Gov. Jerry Brown

July 15, 2013

Stakes are high in state, federal water contract negotiations

Gov. Jerry Brown's plan to build two massive water diversion tunnels in the Delta has hogged the spotlight in the crowded theater of California water issues. But contract negotiations going on backstage could prove just as significant.

Gov. Jerry Brown's plan to build two massive water diversion tunnels in the Delta has hogged the spotlight in the crowded theater of California water issues. But contract negotiations going on backstage could prove just as significant.

The state and federal water agencies that control most of Northern California's water are negotiating new contracts with their 279 farm and urban water buyers. These contracts will govern those relationships – and extend the government's obligation to provide water – for decades.

How the new contracts are shaped will affect water rates for millions of Californians. It also will change how taxpayers at large continue to subsidize the many dams and canals that deliver water.

The process is a kind of house-cleaning for the giant financial investment required to build the proposed tunnels in the Sacramento-San Joaquin Delta. If the $25 billion project is approved next year, the state will be selling bonds for decades to pay for it; and the bond buyers, before committing, will want to see that the state has a solid contractual foundation with water agencies.

"There are a lot of issues on the table," said Patricia Schifferle, a consultant to the Planning and Conservation League, an environmental group monitoring the process. "But mostly it is about how can we extend these contracts, and is it going to be a blank check or are we going to know exactly what the public is being charged."

New contracts will set many of the terms for repaying any bonds issued to fund the tunnels. Even if that project does not proceed, new contracts are needed to finance billions of dollars in maintenance and investment. Among the projects in the works:

Earthquake strengthening for the dam at San Luis Reservoir, a crucial storage point for Delta diversions. Cost: At least $300 million.

Earthquake strengthening for the dam at Lake Perris, a State Water Project reservoir in Southern California. Cost: At least $150 million.

A plan to raise Shasta Dam by 18 feet for more storage. Cost estimate: $1 billion.

Another new water storage project, on the west side of the Sacramento Valley, called Sites Reservoir. Cost: $3 billion to $4 billion.

The negotiations are led, in separate processes, by the U.S. Bureau of Reclamation, operator of the Central Valley Project, which includes Shasta and Folsom dams; and by the California Department of Water Resources, operator of the State Water Project, including Oroville Reservoir.

Both agencies also operate massive diversion pumps in the Delta, and canals that deliver that water to the Bay Area and Southern California.

A big reason DWR wants new contracts with its 29 water contractors is that existing contracts begin expiring in 22 years. This means DWR already cannot sell the bonds typically used to finance major projects with standard 30-year terms. Shorter-term bonds boost borrowing costs, which the contractors pass on to millions of household and farm water ratepayers.

"Right now, the contractors aren't feeling much of a financial pinch," said Scott Jercich, DWR program manager for contract extensions. "But as time goes on, gradually the debt service is going to increase to where it's going to be financially challenging."

DWR hopes to wrap up negotiations by August and release an environmental impact study on the contracts by the end of the year.

Cost divisions complex

The Bureau of Reclamation process is different. Rather than extending and renewing contracts now, it is engaged in a "cost allocation study." This will determine how water system operating costs are split among water users, hydroelectric power customers and taxpayers at large.

How these costs are divided is a contentious subject that hinges on complicated economic modeling.

For instance, in recent years, more of the water storage capacity behind Folsom Dam was assigned to flood control during winter months to protect the city of Sacramento. This meant less water was available to water contractors. Water agencies argue they are subsidizing this benefit for Sacramento because their water contracts were not adjusted to reflect the change.

By calculating the financial gains and losses of such changes, the cost allocation will change how much each project beneficiary pays to operate dams and repay federal taxpayers for the dam construction debt that remains.

As a sign of how complex this process is, the bureau estimates the study will not be done until 2016. Only afterward can it begin to negotiate new contracts.

"We need that study completed to know exactly what each contractor's unpaid balance is going to be," said Dick Stevenson, acting regional resources manager at the Bureau of Reclamation.

The bureau was required by federal law to complete the cost allocation study by 1988, a failure that has been criticized by federal oversight agencies. Both the bureau and DWR, in their contract updates, must deal with a number of serious management problems identified in recent investigations. Among them:

A March report by the Interior Department Inspector General found the Bureau of Reclamation is not collecting enough money from its water contractors. As a result, it is likely to miss a congressionally mandated 2030 deadline to repay the taxpayer debt that built the Central Valley Project facilities, starting in 1937. That debt was $627 million in 2011.

Despite this problem, bureau contractors actually get large cash refunds when water deliveries exceed projections. An obscure contract provision requires the bureau to refund water payments that exceed delivery projections made at the start of each year.

DWR was criticized by the Legislative Analyst's Office in 2009 for categorizing too many water system costs as recreation-related. As a result, costs that should be borne by water users are, instead, covered by the state general fund and taxpayers at large.

Talks are civil but tense

The contract negotiations have been civil so far – but they are still in the early stage.

As an example of the tensions that can emerge, DWR and its contractors are haggling over something that seems relatively simple: How much cash operating reserve DWR should keep on hand in case of emergencies.

DWR proposed a $200 million reserve, equivalent to 120 days of operating expenses common in the utility industry. Currently, it holds a $27 million reserve, equal to about two weeks of expenses.

A larger reserve would increase water bills, because the water contractors would have to pay into the reserve. Contractors objected and countered with 90 days, proposing to achieve this partly with accounting maneuvers.

In a negotiating session Wednesday in Sacramento, DWR compromised on 90 days, and its negotiators insisted it be all cash. But they decided they like the accounting tricks, too, including eliminating the grace period for payment of water bills so the money comes in more quickly.

"You add all that up and it looks to me like a lot more than a $200 million reserve," said Deven Upadhyay, a negotiator for the Metropolitan Water District of Southern California, DWR's largest urban water contractor. "Did this proposal just grow, and are we trying to just beat each other?"

DWR negotiators disagreed, saying 90 days is a significant compromise, and noting the accounting shifts don't increase water bills.

"Our intent was not necessarily to grow anything," said DWR Deputy Director Carl Torgersen. "Our responsibility, at the end of the day, is to be the steward of California's water supplies. That will always be our first priority."

Contact The Bee's Matt Weiser at (916) 321-1264. Follow him on Twitter @matt_weiser.

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