F. Lee Brown, 3200 El Toboso N.W. Albuquerque, NM 87104 May 17,2010 ‘To: Estevan Lépee, Director, Interstate Seam Commission (ISC) From: F. Lee Brown, Ph.D., H2O Economics Subject: Economic Review of Draft Agreement between ISC and Intel Corporation Introduction This memorandum provides a “written cost-benefit and risk review” of the draft ‘Agreement between ISC and Intel Corporation pursuant to a elated, but separate, professional services agreement between the ISC and F. Lee Brovwn, dbs E20 Economics. Specifically, this 1. Surnmarizes the elements ofthe transaction between ISC and Intel embodied by the ‘Agreements 2._ Identifies the benefits, costs and risks associated with the ‘ransaction from the perspective of the ISC and provides estimates of them where quantifiable and their order of magnitude ‘where not readily quantified; and 3._ Provides a summary evaluation ofthe transaction, Narrative Summary of Transsction The transaction is described most suecintly on page two of the Agreement as an exchange between [SC and Intel whereby “water rights and financial resources” are conveyed by Intel to the ISC in return forthe ISC’s assumption and relief of “certain of Intel's obligations to offset Intel’s pumping depleton effets tothe Rio Grande.” In ‘order to identify the benefits, costs and risks of this transaction to the ISC, then, some further background description of Intel's offset obligations is required. In addition, various limitations and contingencies inthe Agreement constrain the assumption and relief ofthese offset ‘obligations by the ISC, thereby affecting the benefits, costs ard risks accruing to it. These limitations and contingencies must therefore also be described Background Intel was issued a license to pump ground water by the Office of the Sate Engineer (OSE) on ‘August 16, 1999 under OSE File No. RG-S7125 et al! RG-57125 allows Intel to ppropriate up 103,248 6 acre-fet per annum of ground water, provide that inte offset the hydrogeologic effect of its pumping upon the flow ofthe Rio Grande through a) purchase and transfer of existing pre-1907 water rights to its RG-57125 well field or bi return flow tothe Rio Grande Pursuant fo its license Intel as extensively pumped ground water for industrial purposes, is required to regularly epor the extent ofits measured pumping and tum flo tothe OSE? and has followed practice of purchasing and transferring valid pre-1907 water righs into RG- 57125." The combination ofits retum flow and acquisition ofpre-1907 water ight has kept intel in annual compliance wth its RG-57125 license to date Infect, etun Now credits alone hhave provided more than sufficient offset to the river up to the present "agremen pl accordance wit ts Return Flow Plan apeoved by te OSE on June 29,1995, according wo the Agreement, pi. {740.9 acre fe per anu ofr 1907 consumptive ae ight ae led in Agreement ® Discusion wih Kevin Flanigan on May 10,2010 Teephene: 150.197.5910 OHEURARAAED Nat Ohrown vom.Offer Obligation to be Assumed by ISC ‘The Agreement stats that, subject to specific constraints and limitations, “[}rom the date of Closing, ISC shall offset Intel's depletion effects to the Rio Grande under RG-S7125 not ‘othervise offset by Intel's rerum flow credits. This clause defines the “certain of Intel's “obligations” phrase above which Intel proposes to transfer to txe ISC in exchange for 740.9 acre- feet per annum of pre-1907 consumptive use rights and ten million dollars. For purposes of | analysis, it is useful 1 divide the term ofthe Agreement into tyo periods: A) the period from Closing until such time, ifany, when Intel may begin to cease purnping under RG-57125 (the date of Cessation’) and B) the peri after Cessation Figure 1, prepared by Kevin Flanigan of the ISC, depits this situation withthe vertical dashed line being the year of Cessation. Prior to Cessation, the hydrogeologic impact of Intel's cumulative pumping will continue fo ‘grow, assuming that tel continues to pump at a high rate rather than reduce pumping ‘substantially. In fact if Intel never ceased purnping, the impact curve would eventually become asymptotic f0 the permitted limit of 3,248.6 acre-feet, or whatever maximum level of pumping Intel sustained. That is, ll ofits water withdrawals would be coming from the river rather than aquifer storage, though with a time lag of course. In this even, its offset obligation would effectively become the full 3,248.6 acre-feet per annum, or whatever maximum sustained level ‘of pumping below the limit that i established. Given this situation, as long as Intl continues to relum a lage portion ofits pumping to the river as effluent through the Albuquerque Bernalillo Water Utility Authority treatment plant, it only ‘needs to make up the difference between its calculated offset cbigation and its metered return flow through other offsets acquired by the purchase and transfer of pre-1907 rights or some other means. For example, iit pumped the full 3,248.6 acre-feet and returned 80% ie. approximately 2,599 acre-feet, then it would eventually need 649.6 acre-feet per annum of pre-1907 ‘consumptive use rights." If its return flow were reduced below that level, however, for any ‘eason, the reduction would need to be made up by other offset means on a one to one basis. That is, each acre-foot of reduction in rtum flow would necessitate an increased offset of one acre- foot by other means. Prior to Cessation, then, the key protections needed by the ISC in assuming Intel’ offset obligation are the maintenance ofa high level of Intel return flow and the adequacy of Inel’s soquired rights in protecting against shortfalls in return flow. Provisions in the Agreement provide these protections and will be discussed below after intial consideration ofthe period following any Cessation. Spe 2 Defniton 2-0 6196-3268 62,599ROUSTHO WIS | aa SuRZ OL SOV OTST Liv Se018 onianne ‘SNOUSTAIO WYRUS Brat Bina ano | '3OUNOS USHLONY WOW WaLYM 138440 40 35vaT3E | ‘uO ‘SIMORS Yal¥M O3SVa1 YO. GauNOOY «| "SUGRO MOTs NUL | OWNS 48138439] (We) Nousmtaza was 36 1SNW SLOVaIN 4O INNOHY U¥AA NAAD ANY Ni I ‘Shiai Jo NOUWENG ‘ONY atv 30, ! Atha NOUONNS ¥ I Shudve 40 LNNOWY SOISVa NOLLATIIOWVENLS beinbiaShould Intel cease pumping at some year inthe future, its offset obligation would nevertheless continue well beyond that year, albeit at «diminishing rate, again as depicted in Figure 1. But, ‘then Intel would no longer have the benefit of ts return flow in meeting its offset obligation. For illustration, suppose that just prior to cessation of pumping Intel was withdrawing roundly 3,200 acre-feet annually from the aquifer of which it was rtuming 2,720 acre-feet tothe Rio Grande as ‘seated effluent. And suppose further that its hydrogeologic depleting effect upon the river in that ‘year was 3,000 acre-feet. Were ito cease pumping altogether, it would no longer have any Tetum flow, yet it still would need to offset something like 2,700 acre-feet of depletion” in the first year after cessation of pumping caused by its past withirawals, as calculated by the pertinent OSE model. Moreover, there would be additonal offsets in each and every year ‘thereafter, gradually falling towards an annual effect of zero as an asymptotic limit overtime. Pos-Cessation, then, ISC would need a source of offsets almost certain tobe sharply higher initlly than the quantity of aequied pre-1907 rights which Intel conveys ait through the ‘Agreement. However, this residual offset obligation is finite in size” and, practically speaking, limited in duration and can be calculated. Although the source of offsets by which the ISC intends to meet the residual offset obligation is not explicitly identified inthe Agreement, discussions with ISC staff" identify “credit water available under the Rio Grande Compact" as one preferred alternative to the purchase of additional pre-1907 rights. And, because the residual offset obligation is finite, purchase of perpetual water rightsis conceptually unnecessary to adequately meet the obligation Limitations and Contingencies Affecting the Obligation Prior to Cessation, the Agreement limits the ISC offset obligation inthe event ofa significant reduction in Intel's return flow. Specifically, {3-C-iiresimposes the offset obligation upon Intel should annual return flow fall toa level in which more than 250 acre-feet of ther forms of offset would be required to meet the offset obligation." This limitation ensures that return flow plus no ‘more than 250 acre-feet of consumptive use rights willbe sufficient to meet all offsets for which SC is responsible prior to Cessation. Finally, any unexpected offset requirement generated by ppamping by Intl in excess of its permitted limit remains a responsibility of Intel, Post-Cessation, the magnitude of the residual offset obligation will vary withthe year in which cessation of pumping occurs and the amount of pumping which has preceded cessition. And, in general, assuming continued pumping at the high end ofits permit, Intel's residual offset obligation will increase with the year in which it decides, ifever, to cease pumping. The ISC estimates that a hypothetical cessation date of 2024, for example, would ereatea residual offset obligation of roundly 40,000 acre-fet, while delaying the date of cessation for a hundred years from Closing might increase the residual offset obligation te rounaly 75,000 acre-feet. Should Intel choose to delay its cessation date beyond a hundred yeurs, the ISC is protected from any ° The instantaneous fet upon the river mediately before Cessation eins 3,000 ace, but he reduction in fet is sacle fs tht he ttl effet over even te fryer would be sbstantaly reduce, in Figure {he residal of obligton eh tol ares under the impact curve afer Cessation. hough the Ippo curve ist never mathematically reaches 20, the tea isl arite number as opposed ini I" Discusion wih Estevan Lépez and Kevin Flanigan on May 10,2010 Baas " urermore 8-8 requis Intl to apply all tur Now credis to oft purposes. "Discusion th Kevin Flanigan on May 11,2010,further increase in its assumed residual offset obligation by $3-C-, which makes Intel responsible once again for any offset obligation incurred due to any pumping after one hundred ‘years from the date of Closing ofthe Agreement ‘Benefits, Costs and Risks to ISC Based upon this summary narratve ofthe transaction embodied inthe Agreement, the benefits, costs and risks to ISC can be idenified and examined, Due tothe nature of ISC as a public agency, the benefits, costs and risks generated by the transaction take ‘wo forms. Fist, there are those which accrue direcly to the agency and affet its mission performance, Second, there are more diffuse benefits, costs and rks tothe New Mexico public asa whole, which may or may not impact the agency directly. The discussion below will endeavor to distinguish between these categories as fully as possse Benefits ‘The agency benefits stemming from the Agreement are most readily identified and quantified as 1) the 740.9 acre-feet per annum of pre-1907 consumptive use righs inthe Middle Rio Grande. basin and 2) the ten milion dollars to be paid by Intel tothe ISC. Moreover, numerous clauses!* inthe Agreement make clear thatthe intent ofthe Agreement isto “enhance ISC’s ability” to perform its mission, These benefits can be further quantified by valuation ofthe pre-1907 water rights at market prices and by discounting the temporal series of monetary payments to their present value. Each ofthese calculations is undertaken below. ‘Because water rights in the Middle Rio Grande are not traded on an organized, public exchange there is no single bid or asking price at any given time. Nevertheless, an historical record exists and recent transactions for which prices can be obtained provide some guide oat least a range of values for the rights, Figure 2 depicts the historical trend in prices of pre-1907 water rights in the Middle Rio Grande,'* based upon the weighted average of & non-random sample of actual prices pid. Prices paid inthe latter part of 2009 and into 2010 are reporedly lower the 2009 average, reflecting the national and local recession. On the other hand, a lage block of 740.9 already validated, pre-1907 rights, if sold at auetion, would likely command a premium. A reasonable estimate of its value then would be $12,965,750, plus or minus fifteen percent, at roundly 17,500 per unit of right. ‘The ten million dollar sum is divided by the Agreement into ten sanual payments of $1,000,000 cach,” adjusted for inflation. The curent rerum on a Treasury Inflation Protected Security (TIPS) maturing in nine yeas is 1.185%” which is roughly equalto the current rate of inflaton in the CPI-U series, less food and energy. If inflation remains at ths level, the present value of | the future series of payments is approximately the same as their fece value often million dollar. In total, then, the direct benefits tothe ISC are roundly $23,000,000, plus or minus ten percent "The preamble, 1 and 8-B,coname oe. "6 Lae Brown, presentation to New Merice chapter ofthe American Water Resouces Astcition, March 23, 2m. "pe, ° Te nfltionary austment factor dente in $2-D is the Consumer rice Index for Al Urban Consumes, ss food and energy (US. Bureau of Labor Staite Series ID CUUROOOOSAOL IE). "Tens bord, CUSIP HOTDRZBLA6, exchange closing on May (4, 29109 1204 FEES SFE EE ESL PEELE SE SESHEPEEF jap intel con community newmexic 2 For example, without te Agreement agufr drawdown might eventually cause Inel totum to cre diversion of is maximum 3.2486 acre-feet per annum permite pumping. 2507.7 =3248 6-140, 2 spreadsheet prepared Apri 21,2010. Jane 262107 Memorandum fom Davi B. Anderson, OSE, to Uday Jos, Special Assistant Atomey GeneraCosts Of course ifthe result ofthe Agreement is simply to transfer the exact same offset obligation from Intel to TSC, then this last benefit would only be a mirage. But, recall the discussion of Cessation in the Narrative Surnmary above. Once Intel activates the Cessation process, in any year up toa hundred years following the date of Closing, then there isan initially rapid fallofTin the offset obligation and ultimately a finite amount of acre-feet of residual offset required."* The estimated maximum residual offset obligation was roundly seventy-five thousand acre-feet with Cessation at century after Closing, with earlier dates of Cessation being smaller. Parenthetically, Intel itself could theoretically achieve this same finite residual offset obligation through Cessation by itself, but, practically speaking, 1) it does not have the range of offset options available o it that exist forthe ISC; 2) self-servieing i's residual obligation would likely be a much more expensive proposition for Intel and 3) the period of time to fulfillment of its residual offset obligation would extend its New Mexico respoasbilites well beyond any date of Cessation. ISC does not have to purchase 2,507.7 additional aee-feet per annum of right-oF likely any additional rights whatsoever-to meet Intel's residual offset obligation Instead, ISC can make use of provisions in the Rio Grande Compact” which allow the State of [New Mexico to accrue credits through delivery of water to Texas in excess ofits scheduled requirement and then subsequently store water in post-Compact, upstream reservoirs for other uses in future yeas by relinquishing those credits. One option available to the ISC is to make use of this Compact mechanism in meeting its residual offset obligation under the Agreement, and the State of New Mexico currently possesses sufficient accrued credits to fulfil its residual offset obligation for even the largest calculated magnitude.”” [Because these accrued and relinquished credits are under the administrative jurisdiction ofthe Rio Grande Compact Commissioner for New Mexico,” they ¢o not trade in any market, Yet from an economic perspective, there is an opportunity cost incurred by allocating them for residual offset purposes. Namely, they cannot then be used for some other purpose. Most specifically, once relinquished, they are no longer available to offset future annual debits in New Mexico's deliveries under the Compact. That risk is discussed further inthe following section of | this report. Instead, for purpose of placing @ monetary value upon this opportunity eost, reference is made to another foregone use for these accrued credits. Namely, they may also be relinquished to provide upstream storage water for eventual release in support of the Rio Grande Silvery Minnow (RGSM), an endangered species. The U.S. Bureau of Reclamstion has recently paid as much as $100 per acre-foot of water released into the Rio Grande for support of the RGSM, and New Mexico's accrued credits could be relinquished for this purpose as an altemative to meeting Intel’s residual offset obligation, ‘Aun for emphasis also recall a key Agreement provision: if nel dbs not atvate Cessation within a hunted ypu pete, en rena the emit ligaos forall opamp ae te unde year perk 2Efrzis.23, NMSA 1978, Anite VI an VI * Discussions with Estevan Lopez (ay 11,2010) an Kevin Flanigan (May 14,2010), New Mexico ha accrued «gets oF bout 180,000 acre ft at the nd of 2008, "ay Compact the New Mexico Sate Engineer is x officio the Rio Gnnde Compact Commission for New Mexico