet.

This second equation doesn’t estimate the total retail cost per acre foot, but it’s a good way to see if further cost/benefit analysis is justified. Because financing costs for water projects almost always constitute at least 50 percent of the price a customer pays for an acre foot of water, and in many cases that percentage rises to 80 percent if not even more. If the financing cost is itself too high, you don’t have to bother with the rest of the analysis.

Before presenting examples of financing cost estimates per acre foot, it’s necessary to explain that even such a stripped down analysis is still riven with uncertainty. Merely calculating capital cost per acre foot requires estimates that aren’t excursions into fantasy. Does anyone really think the Delta Conveyance will only cost $20 billion? And what about average annual yield? Will the Sites Reservoir yield the officially projected 250,000 acre feet per year, or will nature and politics combine to lower that yield by 50 percent if not much more? And then there is the cost of money. Shall the rate be 4 percent or 5 percent? Shall the term be 20 years or 30 years? And how might inflation whittle down the real cost of that repayment burden in the future?

With all that in mind, here are the best and worst case financing costs per acre foot for the Delta Conveyance:

Best case: Construction cost $20B, annual yield 1 MAF/year: at 5%/20 year = $1,605/AF, at 4%/30 year = $1,157/AF

Worst case: Construction cost $50B, annual yield 500,000 AF/year: at 5%/20 year = $8,024, at 4%/30 year = $5,783/AF

Here are the best and worst case financing costs per acre foot for the Sites Reservoir:

Best case: Construction cost $4B, annual yield 250,000 AF/year: at 5%/20 year = $1,284/AF, at 4%/30 year = $925/AF

Worst case: Construction cost $8B, annual yield 100,000 AF/year: at 5%/20 year = $6,419/AF, at 4%/30 year = $4,626/AF

Please note we cannot predict that the Sites construction will deliver a 100 percent overrun compared to official projections. Only that such scenarios are common in California.

But what affects the cost of a project? How do we move total construction cost from worst case to best case? A fair discussion of this question shouldn’t focus on the Sites Reservoir or the Delta Conveyance, nor should it ignore other considerations. The Delta Conveyance, in particular, is a project that will deliver water from Northern California to Southern California even if a major earthquake or prolonged super storm breaches so many levees that the delta turns into a salt water estuary. That security is worth a premium, and that challenge has to be met either with the Delta Conveyance, or with something else.

But why does everything cost so much in California? What proponents of more water infrastructure must aggressively evaluate and quantify is how much state regulations and litigation add to construction cost. In Texas, for example, a planned major desalination project is expected to deliver a construction cost / annual yield of $12,000 per acre foot. That’s less than half what the proposed Huntington Beach desalination plant would have cost. This is a typical example.

With water supply projects that depend on rainfall, and require a balance between water that is diverted for farms and cities and water that is reserved for environmental flows, another huge uncertainty impacts the cost/benefit. If the Delta Conveyance is ever built, won’t environmentalist litigants fight the allocation every year? Won’t they as well litigate to reduce pumping at the existing intakes in the Clifton Court Forebay since southbound water is now going to flow through the tunnel instead?

The disparity in projected annual yields from high to low in almost every water project proposal is so stark it’s hard to believe. Foes of the Sites Reservoir claim the yield could be as low as 29,000 acre feet per year. If they succeed in selling that projection, the project is dead. Similar rock bottom projections of yield by foes of water supply infrastructure are a big part of why building the Temperance Flat Reservoir, or raising the Shasta Dam, are both dormant, if not dead ideas.

The challenge of financing water infrastructure is tied to the politics. Costly regulations and a litigation friendly environment are political choices. Almost as directly, accepting projected yields that barely utilize the diversion capacity of a water supply project is also a political choice. When deregulation lowers cost, and more creative environmental stewardship enables higher estimates of annual yield, projects become affordable to the ratepayers and investors who can make them happen. The impact of these political variables on the viability of water infrastructure financing cannot be overstated.

DCP_Detail Map