The 2010–11 Budget: Resources and Environmental Protection

Background

Governor’s Spending Proposal

Total Spending Down by 38 Percent. Expenditures for resources and environmental protection programs from the General Fund, various special funds, and bond funds are proposed to total $6.7 billion in 2010–11, which is 5.6 percent of all state–funded expenditures proposed for the budget year. This level is a decrease of $4 billion, or 38 percent, below estimated expenditures for the current year. The proposed net reduction is mostly from bond funds. Specifically, the budget proposes bond expenditures totaling about $1 billion in 2010–11—a decrease of $4.2 billion, or 80 percent, below estimated bond expenditures in the current year.

The budget also includes a net reduction of $134 million (7 percent) in General Fund spending, reflecting both proposed spending decreases and increases. The spending decreases reflect a combination of program expenditure reductions and funding shifts to alternative new revenue sources. The budget includes a reduction of $33 million for emergency fire suppression, reflecting an estimate that a lower level of resources will be needed in the budget year following a high level of spending on firefighting activities in the current year significantly beyond the amounts initially budgeted. Still, even with this decrease, the $223 million from the General Fund proposed for emergency fire suppression in 2010–11 is the largest amount ever initially proposed in the Governor’s budget plan. This amount is based on the most recent five–year average of these costs. In addition, the budget reflects two major funding shifts in the resources area for the budget year: (1) the replacement of $140 million General Fund support in the Department of Parks and Recreation (DPR) with new revenues from the proposed Tranquillon Ridge oil and gas lease agreement and (2) the replacement of $200 million General Fund support in the Department of Forestry and Fire Protection (CalFire) with new revenues from a proposed surcharge on property insurance premiums statewide.

The budget proposes increased General Fund spending as follows: (1) an additional $201 million to pay for resources–related bond debt–service costs, an increase of 28 percent above estimated current–year expenditures for this purpose; and (2) $30 million to restore General Fund expenditures in the Department of Fish and Game (DFG) that were shifted on a one–time basis to a special fund in the current year. Although not reflected in the resources spending totals, the budget also reflects the administration’s intent to make a $98 million partial repayment of a loan made from the Beverage Container Recycling Fund to the General Fund in a prior year.

Multiple Funding Sources; Special Funds Predominate. In contrast to the current year where bond funding predominates, the largest proportion of state funding for resources and environmental protection programs in the budget year—about $3.8 billion (or 57 percent)—would come from various special funds. These special funds include the Environmental License Plate Fund, the Fish and Game Preservation Fund, funds generated by beverage container recycling deposits and fees, an “insurance fund” for the cleanup of leaking underground storage tanks, and a relatively new electronic waste recycling fee. Of the remaining expenditures, $1.8 billion would come from the General Fund (27 percent of total expenditures) and $1 billion from bond funds (16 percent of total expenditures).

Summary of Resource Spending Proposals. Figure 1 shows spending for major resources programs—that is, those programs generally within the jurisdiction of the Natural Resources Agency. As the figure shows, the General Fund provides a significant amount of the funding for a number of resources departments. We discuss the extent to which the General Fund is used to support particular resources (as well as environmental protection) programs in greater depth later in this analysis. The year–over–year changes in General Fund spending mostly reflect funding shifts (both replacing and restoring General Fund support), rather than changes in the level of program expenditures.

While the budget proposes a net reduction in bond spending, it nonetheless reflects a number of new proposals to spend bond funds. These include a proposal to spend $321 million in bond funds (from Propositions 13, 84, and 1E) for flood control projects and levee improvements in the state’s Delta and Central Valley regions. The budget also proposes $49 million in bond funds (from Propositions 84 and 50) for groundwater monitoring, water conservation, and other activities implementing the package of Delta/water–related legislation approved by the Legislature in November 2009. Finally, the budget proposes $23 million (mainly bond funds, but also including special funds) for recreation and fish and wildlife enhancements at State Water Project (SWP) facilities, and proposes reform of related statutes, including the Davis–Dolwig Act enacted in 1961. (We provide an update on the bond resources available for resources and environmental protection programs later in the Resources Bond Issues write–up later in this analysis.)

Summary of Environmental Protection Spending Proposals. Similar to Figure 1, Figure 2 shows spending and fund source information for major environmental protection programs—those programs within the jurisdiction of the California Environmental Protection Agency (Cal–EPA). As Figure 2 shows, the budget proposes a few major spending changes in these programs. Most of the 30 percent reduction for the Air Resources Board (ARB) reflects an anticipated decrease in spending from the Proposition 1B transportation bond for air quality improvements in the state’s major trade corridors. The 10 percent net increase for the State Water Resources Control Board (SWRCB) reflects both a reduction of $98 million in bond–funded local assistance and an increase of $158 million in spending from the Underground Storage Tank Cleanup Fund to pay more claims seeking reimbursement from the fund for costs to clean up leaking tanks. The latter change results from the enactment of Chapter 649, Statutes of 2009 (AB 1188, Ruskin), that temporarily increased the level of the fee that supports the fund.

Governor’s Proposed Budget–Balancing Solutions

Largest Budget Solutions Involve New Alternative Revenue Sources. The primary budget–balancing solutions proposed by the Governor in the resources area involve new revenue sources to replace General Fund support for (1) state parks and (2) wildland fire protection and emergency response.

Regarding funding for state parks, the Governor proposes to use $140 million of Tranquillon Ridge oil and gas lease revenues for this purpose in the budget year. In subsequent years, the Governor proposes that these lease revenues be used for the support of state parks.

Regarding funding for wildland fire protection and emergency response, the budget proposes the Governor’s Emergency Response Initiative (ERI), to be implemented together by CalFire, the California Emergency Management Agency (CalEMA), and the Military Department. The ERI is intended to enhance the state’s emergency response capabilities, and would be funded by a 4.8 percent surcharge on all residential and commercial property insurance premiums statewide. The budget proposes that ERI special fund revenues in 2010–11 be used to offset $200 million of the department’s General Fund support for wildland fire protection. In subsequent years, ERI revenues would be used both to create General Fund savings and expand emergency response programs in CalFire and other departments. The General Fund savings in subsequent years—estimated around $219 million—result from ERI revenues being used to replace General Fund support for CalFire’s Emergency Fund and CalEMA’s assistance to local governments.

Other Funding Shifts. The budget proposes to shift $6.4 million of funding for various water quality and water rights regulatory programs from the General Fund to existing fee–based funding sources.

Program Reductions. The budget proposes only a few program reductions as budget–balancing solutions. These include a reduction of $5 million from the General Fund for recreational hunting and fishing programs in DFG.

Governor’s Proposed Reorganizations And Program Reforms

Continuing the Reorganization of the State’s Recycling and Waste Management Functions. The budget reflects the implementation of Chapter 21, Statutes 2009 (SB 63, Strickland), that combines the functions of the California Integrated Waste Management Board and the Department of Conservation’s Division of Recycling to create the Department of Resources Recycling and Recovery in the Natural Resources Agency as of January 1, 2010. The administration notes that the location of all of the state’s waste management and recycling functions currently in the Natural Resources Agency may not be the appropriate one for each of these functions. Given this, the administration has stated its intent to pursue further changes to the reorganization of these functions. Details of the administration’s proposal were not yet available at the time this analysis was prepared.

Beverage Container Recycling Program Changes. In conjunction with the budget, the Governor has submitted a legislative proposal to implement various programmatic and budgetary changes in the beverage container recycling program. Some of these changes are proposed to take effect several years from now, such as a proposal to incorporate the cost of recycling into the price paid by consumers for beverage containers. Other changes, such as the proposed elimination of several recycling programs and subsidies that the administration contends are unnecessary, would take effect beginning in the budget year.

The Role of General Fund in Resources and Environmental Protection Programs

Where Does the $1.8 Billion Go? As mentioned above, the budget proposes about $1.8 billion from the General Fund for resources and environmental protection purposes, including for general obligation bond debt service. Over the last decade, the level of General Fund support for these purposes has been highly variable—reaching a peak of about $2.6 billion in 2000–01 (when the state’s General Fund condition was particularly healthy), and a low point of about $1 billion in 2003–04.

Debt Service a Major Driver of Resources–Related General Fund Expenditures. Figure 3 shows the departments that are recipients of General Fund monies in the resources and environmental protection area, and the corresponding percentage of their budgets that are funded from the General Fund. As shown in the figure, the General Fund expenditure for resources–related general obligation debt service accounts for $929 million (52 percent) of the $1.8 billion. Expenditures for debt service have increased exponentially over the last decade, reflecting voter approval of several, increasingly larger bond measures. Accordingly, outside of debt service, $871 million of the $1.8 billion from the General Fund directly supports program budgets.

$871 Million General Fund Proposed for Programs Largely Reflects Fire Protection Costs. As shown in Figure 3, the largest General Fund programmatic expenditure by far in the resources area is for CalFire. The General Fund supports CalFire’s (1) core fire protection program ($523 million), (2) the forest resource management program ($28 million, of which about $11 million is for timber harvest plan review), and (3) the Office of the State Fire Marshal ($3 million). While the General Fund supports 29 percent of the department’s total budget, it supports about 70 percent of its state operations (that is, excluding capital outlay).

The General Fund budget proposed for CalFire for 2010–11 would total $754 million if not for the proposed $200 million funding shift to ERI revenues—a total amount that is substantially higher than the expenditure level a decade ago. Without the proposed funding shift, General Fund expenditures would be 75 percent ($323 million) higher than in 2000–01. There are a number of factors that have driven the department’s fire protection costs upwards so significantly, including increasing labor costs, the growing population in and around wildland areas, and unhealthy forest conditions (particularly in Southern California).

General Fund Support Has Dropped in Other Areas. Apart from its support for fire protection, the General Fund generally supports resources and environmental protection programs at levels that are lower than in 2000–01. For example, from a 2000–01 peak, General Fund support for the Department of Water Resources (DWR) and SWRCB has declined by 74 percent and 66 percent, respectively. For the most part, these declines in General Fund support are not reflected in reduced program levels. Rather, for resources departments, these declines have been largely offset by newly available bond funds and in some cases by revenues from increased fees (such as state park fees). For Cal–EPA regulatory departments, the decline in General Fund support mostly reflects the shifting of funding from the General Fund to regulatory fees.

In spite of the declines in the level of General Fund support for these programs, the General Fund still provides significant support in a number of resources and environmental protection departments outside of CalFire. The $110 million proposed for DWR largely goes for flood management purposes, of which about $51 million is for financing of a flood–related lawsuit settlement. For DFG, the $69 million proposed from the General Fund is for a wide variety of activities, including enforcement, habitat conservation planning, and sport fishing and hunting programs. For SWRCB, the $34 million proposed from the General Fund supports a number of water quality management activities, including basin planning and general cleanup programs.

While relatively small in absolute dollar terms, the General Fund continues to be the primary means of support for a number of resources and environmental protection departments outside of CalFire, including the Coastal Commission and the California Conservation Corps.

Conclusion. While General Fund support for resources and environmental protection programs are declining overall under the Governor’s proposed spending plan, our analysis indicates that there are nonetheless additional opportunities to help the state address its significant General Fund problems. In the sections that follow, we offer a number of specific recommendations for achieving General Fund savings. These reflect both program reductions and opportunities to shift funding from the General Fund to alternative funding sources.

Water Issues

Implementation of the New Legislative Water Package

In the analysis that follows, we (1) summarize the package of Delta and other water–related legislation passed by the Legislature in November 2009, (2) discuss how the legislative package impacts the CALFED Bay–Delta Program (CALFED) and its oversight, (3) summarize CALFED expenditures proposed in the budget, (4) review the Governor’s budget proposals explicitly related to the package, and (5) discuss key issues for the Legislature to consider related to financing the legislation.

Recapping the Legislative Water Package

In 2009, the Governor called a special session to focus on solving water–related problems in the state’s Sacramento–San Joaquin Delta region. The session resulted in the enactment of five pieces of legislation, covering matters related to Delta governance and land use policies, water conveyance, groundwater management, water rights, and a water bond to be placed on the November 2010 ballot. We summarize the major provisions of the legislative package in Figure 4.

Package Addresses Broad Array of Water Issues. As can be seen in Figure 4, the legislative package addressed many fundamental water issues facing the state. For example, the bill related to Delta governance creates the Delta Stewardship Council to manage the state’s interests in the Delta, requires the council to develop a Delta Plan to guide the management of Delta resources by multiple state and local agencies, and creates a state conservancy for the acquisitions of land in the Delta mainly for preservation and restoration of habitat. This bill also requires DFG and SWRCB to provide input to the Delta Plan process on environmental in–stream flow requirements and water quality matters, respectively.

The other bills in the legislative package address water issues that are broader in geographic scope than the Delta. For example, the water conservation bill establishes a statewide target of a 20 percent reduction in urban per capita water use by 2020. (Related conservation provisions also seek greater efficiency in agricultural water use.) Another bill in the package requires increased reporting to the state water boards of water use and unlawful diversions and increases enforcement of water rights at the state level. The groundwater bill requires local agencies to conduct monitoring of groundwater elevations at the basin level, and imposes penalties on counties whose water agencies do not fulfill the monitoring requirements. The legislative package also placed an $11.1 billion general obligation bond measure on the November 2010 ballot. Figure 5 summarizes the bond measure’s allocation of funds among various water–related purposes.

Water Bond Not a Financing Mechanism for All Other Components. The water bond, if approved by the voters, could potentially fund some elements of the legislative package (for example, by providing funding for capital improvements that help in meeting the urban water conservation goals). However, the bond issue was not designed to be the financing mechanism for the whole package. For example, other sources of funding will have to be found for the ongoing administrative operations of the new Delta Stewardship Council and the conservancy. As another example, the water bond explicitly does not provide funding for the design, construction, operation, or maintenance of Delta conveyance facilities—facilities involving the movement of water either through or around the Delta. We discuss these financing issues in greater detail later in this analysis.

The Legislative Package and CALFED

The CALFED Bay–Delta Program. The CALFED encompasses multiple state and federal agencies that have regulatory authority over water and resource management responsibilities in the San Francisco Bay/Sacramento–San Joaquin Delta region. The objectives of the program are to provide good water quality for all uses, improve fish and wildlife habitat, reduce the gap between water supplies and projected demand, and reduce the risks from deteriorating levees. The program’s implementation has been guided since 2000 by what is referred to as the CALFED “Record of Decision”—a legal, environmental planning document that lays out the roles and responsibilities for each participating agency, sets program goals and milestones, and covers the type of projects to be pursued.

In recent years, the Secretary for Natural Resources has been the lead state agency with responsibility for CALFED program oversight, including overall program planning, performance evaluation, and tracking of the progress of these activities. Accordingly, funding for CALFED was provided from the Secretary’s budget. Through legislative budget actions, the Secretary assumed the responsibility for oversight of CALFED oversight as well as some program responsibilities that were previously carried out by the California Bay–Delta Authority (CBDA). The CBDA, originally created to coordinate implementation of continuing CALFED– and Delta–related programs, was in effect eliminated several years ago (although not eliminated in statute), when the Legislature eliminated its funding and transferred its responsibilities to the Secretary.

The passage of Chapter 5 (Statutes of 2009, 7th Extraordinary Session) in the new water package means that the new Delta Stewardship Council will take the lead role in providing oversight for CALFED. The CALFED program oversight and coordination staff in the office of the Secretary, as well as CALFED fiscal staff in CalFire, are to be transferred to the council along with related funding. In addition, the CBDA was statutorily eliminated and its responsibilities assigned to the new council.

Budget Reflects CALFED Expenditures Across Many Departments. While the new Delta council will take the lead for oversight of CALFED, multiple state agencies will continue to spend money to carry out CALFED activities. The state agencies have estimated the amounts that would be spent for these purposes (as seen in Figure 6), including some additional funding amounts requested in the 2010–11 budget plan. Information about these expenditures continues to be compiled by the Delta Stewardship Council by the reporting of the CALFED budget, which cuts across numerous departments.

The Governor’s budget plan proposes a number of major changes in CALFED expenditures. For example, there would be a major increase in funding for SWRCB for, among other purposes, the development of Delta flow standards. A major decline for CALFED activities for DWR does not reflect an actual decline in the level of programmatic activity, but rather reflects the fact that three years’ worth of expenditures (for 2009–10 through 2011–12) were all appropriated in the budget act for the current year.

Time for a Zero–Based Budget for CALFED. In past years, when CALFED and other Delta–related programs activities were at a major crossroads, the Legislature directed the administration to submit a zero–based budget identifying the proposed expenditures of the various state agencies involved in this programmatic area. The intent was to require the administration to justify all CALFED expenditures and thereby enable better legislative understanding of the overall size of the program and how funds were being expended.

Given the Legislature’s new policy direction for the Delta and the recent changes in CALFED program oversight, this is an appropriate time, in our view, for the Legislature to direct the council to submit a similar zero–based budget encompassing all CALFED and Delta–related activities in conjunction with the Governor’s submittal of the 2011–12 budget. The budget should include a workload analysis and the goals for each of the state’s Delta–related investments. The Legislature would then be in a position to eliminate duplicative or unnecessary activities in favor of those that move the state toward the Legislature’s stated policy goals for the Delta.

Governor’s Budget Proposals to Implement the New Water Legislative Package

Budget Proposals Total $118 Million. As shown in Figure 7, a total of $118 million is proposed to implement the new legislative water package in the budget year. There are two major components of the budget package:

• Capital Projects: $52 Million. The budget would allocate $28 million to DWR for the Two–Gates Fish Protection Demonstration Program and $24 million to the Wildlife Conservation Board for Natural Communities Conservation Planning projects. Both projects are supported with existing bond funds. (We discuss our concerns with the Two–Gates proposal later in this analysis.)
• Delta Stewardship Council: $49 Million. The proposed funding would come mainly from existing bond funds and reimbursements from other state agencies (including SWP funds). The budget would for the most part continue funding for CALFED activities at the same level that were supported before their shift from other state agencies.

Two–Gates Fish Protection Demonstration Project

The Two–Gates Fish Protection Demonstration Project, which would be jointly funded by the state with the federal government, is designed to install operable gates in the central Delta for fish protection and water supply benefits. The Governor’s budget proposes to revert the $28 million in Proposition 84 bond funding that was (1) originally appropriated for the project in the current year in the new legislative water package and (2) replaced those monies with a new appropriation of Proposition 50 funding in the budget year of the same amount. However, the federal government has put the project on hold due to concerns about a scientific review of the proposal. It is uncertain at this time if and when federal authorities will resume funding of the project.

Two–Gates Project Should Be Put on Hold. We recommend that the Legislature approve the Governor’s proposal to revert the Proposition 84 bond funding for the Two–Gates Fish Protection Demonstration Project. However, we recommend that it not approve at this time the administration’s proposal to appropriate an identical amount of Proposition 50 funding for the project. This project should be put on hold until such time as the federal government again agrees to support the project and the state has had an opportunity to reevaluate the proposal.

Evaluation of Governor’s Budget Proposals for Delta Stewardship Council

In order to provide context for an evaluation of the Governor’s budget proposals for the new Delta Stewardship Council, we believe it is useful to first review two of the Council’s core statutory responsibilities—the development of the Delta Plan and its work in connection with the Bay Delta Conservation Plan (BDCP) process. We discuss both of these responsibilities further below, and then comment on the 2010–11 budget that is proposed for the council.

The Delta Plan. The council’s main statutory assignment is the development and adoption of the Delta Plan, a planning document to guide state and local agency actions within the Delta. The plan is intended to further the state’s goals of ecosystem health and water supply reliability which are to guide the state‘s actions in the Delta. The plan would guide the state’s coordination efforts with other levels of government, and take into account other state Delta planning efforts, including the BDCP process (which we discuss in greater detail below).

The Bay Delta Conservation Plan. As part of its development of the Delta Plan, the council is required to consider the BDCP currently being developed by DWR and a group of stakeholders (including state environmental agencies, local water agencies, and environmental organizations). The council is not required to incorporate the BDCP into the Delta Plan, however, unless certain conditions are met. Specifically, DFG must determine that the BDCP meets the qualifications to be deemed a natural community conservation plan. Also, the BDCP must have been approved as a habitat conservation plan that meets requirements in the federal endangered species law. The BDCP is being developed to create a long–term conservation strategy for the Delta. When complete, the plan would provide the basis for the issuance of endangered species permits necessary to allow operations of both the state and federal water projects in the Delta for the next 50 years.

This BDCP planning process is voluntary. The stakeholders and the departments participating in this planning process are not required to adopt this plan when it is completed. If the BDCP were not adopted, then the state and federal water projects would again be at risk of being held in noncompliance with endangered species laws. These agencies would therefore be required to achieve compliance with endangered species laws by the more traditional regulatory permitting process.

In order to ensure that the Delta Plan and the BDCP mesh well, the council is expected to closely monitor and, to some degree, participate in the BDCP process. However, state law also contemplates that the council will independently review the BDCP and make recommendations as to how it would be implemented.

The Proposed Council Budget. The Governor’s budget proposes a total of $49.1 million and 58 positions for the council for 2010–11. Of these positions, 50 are CALFED positions that would be transferred from various state agencies (mainly the Secretary and CalFire) to the council. Eight positions would be new—the council’s seven–member board and an assistant to the chair. The proposed complement of staff is shown in Figure 8. Most of the council’s funding would come in the form of bond–funded reimbursements ($29.8 million), direct bond appropriations ($9.7 million), and the General Fund ($5.9 million).

Contract Funding Proposed. The council budget would provide funding for $42.7 million in contracts with outside contractors and other state agencies. Of that total, $16 million (paid for with reimbursements from DWR) would be earmarked for the development of the Delta Plan. The budget also assumes that the council would contract for a project director (at an as–yet–undetermined amount), who would develop a process and schedule to accomplish the Delta Plan, to make presentations to the council, and to ensure integration of the Delta Plan. Under the Governor’s budget plan, this contracted project director would report to an executive–level staff member at the council.

The council budget would also continue an existing CALFED contract originally established under the Natural Resources Agency for a BDCP liaison at an annual cost of about $159,000. The contractor would coordinate Delta–related activities among various state and federal agencies and the council, as well as manage public and legislative outreach activities on behalf of the council.

Some Budget Modifications Warranted. In general, we believe the council’s budget proposal follows legislative direction regarding the transfer and use of existing resources to establish the council. However, we recommend two modifications to the proposed budget. We find that the work that would otherwise be assigned to a project direction contractor should instead be handled by one or more of the proposed 19 executive–level staff proposed for the council. Accordingly, we recommend reducing the council’s budget by $200,000 (bond funds), our estimate of the approximate annual cost of such a contract.

The proposal to continue the current contract arrangement for a BDCP liaison is also problematic. The current contractor for the council is the Metropolitan Water District of Southern California. Contracting with such a major stakeholder of the BDCP could compromise the ability of the council to conduct its BDCP–related work objectively and without the perception that it was being unduly influenced by one party to the BDCP process. Thus, we recommend reducing the council’s budget by $79,000 (bond funds) to eliminate the contract for the remaining six months of the contract (June through December 2010). We believe the liaison functions could likewise be handled by one of the council’s executive–level staff.

Long–Term Financing Approach Needed

How Will Implementation of the Delta Plan Be Financed? The new legislative water package requires that implementation of the Delta Plan to be developed by the council begin by January 2012. However, the water package did not provide a long–term financing plan (the proposed water bond was not designed to fund all components of the legislative package), including for implementation of the Delta Plan. Thus, it is not clear how implementation of a new Delta Plan would be able to proceed in a timely manner as contemplated in the recent legislation.

As we have noted in the past, we believe development of a long–term plan to guide the state’s investments in the Delta is warranted. In the absence of such a plan, it has been difficult for the Legislature to evaluate numerous Delta–related funding requests. The development of a long–term financing plan should await the completion of a number of Delta–related assessments. However, these assessments are now largely complete. The two–year timetable for development and implementation of a Delta Plan makes it all the more imperative that such a long–term financing plan also be developed and put in place.

We also continue to believe that such a financing plan should reflect the implementation of the “beneficiary pays” funding principle, whereby the public and private beneficiaries of a state expenditure pay an appropriate share of costs based on the benefit received. We have elaborated on the analytical arguments for this approach in past analyses of resources issues.

Council Should Develop a Long–Term Financing Plan for Delta Improvements. Based on these findings, we recommend that the Legislature adopt statutory language as a part of the budget directing the council to develop a comprehensive long–term financing plan for state expenditures to implement the Delta Plan in conjunction with the Governor’s 2011–12 budget proposal. The plan should identify a long–term funding strategy to support the ongoing operations of the council and the Delta Conservancy. This plan should be based on the beneficiary pays principle and should clearly delineate public versus private benefits of ongoing state operations expenditures and capital projects reflected in the Delta Plan. If new fees are proposed to carry out actions recommended in the Delta Plan, the fees should be reasonable and proportionate to the benefits directly received by the fee payer. Finally, as we have often recommended in the past, bond financing should be used only for capital projects that have long–term benefits, and for reasonable administrative costs related to those capital projects.

The Davis–Dolwig Act—Fundamental Reform Still Needed

Governor’s Budget Proposal Should Be Rejected Again

Davis–Dolwig Budget Proposal. The Governor’s budget proposes to spend $22.6 million in bond and special funds for recreation and fish and wildlife enhancements in SWP. The funding is proposed in connection with the state’s 48–year–old law, the Davis–Dolwig Act (Davis–Dolwig), which states the intent of the Legislature that such activities be included in the development of the statewide water system and that the cost of such activities be a state funding responsibility.

The budget also proposes statutory reforms to the act, in part to provide a dedicated funding source for its implementation. Specifically, the Governor proposes a statutory change to provide an ongoing, annual appropriation of $7.5 million from the Harbors and Watercraft Revolving Fund (mainly funded from boating–related fees and gas–tax revenues) to DWR for Davis–Dolwig costs.

The Governor also proposes a statutory clarification to declare that, absent a legislative appropriation, Davis–Dolwig does not obligate the General Fund or DWR to cover costs for SWP–related recreation and fish and wildlife enhancements. In addition, the administration proposes to delete an existing provision of Davis–Dolwig that states the intent of the Legislature to appropriate monies from the General Fund in the annual budget act for these purposes.

Recommend Again That Proposal Be Rejected. The budget proposal is essentially the same one that was submitted last budget cycle and that was rejected by the Legislature. In our 2009–10 budget analysis and subsequent report, Reforming Davis–Dolwig: Funding Recreation in the State Water Project, we reviewed policy and fiscal issues that arise from the way Davis–Dolwig is currently being interpreted and implemented by DWR, and offered our recommendations for legislative action. As we found in our prior analyses, the Governor’s latest proposal does not address a number of major problems that we have identified with the implementation of the act. Moreover, we again find that the administration’s approach improperly limits the Legislature’s oversight role for state expenditures in this area. We recommend that the budget request be denied, and we continue to offer the Legislature an alternative package of statutory reforms to the act.

We first discuss some particular problems we have identified with the Governor’s proposal, before turning to our recommendations for Davis–Dolwig reform.

Problems With Governor’s Proposal

Inconsistency in Justification for Budget Proposal. The Legislature’s review of this budget proposal is complicated by the department’s inconsistent claims about whether SWP construction projects are being put on hold due to Davis–Dolwig funding problems.

As there is currently no dedicated state funding source for costs allocated to Davis–Dolwig by DWR, the SWP contractors, who pay most of the costs of SWP, have fronted the monies for these costs over many years on the assumption that they would eventually be repaid by the state. According to documents submitted by the department in support of last year’s budget proposal, a lack of a dedicated state funding source for Davis–Dolwig costs has resulted in a situation in which new revenue bonds for SWP construction have been placed on hold, delaying these construction projects. The DWR cited this as a key reason for the adoption of its Davis–Dolwig budget proposals, and made the same statements in meetings with legislative staff and bond counsel. While the department later retracted this statement in legislative budget hearings last April, it has included such statements again as justification for the current budget proposal. These inconsistencies make it difficult for the Legislature to assess the merit of the administration’s budget request.

No Guarantee of Any Recreation and Fish and Wildlife Enhancement Benefits. Instead of providing funding directly to recreation and fish and wildlife enhancements (the fundamental purpose of Davis–Dolwig), the $22.6 million in the Governor’s proposal is to be used to fund a portion of the total annual budget of the overall SWP. This reflects an accounting method adopted by the department in the 1960s whereby total SWP costs are allocated among the project’s beneficiaries. The Department of Finance (DOF) raised concerns about this accounting method as far back as the 1970s. As such, very few physical recreation facilities (for example, boat docks or campgrounds) or fish and wildlife enhancements would actually be provided with the requested funds. Under the administration’s approach, Davis–Dolwig funds would be allocated to pay for such items as an SWP communications system upgrade, an administrative office building, and a pump replacement.

Improper Limits on Legislative Oversight. We are concerned about the proposal to provide authority for ongoing appropriations of funding from the Harbors and Watercraft Revolving Fund (HWRF) without annual review of these expenditures by the Legislature. This approach means that there would continue to be insufficient oversight of the Davis–Dolwig commitments made by DWR and how funds are spent for these purposes. In addition, our analysis indicates that the HWRF has a structural deficit and thus cannot sustain support for these additional funding commitments over time.

Failure to Address Various Problems With Davis–Dolwig Implementation. Finally, we find that the Governor’s proposal fails to address a number of problems that we identified in our previous analyses with the implementation of Davis–Dolwig. Specifically, our previous review found that DWR has interpreted the provisions of the Davis–Dolwig Act broadly, and as a result has:

• Over–allocated total SWP costs to recreation, thereby overstating the appropriate public funding share of SWP costs for recreation.
• Incurred operational costs at some SWP recreation facilities without prior legislative budgetary review.
• Allocated some regulatory compliance costs of SWP operations to Davis–Dolwig and the state, rather than including them in charges to SWP contractors.
• Allowed construction to start on costly capital repairs to the Lake Perris Dam without consideration of other potential legislative priorities for spending for recreation programs.

Going Forward: LAO’s Davis–Dolwig Reform Recommendations

We recommend that the department report at budget hearings on its inconsistent statements regarding whether the lack of a dedicated funding source for Davis–Dolwig obligations is affecting DWR’s bond–funded projects. The department should resolve whether this is a problem that the Legislature needs to address. If it considers this situation to be an impediment to bond–funded projects, DWR should provide specific information indicating which such projects have been delayed and the extent of such delays.

Regardless of how this issue relating to bond–funded projects is resolved, we maintain our view that fundamental reform of the implementation of Davis–Dolwig is still needed for the reasons discussed below. Accordingly, we recommend that the Governor’s proposal be denied and that the Legislature adopt alternative actions. Specifically, as discussed in detail in our previous analyses, we recommend that the Legislature:

• Amend the act to specify what are eligible costs under Davis–Dolwig (and hence to be paid for with state funds) and what costs are to be met by SWP contractors.
• Direct DWR to evaluate whether SWP facilities mainly used for recreation can be divested from the SWP. Moreover, until this and the cost allocation issues cited above are resolved, we recommend that DWR not commit to any new recreation–focused investments in the SWP.
• Provide clear policy direction on the status of costs previously allocated by DWR to Davis–Dolwig and for which the money has been fronted by the SWP contractors.

Our rationale for these actions is outlined in more detail in our prior reports.

In keeping with the reforms discussed above, we recommend adoption of the Governor’s proposal to delete the current provision of Davis–Dolwig stating the intent of the Legislature to appropriate monies from the General Fund in the annual budget act for SWP–related recreation and fish and wildlife enhancements. Such a change, in our view, would clarify the Legislature’s intention to determine its program funding priorities on a year–to–year basis in the future, including the allocation of any resources for implementation of Davis–Dolwig requirements.

Flood Emergency Fund Proposal Problematic on Many Fronts

The budget proposes to redirect $1 million of General Fund flood program funding in DWR to create a permanent emergency fund (E–Fund) for flood emergencies. According to the department, this fund would provide expenditure authority to proactively respond to flood emergencies, and allow the department to tap into a newly created special fund for these purposes. Below, we outline the proposal and comment on our concerns about the lack of fiscal controls and basic expenditure criteria for accessing the proposed fund. We also discuss our concerns about how the proposal would undermine legislative oversight of the department’s expenditures.

DWR’s Flood Management Program and Emergency Response

State’s Role in Flood Emergencies. Under current law and practice, the department responds to local requests for assistance related to flood emergencies. This can be after a flood is in progress, or prior to a flood event when imminent failure of a levee seems likely. The department coordinates as a first–responder the deployment of personnel and flood–fighting equipment, and generally coordinates the activities of various levels of government. When called upon, the department uses the state funding available for flood management to position itself for a response, in coordination with other levels of government and other state emergency response entities (such as Cal–EMA). In most circumstances, the state may declare an emergency which triggers assistance from the federal government to offset some of the expenses of the state.

General Fund Support Proposed for Flood Management Activities. The Governor‘s budget proposes about $40 million from the General Fund for state operations and local assistance for the flood management program (excluding debt–servicing costs for a flood–related lawsuit settlement). This funding would be used by DWR for (1) floodplain management activities, including the identification of land subject to flooding, and encouraging local land use practices that take the existing flood threat into account; (2) management of the Central Valley Flood Protection Board; (3) maintenance of the state–federal system of flood control, including encroachment control and inspection; (4) administration of local flood control subventions; and (5) flood forecasting and natural disaster assistance.

Legislature Previously Augmented Flood Management Expenditures. In recent years, the department indicated that it had substantial unmet funding requirements in the state’s flood control system, particularly with regard to levee capital projects. In the 2005–06 budget, the department proposed a number of increases in funding for these purposes over a three–year period. The Legislature approved each of these budget requests, thereby augmenting the department’s flood management funding authority from General Fund, bond funds, and special funds. General Fund support for flood management baseline activities has increased from about $14 million in 2004–05 to about $40 million in the proposed budget (a 184 percent increase). In addition, bond funding for state operations has increased from less than $10 million in 2004–05 to about $95 million in the proposed budget.

Governor’s Budget Proposal

E–Fund Proposal. The department’s budget has been built in the past on the assumption that three flood emergency events will occur each year at a cost to the state of approximately $500,000 per flood event. The department’s activities include providing sandbags, coordinating state flood fighting efforts (including Conservation Corps members), and levee monitoring. However, actual flood emergency events, and the associated costs for the department to respond, vary greatly based on the weather pattern in any given year. The response to a single flood event has sometimes cost the state more than $1 million.

The budget proposes to establish a new $1 million fund, using General Fund resources, which would be used exclusively to respond to imminent flood threats with duration of no more than seven days. The administration would be provided authority to redirect the existing General Fund support for flood management. The Director of DWR could access this new fund, at his or her discretion, to support emergency response activities. Proposed budget bill language would further allow DOF to immediately transfer additional funds (General Fund) to the E–Fund without legislative notification whenever the $1 million appropriation was exhausted.

How E–Fund Fits Within Total Funding for Flood Emergencies. Of the $40 million for flood baseline activities, the department proposes to allocate $12.8 million in General Fund support for flood emergencies, response, and recovery activities, from which $1 million could be redirected by DWR to the new E–Fund. Significant additional funding beyond these resources would be available under the Governor’s budget proposal for flood management purposes. This includes additional expenditures for flood system maintenance, risk notifications, activation of the State–Federal Flood Operations Center, and the conduct of feasibility studies for improvements for the state system of flood control. The department would also be provided $211 million in bond funds to evaluate floodplains as well as to complete flood system improvements.

Lack of Compelling Justification for E–Fund Proposal

The department contends that setting up a dedicated funding account for flood emergencies via the E–Fund would improve the likelihood and timeliness of cost recovery from the federal government in flood emergencies. In support of its proposal, the department cites federal law that requires a state to demonstrate that an emergency has exceeded the state’s capacity and resources to respond before it can access federal emergency assistance funding. The department provides that the E–Fund is meant to be a reflection of the state’s commitment of resources to respond to flood emergencies and thus of its capacity to respond to an emergency.

However, it is unclear how the E–Fund, as proposed, would accomplish this goal. Since the fund could be augmented—without restriction—with resources at DOF’s discretion, it is unclear how the fund’s existence could be used to demonstrate to the federal government that an emergency has exceeded the state’s capacity and resources to respond in order to trigger federal assistance.

The administration has not cited any specific instance in which the lack of such an E–Fund structure hindered state access to federal emergency funding. We are not convinced that the department’s E–Fund proposal would have any effect on the state’s ability to access federal emergency funding.

E–Fund Proposal Lacks Fiscal Controls and Expenditure Criteria

E–Fund Proposal Lacks Sufficient Fiscal Controls. As noted earlier, the administration’s proposal would redirect General Fund monies from the existing flood management program to a new emergency fund. As we also discussed, DOF would then be allowed to replenish the fund at its discretion with General Fund monies, without any prior notification to the Legislature. We find that this type of “revolving door” funding authority could substantially undermine legislative oversight of departmental expenditures and would provide insufficient fiscal controls. (We have similar concerns about an emergency fund for emergency fire suppression.) We further explain our concerns below.

Funding Impacts to Current Programs Unclear. The department has not explained which current flood management activities would be affected by the redirection of resources to the new E–Fund. While the department states that the level of any current programmatic activity would not be reduced, it is not clear how this could be the case if funding formerly available for these activities were now set aside in the E–Fund. In our view, such changes greatly weaken legislative oversight over state spending in this area.

Basic Criteria and Priorities for Expenditures Lacking. The administration has not explained how monies in the new E–Fund would be allocated or prioritized by the department. According to the department, the E–Fund could be accessed simply when the department determined there was an “imminent threat” of a flood. It is unclear, however, whether this means the department could access the funds to deploy personnel and equipment even if the customary process of declaring an emergency has not yet been completed.

Analyst’s Recommendation

Because of the lack of fiscal controls and unclear expenditure criteria to access the proposed new E–Fund, we recommend that the Legislature not approve the proposal. This approach, in our view, would undermine legislative oversight of the department’s expenditures for this important state function while providing no demonstrated improvement in the state’s access to federal emergency funding.

Energy Issues

Renewable Energy Requirements: Administration Circumventing Legislature’s Authority

California has been at the forefront of promoting the development of renewable energy sources for many years, as demonstrated by the enactment of a state law commonly referred to as the renewables portfolio standard, or RPS. The state’s RPS law requires specified electricity providers to increase the amount of electricity they acquire from renewable resources, such as solar, geothermal, biomass, or wind power, either from their own power sources or through the purchase of energy from others.

The adoption of renewable energy procurement requirements raises a number of important and complex policy issues. The Legislature has clearly demonstrated its intention to set state policy in this area in statute. Our review finds, however, that the administration is currently spending state funds, and proposing further such expenditures, to develop new renewable energy procurement requirements that circumvent current legislative policy as reflected in state law. We find that such action is (1) premature until and unless the Legislature adopts a new RPS statute and (2) leading to inefficient duplication of efforts by state agencies and wasteful spending.

In the analysis that follows, we review current RPS law, discuss the administration’s recent activity that circumvents that law, and make budget–related recommendations to address this concern.

Current RPS Law

RPS Standard Now Set at 20 Percent. Current law, as amended in 2006, requires each privately owned electric utility to increase its share of electricity generated from eligible renewable energy resources by at least 1 percent each year so that, by the end of 2010, 20 percent of its electricity comes from renewable sources. State law defines what specific types of energy sources are to be considered renewable for purposes of the RPS requirement. (The RPS requirement also applies to Electric Service Providers [ESPs]—companies that provide retail electricity service directly to customers who have chosen not to receive service from the utility that serves their geographic area.)

Enforcing the RPS. Current law requires the California Public Utilities Commission (CPUC) to enforce compliance by the private utilities (commonly referred to as investor–owned utilities, or IOUs) and ESPs with the 20 percent RPS. Only IOUs are required to submit plans to the CPUC that describe how they will meet RPS targets at the least possible cost. The RPS law contains provisions that specifically govern how this policy is to be implemented by state officials. For example, the CPUC is prohibited from ordering an IOU or ESP to procure more than 20 percent of its retail sales of electricity from eligible renewable energy resources. As another example, the RPS law caps the costs that an IOU must pay to acquire potentially higher–cost electricity from renewable sources, regardless of the annual RPS targets.

Publicly Owned Utilities Set Their Own Renewable Energy Standards. Current state law does not require publicly owned utilities to meet the same RPS that other electricity providers are required to meet. Rather, current law directs each publicly owned utility to put in place and enforce its own renewable energy standards and allows each publicly owned utility to define the electricity sources that it counts as renewable. No state agency can require a publicly owned utility to comply with renewable energy standards or impose penalties if one fails to meet the renewable energy goals it has set for itself.

Vetoed 2009 RPS Legislation. During the 2009 legislative session, the Legislature passed, and the Governor subsequently vetoed, a package of RPS–related bills. These bills—which included SB 14 (Simitian), AB 21 (Krekorian), and AB 64 (Krekorian)—together would have increased the RPS target for IOUs and ESPs to 33 percent by 2020 and also made publicly owned utilities subject to the same RPS targets as these other electricity providers. In his veto messages, the Governor cited his policy concerns about the Legislature’s approach to meeting a 33 percent RPS, a target which he nonetheless supported. For example, the Governor contended that these bills unduly limited utilities’ use of renewable electricity imported from other Western states to meet California’s RPS targets. Even though the legislation was vetoed, the passage of the 2009 measures demonstrated the Legislature’s continued intention to set policy in this area through the enactment of new statutes.

Administration’s Recent RPS Activity Circumvents Legislative Authority

As discussed below, our review finds that over the last few years, the administration has been involved in a number of activities that, in effect, circumvent the Legislature’s policy direction as reflected in current RPS law.

Governor’s Two Executive Orders. In November 2008, the Governor issued an executive order calling for all providers of retail electricity (thereby including publicly owned utilities) to obtain 33 percent of their electricity from renewable sources by 2020. State government agencies were directed to “take all appropriate actions” to implement this target. In September 2009, after vetoing legislation that would have placed a 33 percent RPS target in statute, the Governor issued another executive order directing ARB to develop a regulation “consistent with” a 33 percent renewable energy target. The executive order indicated that the administration believed that it had the legal authority to establish such regulations under the Global Warming Solutions Act of 2006 (commonly referred to as “AB 32”). The ARB currently is working to develop this regulation.

Executive Orders Cannot Replace or Circumvent Lawmaking. In a recent written opinion, the Legislative Counsel advised us that, as a general proposition, the Governor may not issue an executive order that has the effect of enacting, enlarging, or limiting legislation. In the context of the Governor’s September 2009 executive order, we are advised that the ARB may not adopt a renewable energy–related regulation that contravenes, changes, or replaces the statutory requirements of the current RPS law. According to Legislative Counsel, AB 32 does not authorize the ARB to adopt such a regulation. Since current RPS law is very prescriptive in its requirements, this prohibition would severely constrain the ARB in developing its regulation pursuant to the executive order. For example, we are advised by Legislative Counsel that the ARB could not develop a regulation that contravenes the current–law prohibition upon requiring an IOU to procure more than 20 percent of its electricity from renewable sources. Given this legal opinion, in our view it would clearly be inappropriate for the administration to circumvent the existing RPS law by attempting to implement a new renewable energy standard on its own authority.

Planning Activities. Despite these legal constraints, the administration has been involved in various planning activities that assume an RPS target that is different than the one established in current law. For example:

• The ARB’s plan to implement AB 32 (commonly referred to as the AB 32 Scoping Plan) includes a 33 percent RPS as one of its primary measures to achieve the state’s greenhouse gas emission reduction goals.
• Multiple Integrated Energy Policy Reports prepared by the California Energy Commission have evaluated the state’s ability to achieve a 33 percent RPS.
• The Renewable Energy Transmission Initiative planning group (an administration initiative involving multiple state energy and environmental agencies, public and private utilities, and environmental interests, among others) has conducted its planning work and analysis based on the assumption of the imposition of a 33 percent RPS target.
• The CPUC is moving forward with efforts to implement a 33 percent RPS with respect to the private utilities it regulates, through its Long–Term Procurement Plan process.

Budget Issues

Administration’s Spending Related to a 33 Percent RPS. Although the Legislature has not approved a budget request related explicitly to the evaluation or implementation of a 33 percent RPS, the administration has spent significant resources for these purposes and has plans to continue this spending. Figure 9 summarizes these ongoing and proposed expenditures, which would total $4 million in 2010–11 under the Governor’s budget proposal.

The ARB estimates that it will spend $1.9 million (from the Air Pollution Control Fund) in the current year and $750,000 in the budget year to develop RPS–related regulations pursuant to the Governor’s executive order and the AB 32 Scoping Plan. No specific funding requests for this purpose have been submitted to the Legislature for the budget year. For CPUC, the 2009–10 Governor’s Budget proposed a $322,000 increase for the commission to begin the process of implementing a 33 percent RPS. The Legislature denied this budget request, finding that the proposal was premature, pending enactment of the enabling legislation to establish the 33 percent RPS. However, the CPUC has continued to conduct planning and analysis for a 33 percent RPS, and estimates that it will spend $553,000 (from the Public Utilities Reimbursement Account) in the current year for this purpose ($423,000 for staff costs and $130,000 for consulting fees).

The CPUC plans to spend $423,000 for staffing costs for these same purposes in the budget year from its existing budget resources. In addition, the Governor’s budget includes requests totaling $2.8 million (from the Public Utilities Commission Utilities Reimbursement Account [PUCURA]) for CPUC to implement a 33 percent RPS in 2010–11. These requests include $1.8 million for seven personnel–years in staffing to implement a 33 percent RPS, and $1 million annually (for each of the next five years) to contract for RPS program evaluation and technical assistance.

Administration’s Spending Plans Are Problematic. The administration’s spending plans discussed above are problematic for a couple of reasons. First and foremost, the expenditures by CPUC and ARB to develop RPS–related regulations are premature given the current statute authorizing a 20 percent RPS. This regulatory activity should not occur until or unless the Legislature enacts a 33 percent standard, and only then should be implemented in a fashion consistent with any policy parameters for a revised RPS that have been established by the Legislature.

The ARB’s expenditures to develop a higher RPS are particularly problematic. This is because ARB is delving into a subject matter—renewable energy procurement—that is both outside its area of statutory responsibility and outside its area of technical expertise. The ARB is spending significant funding to work with CPUC to come up to speed on the subject matter of renewable energy procurement. In our view, this is an inefficient use of state resources. These ARB activities also constitute an inappropriate duplication of effort, given that CPUC plans to move ahead at the same time to implement a 33 percent RPS that would apply to the entities that it regulates.

Analyst’s Recommendations. Given that the administration’s spending plans are both premature and an inefficient and duplicative use of resources, we recommend that the Legislature take the following actions to remedy this situation. Specifically, we recommend that the Legislature:

• Deny CPUC’s budget request for an additional $2.8 million (from PUCURA) for RPS–related activity in the budget year.
• Reduce CPUC’s PUCURA appropriation (Item 8660–001–0462) by an additional $423,000—the amount the commission anticipates spending from its base budget to implement a 33 percent RPS in the budget year.
• Reduce ARB’s Air Pollution Control Fund appropriation (Item 3900–001–0115) by $750,000—the amount the board anticipates spending from its base budget to develop a renewable energy standard regulation in the budget year.
• At budget hearings, specifically direct CPUC and ARB to immediately cease spending funds for the purpose of developing a new renewable energy standard or similar requirement absent the enactment of legislation that authorizes such activities.

Fee Structure for Power Plant Siting Program Should Be Revised

The California Energy Commission (CEC) is charged with the duty of issuing permits for large thermal power plants in the state. Over the past decade, the commission has seen a significant increase in the number of applications for the siting of new power plants—a trend that is expected to continue. In 2003, the Legislature enacted both a siting application fee and an annual compliance fee to partially support the CEC’s siting and compliance activities, with electricity ratepayer funds covering the balance of these costs.

In the analysis that follows, we evaluate the current funding structure for the siting program, and offer our recommendations to revise the process. Our recommendations serve two purposes: (1) to more accurately reflect the direct benefits received from the program by power plant developers and operators and reduce the disproportionate cost burden imposed on the state’s electricity ratepayers and (2) address current backlogs in the program and facilitate more timely permitting of such facilities.

Background

CEC’s Siting Program’s Responsibilities and Workload. The CEC’s Power Plant Siting and Certification Program is responsible for licensing thermal power plants of 50 megawatts (MW) or greater, as well as related transmission lines, fuel supply lines, and other facilities. This would include, for example, any natural gas–fired, solar thermal, and geothermal plant that meets the 50–MW threshold, but would not include others, such as hydroelectric, photovoltaic, and wind power. After licensing, the commission is required to monitor compliance of the facility with all applicable federal, state, and local laws, as well as any conditions of certification imposed by the commission. The commission also must approve any modifications, expansions, or requests to reactivate plants that have been closed down, such as for major repairs.

Since 1999, the CEC has seen a significant rise in the number of power plant applications submitted for permitting to its siting program. According to the commission, the program’s workload is now four times higher than the historical average. This reflects a combination of factors, including increasing energy demands from a growing population, the need to replace aging power plants, and implementation of the state’s renewable energy goals.

The siting program currently has 26 projects under active review, of which 15 are traditional natural gas–fired power plants and 11 are solar thermal power plants. In addition, the commission is also reviewing two major amendments to existing licenses. The commission expects to receive another six to eight power plant applications over the next six months alone.

Solar Thermal Permit Applications Take Longer to Process. The Warren–Alquist Act (the statute establishing the commission’s roles and responsibilities) requires that the permitting of all power plants under the siting jurisdiction of the CEC be completed within 12 months of the filing of an application. This requirement applies both to traditional (primarily natural gas–fired) plants and renewable (primarily solar thermal) power plants.

According to the commission, this statutorily required time frame to complete the permitting process has been feasible for the permitting of traditional power plants. However, the commission has found that the permitting of solar thermal power plants (the most common application for renewable generation) can take up to 75 percent more time and resources than is required for traditional power plant applications. One reason is that, because the physical footprint of a typical solar thermal plant is generally much greater than the traditional plant, a more extensive environmental review is generally required for this type of applicant.

Governor’s Budget Proposal

The Governor’s budget proposes about $27 million for the siting program in 2010–11. As proposed, the vast majority of the program’s support ($23.5 million) would come from the Energy Resources Program Account, which is funded by a surcharge assessed on electricity ratepayers throughout the state. Of the remaining funding for the program, $2.5 million comes from the Energy Facility License and Compliance Fund, which is supported by fees charged on electricity generation developers and operators, and $1 million from other miscellaneous sources.

Current Fee Structure No Longer Appropriate

The Energy Facility License and Compliance Fund receives its funding from two sets of fees—(1) the Application for Certification (AFC) fee (a permit application fee) and (2) an annual compliance fee for projects which have already been granted a license. The AFC fee levels are set in statute, and include both a base fee as well as a per–MW charge based on the size of the proposed facility. This fee is adjusted annually for inflation. Current law exempts projects that rely on a renewable resource as the primary fuel source from both the AFC and the annual compliance fees. Our analysis indicates that some aspects of these provisions no longer result in an appropriate funding structure for this program, for reasons we discuss below.

Current Funding Structure at Variance With Beneficiary Pays Funding Principle. When the current fees levied on power plant developers and operators were enacted in 2003, the Legislature established a policy that the state’s siting program would be funded with a mix of siting fees and revenues from electricity ratepayers. This mix of funding contributions was considered appropriate because both developers/operators and ratepayers benefit to some degree from the siting program. Power plant developers and operators receive direct financial benefits from the commission’s approval of their projects, and are responsible for the commission’s ongoing operational costs to ensure that all permits are consistently enforced. Ratepayers benefit to the extent that additional investments in energy infrastructure increase the reliability of the state’s electricity system.

Nearly all costs of the siting program were originally borne by ratepayers. When we recommended the enactment of siting fees in 2003, we viewed it as an application of the beneficiary pays funding principle. Under this funding principle, an identifiable individual or group which derives a direct benefit from a state service should pay for that service. In applying this principle to the CEC siting program, we concluded that a permit application fee that covers at least 50 percent of the program’s costs would be reasonable given the benefits that accrue to power plant developers. We also recommended the establishment of an annual compliance fee to fully cover the commission’s ongoing compliance monitoring costs. The Legislature enacted such fee requirements that year, although not at the fee level we generally recommended.

Seven years later, our analysis finds that a disproportionate share of support—88 percent—is currently coming from electricity ratepayers.

Exemption Has Reduced Revenues, While Potentially Harming Efforts to Develop Renewable Energy. As mentioned above, current law exempts renewable energy facilities from the siting and annual compliance fees. According to the commission, since the end of 2007, the state has foregone over $3.3 million in revenues from renewable developers that have been exempt from the siting fee. In that same period of time, the fee has generated $6.2 million from traditional power plant developers.

As a result of this exemption, the fee revenues available to support the siting program have not increased in line with its growing workload. The program now has a backlog and the statutory time lines for completing its workload are not being met.

Given these circumstances, the Legislature may wish to consider whether the fee exemption is currently serving its original policy goal—encouraging the development of renewable energy generation. Today, as a result of 2006 legislation, the main impetus for increased renewable energy development in the state has been the state’s mandate that privately owned utilities obtain 20 percent of their electricity from renewable energy sources. The fee exemption likely plays a comparatively small role in such decisions given the potential cost, in one case exceeding $1.2 billion, to develop a renewable energy facility.

If the Legislature’s goal continues to be to encourage and facilitate the development of renewable energy generation, a more effective strategy would be to repeal the fee exemption and devote the additional resources to addressing the current backlogs in the siting program. Ensuring that renewable energy–related permitting is conducted on an ongoing basis in as timely a manner as possible would probably, on balance, do more to encourage such projects. This approach would also be more consistent with the beneficiary pays funding principle in that electricity ratepayers would shoulder less of the costs of a siting program that should more appropriately be charged to the program’s direct beneficiaries.

Analyst’s Recommendations. In order to more fully implement the beneficiary pays funding principle and to facilitate more timely power plant siting at the commission, we recommend that the Legislature direct the CEC to incorporate a revised fee structure into the Governor’s 2011–12 budget plan. Specifically, the commission should be directed to submit to the Legislature, on January 10, 2011, a proposal for a revised fee structure for both the AFC and annual compliance fees—including the necessary statutory language to implement such changes. The proposal should repeal the current statutory fee exemption for renewable energy generation and revise fee levels so that at least a 50 percent share of the siting program’s costs would come from developers and operators. The revised fees should be the same for renewable and non–renewable developers/operators to ensure the EC is meeting the 12–month time period mandated in state law for processing power plant applications.

CalFire Issues

Governor’s ERI and LAO’s Fee Alternative

The Governor’s budget includes ERI—a proposal to levy a new surcharge on all property insurance policies statewide. The Governor proposes to use the resulting revenues to offset General Fund costs in 2010–11 in CalFire. Beginning in 2011–12, these revenues would also be used to augment state program and local assistance expenditures in three departments with emergency response responsibilities—CalFire, CalEMA, and the Military Department, and to offset General Fund costs in CalEMA. Below, we evaluate the Governor’s proposed new funding mechanism for emergency response, comment on the proposed program augmentations, and offer an alternative fee–based funding mechanism to partially support CalFire’s wildland fire protection services.

New Insurance Surcharge Proposed to Fund Emergency Response

New Surcharge Proposal. The Governor proposes to levy a surcharge on all residential and commercial property insurance policies in the state. The surcharge rate would be 4.8 percent of the premium amount. The administration estimates that such a surcharge would generate about $238 million in the budget year and about $480 million per year thereafter.

How the New Revenues Would Be Used. As shown in Figure 10, revenues from the proposed surcharge would be used to offset $200 million of General Fund costs in the budget year. In subsequent years with full–year surcharge revenues, the revenues would be used to offset General Fund costs ($219 million) and to augment state program expenditures ($73 million) in three emergency response departments (primarily CalFire). Beginning in 2011–12, the surcharge revenues would also support a $150 million grant program for local first responders.

Surcharge Is a Tax. Based on our discussions with staff at Legislative Counsel, we believe that this proposal constitutes a state tax increase. Legislative Counsel staff have also advised us that if this proposal were to be enacted, it would increase the state’s funding obligations under Proposition 98, a constitutional provision mandating a set portion of the proceeds of state taxes to be used to provide specified minimum funding levels for public schools and community colleges. The Governor’s budget proposal does not reflect this increased obligation under Proposition 98. Therefore, if the Legislature were to approve the Governor’s proposal, it would create a Proposition 98 obligation, and therefore an additional state cost, that is not now recognized in the administration’s budget plan.

Recommend Rejection of the Surcharge Proposal. We find that the Governor’s proposal to fund certain emergency response activities, largely involving wildland fire protection, with revenues from the proposed insurance surcharge is not a good approach. We therefore recommend that the proposal be rejected. While the Governor’s proposal attempts to link a certain levy (the insurance surcharge) to the benefits received by those paying it, we think that there is a much clearer, more direct way of making such a linkage. As discussed later, as an alternative to the Governor’s proposed funding mechanism, we offer what we consider to be a true fee—one that links the charge to the benefits received directly by a defined, identifiable group of property owners.

If Legislature Enacts Surcharge, Retain Flexibility in Use of Revenues. Should the Legislature approve in concept an insurance surcharge as a new tax revenue source, we would then recommend that the surcharge revenues be deposited into the General Fund, and that the use of such revenues be governed by the Legislature’s funding priorities for General Fund revenues for the particular budget year being considered.

Proposed Augmentations May Have Merit, but Decisions Not Needed Now

Augmentations Are Proposed for 2011–12 and Subsequent Years. The Governor’s budget plan proposes various emergency response–related program augmentations that would be supported with the proceeds of the new insurance surcharge. The proposed out–year augmentations for CalFire, CalEMA, and the Military Department are summarized below.

CalFire Augmentations. The Governor proposes five augmentations totaling $51 million to CalFire beginning in 2011–12. The proposals are the same ones presented by the administration in January and May 2009:

• Additional Seasonal Firefighters ($31 Million, Ongoing). The CalFire engines are currently staffed with three personnel. Under this proposal, during fire season, engines would be staffed with four personnel (a practice currently in place and funded through the E–Fund).
• Helicopters ($2 Million in 2011–12; Total of $150 Million Over Six Years). Under this proposal, CalFire would replace 11 firefighting helicopters and remodel of two helicopter bases. The CalFire’s helicopter fleet is more than 40 years old and is facing increasing maintenance costs and scarcity of spare parts.
• Upgrade of the Wide Area Network ($11 Million in 2011–12; Ongoing Costs of Around $3 Million). Currently only 5 percent of CalFire location have access to the existing Wide Area Network with the remaining locations connecting via dial–up technology. Under this proposal, the entire network would be upgraded and extended to cover most CalFire locations.
• Automatic Vehicle Locators ($5 Million, Ongoing). The CalFire’s current dispatch and communications system relies on fire or aircraft crews to report their location to the dispatch center manually. Under this proposal, vehicles would be fitted with a system that would automatically update the dispatch system with the vehicle’s location.
• Aviation Asset Coordinator ($0.3 Million, Ongoing). The CalFire works with the Military Department and federal military agencies to respond with firefighting aircraft. Under this proposal, CalFire would add 1.5 positions to better coordinate these activities between CalFire and other agencies.

CalEMA Augmentations. The Governor proposes these augmentations for CalEMA:

• Wildland Fire Engines ($15 Million in 2011–12; Total of $67 Million Over Six Years). The administration intends to purchase 131 fire engines to supplement the current CalEMA fleet of about 140 engines.
• Additional Staff ($2.6 Million, Ongoing). The administration intends to add staff for various emergency preparedness and response activities.

Military Department Augmentations. The Governor proposes these augmentations for the Military Department:

• Aerial Fire Suppression Assets ($2.2 Million in 2011–12; Total of $13.5 Million Over Six Years). The administration intends to purchase aerial fire suppression assets, including modifications to existing helicopters and airplanes.
• Additional Staff ($1.3 Million Beginning in 2012–13, Ongoing). The administration intends to add staff for various emergency response activities.

LAO Comments. The administration’s may have merit, but none of the proposed augmentations requires the Legislature to act now to approve or reject the augmentations. This is because the program augmentations are not scheduled to begin until 2011–12. In any event, the Governor did not submit detailed budget change proposals for many of these out–year augmentations, so the Legislature lacks the required information to evaluate them. Therefore, we recommend that the Legislature make any decision on these proposed augmentations as part of its 2011–12 budget deliberations and in the context of the Legislature’s funding priorities for the three affected departments in that year. We also recommend that the Legislature consider each augmentation proposal on its merits separately from discussions on the funding source.

LAO Alternative: Wildland Fire Protection Fee

Implementing the Beneficiary Pays Funding Principle. In the past, our office has offered a number of recommendations for achieving General Fund savings by shifting funding for particular state governmental activities from the General Fund to new or increased fees. While the resulting General Fund savings are clearly a benefit from adopting these recommendations, we have offered these kinds of recommendations in both good and bad fiscal times. Our analysis finds that these fees are the appropriate funding source, as a matter of policy, for the activities in question. For example, in cases where the state is providing a service directly to beneficiaries, such as wildland fire protection, the application of the beneficiary pays funding principle would have these beneficiaries pay for the costs of the services that directly benefit them.

However, it is important to note that the application of the beneficiary pays funding principle does not imply that fees will necessarily cover the full cost of the state’s wildland fire protection. This is because this activity provides benefits to the public at–large (such as by providing habitat protection) as well as directly to a discrete group of identifiable individuals (namely property owners in or near wildland areas). In such circumstances, we recommend that fees be assessed to cover only the portion of costs that can reasonably be allocated to the direct beneficiaries of the state’s wildland protection services, with state General Fund resources being used to pay for the broad public benefits. We think that it is very important that any fee be set at levels that are reasonable and proportional in light of the benefit received, and the additional costs imposed on the state, by the individual feepayer. This is the nexus between fee and feepayer that is necessary for an assessment to pass both legal and policy muster as a fee, rather than as a tax.

Below, we discuss our policy rationale for the enactment of a new wildland fire protection fee.

State Is Responsible for Wildland Fire Protection. Under existing statute, the state is responsible for providing wildland fire protection in State Responsibility Areas (SRAs). These SRAs encompass about 31 million acres of the state, primarily privately owned timberlands, rangelands, and watershed areas. There are an estimated 860,000 homes in SRAs. Initially, CalFire’s mission was the prevention and suppression of wildland fires in undeveloped areas. Over time, however, there has been considerable “mission creep” and the department now spends considerable time and resources protecting homes in SRAs from wildfire, as well as responding to medical emergencies and other non–wildfire calls.

Costs of State Fire Protection Have Increased Dramatically. Today, the state’s largest General Fund program expenditure in the natural resources area is fire protection. Over the last two decades, the cost to provide fire protection in SRAs has increased substantially. For example, between 1998–09 and 2008–09, the General Fund cost for fire protection (including both the base budget and E–Fund expenditures) more than tripled. In the current year, estimated General Fund fire protection expenditures are $750 million.

Increasing Development in and Around SRAs Has Increased CalFire’s Fire Protection Costs. Increasing residential development in and around SRAs has translated to increased CalFire fire protection costs for several reasons. First, with the presence of life and structures in or nearby to the areas for which CalFire is responsible to provide wildland fire protection, more resources are often deployed to suppress wildland fires than would be used in nondeveloped areas. Second, the presence of development can limit the fire prevention and suppression options available to wildland fire managers, thereby potentially increasing the fire risk of an area and increasing fire suppression costs. For example, development substantially restricts the ability of fire prevention agencies to use certain techniques such as prescribed burning to reduce the high volume of flammable vegetation intermixed with development. Lastly, the presence of people in wildlands can increase fire protection costs because fire from structures, vehicles, and human activities can quickly spread to the wildland vegetation.

Wildland Fire Protection Directly Benefits Property Owners in SRAs. As a matter of practice, local governments are primarily responsible for providing structural fire protection in the state, both inside and outside SRAs. This has led some to question what benefit, if any, property owners with structures in SRAs receive from CalFire’s wildland fire protection services. In our view, these property owners directly benefit from, and impose costs on, CalFire’s fire protection activity for a number of reasons. First, if CalFire were not located nearby to help prevent wildfires from reaching the structures and to be as readily available to assist as an emergency responder, then the local fire agencies would need to augment their resources substantially. These increased local costs would be passed on to the property owners under the local jurisdiction by way of increased local assessments. Similarly, without CalFire’s presence, property owners with structures in SRAs could face higher property insurance premiums because there would be a higher fire risk to insure against (unless the local firefighting agency stepped up its resources to fill the gap). Finally, the presence of structures in SRAs impacts the way CalFire fights wildfires, and has greatly increased the state’s costs in providing its fire protection.

Recommend a New Wildland Fire Protection Fee in SRAs. Property owners in SRAs directly benefit from the protection of their property provided by CalFire. Therefore, we believe it is appropriate that property owners in SRAs pay a portion of the state’s cost for fire protection. Because the department provides fire protection for natural resources of statewide significance—such as watersheds that provide drinking water for much of the state—it is also appropriate that the state as a whole pay for a portion of the cost of fire protection. Therefore, we consider it reasonable that the state’s cost of providing fire protection in an SRA be shared between the direct beneficiaries and the state’s taxpayers as a whole.

We recommend that the Legislature enact a fee on the owners of structures in SRAs that would be proportional to the additional costs imposed on the state as a result of the presence of those structures. When determining the level of such a fee for structures in a given area, the Legislature would need to consider actual expenditures made by the department in that area, the local fire risk, and the adequacy of fire protection provided by local governments. We continue to consult with staff at Legislative Counsel about the technical requirements to structure the assessment so that it passes legal muster as a fee rather than a tax. We will share the written opinion that we have requested from Legislative Counsel with the Legislature once it is received. Finally, we recommend that the Board of Equalization (BOE) be authorized to collect such a fee.

Because our recommendation would create a new fee, there would be a significant amount of one–time administrative work by CalFire and BOE to set up the fee–collection mechanism and make the initial determinations of who must pay the fee. It is likely this work would take several months. It may be possible to generate revenues beginning as early as the budget year if the Legislature were to enact our fee recommendation soon. Otherwise, revenues from the new fee would most likely begin accruing in 2011–12.

Structured as a Fee, LAO Alternative Does Not Create Proposition 98 Funding Obligations. As discussed above, we believe that the Governor’s proposed insurance premium surcharge is a tax that would increase the state’s funding obligations under Proposition 98. In contrast, our proposed funding mechanism would be structured as a fee and thus would not add to the state’s funding obligations under Proposition 98.

For a more detailed discussion of our SRA fee proposal, please see our Analysis of the 2008–09 Budget Bill, page B–47.

Improving Legislative Oversight of CalFire’s Fire Protection Budget

Background

Role in Fire Protection. The CalFire is responsible for wildland fire protection in SRAs. These SRAs encompass about 31 million acres (about one–third) of the state, primarily privately owned timberlands, rangelands, and watershed areas. In order to provide this fire protection, CalFire employs around 5,000 permanent firefighters, operates an aviation program (aircraft, helicopters, and air tankers), and runs some 230 fire stations.

Two Main Components to CalFire’s Fire Protection Budget. The Governor’s budget proposes about $1 billion (from all fund sources) for CalFire’s fire protection state operations in 2010–11. As discussed in further detail below, this budgeted amount has two components—the “base budget” and an amount budgeted for emergency fire suppression known as the E–Fund. The base budget is proposed to be supported from the General Fund ($300 million) and revenues from a proposed surcharge on property insurance policies statewide ($200 million). The E–Fund is budgeted with a $223 million General Fund appropriation. The additional $277 million consists of reimbursements from local agencies as well as the federal government for fire protection services provided by CalFire.

Base Budget Intended to Pay for Day–to–Day Fire Protection Costs. The CalFire’s base budget pays for everyday firefighting operations of the department, including salaries, facility maintenance, and other regularly scheduled costs. Included in the base budget are the costs associated with the “initial attack” on a wildfire—that is, the firefighting operations generally undertaken in the first 24 hours of an incident. Typical costs would include retardants, overtime, and equipment. The base budget is the source of support for personnel costs to staff engines with three firefighters year–round. (The base budget is also used for the support of fire stations that are in operation on a seasonal basis.)

The base budget is subject to annual appropriation by the Legislature and follows normal budget review processes (such as the submission of budget change proposals for consideration by the Legislature).

E–Fund Budget Intended to Pay for Large–Incident Firefighting Costs. Once an incident has gone beyond the initial 24 hours and therefore will likely exceed the capability of containment by that CalFire unit, costs associated with firefighting are charged to the E–Fund. Such costs as equipment rental, unplanned overtime, inmate crews, and additional air support are charged to the E–Fund for large incidents. If there were no large–fire incidents in a given fiscal year, expenditures from the E–Fund in that fiscal year would in theory be zero.

For many of these large incidents, the state is eligible to be reimbursed by the federal government for some or all of the costs. However, the federal reimbursement process can take a number of years. Once federal funds have been obtained, they are deposited into the General Fund, where in effect they offset state firefighting costs. As a result, the E–Fund expenditures that occur in any given year do not necessarily reflect the ultimate cost to the state for these activities during that time period.

The General Fund support for the E–Fund is provided by the Legislature as a separate budget appropriation based on an estimate of the large–incident firefighting costs for the fiscal year. For 2010–11, the estimated expenditure is $223 million. According to the administration, this amount reflects the average of the most recent five years of these costs. The budget act’s appropriation item for the E–Fund provides that the Director of Finance can augment the item to pay for emergency fire suppression costs at any time without the approval of the Legislature. The department is required to report actual expenditures from the E–Fund to the Legislature quarterly. However, CalFire does not submit requests for any specific expenditure item from the E–Fund to the Legislature.

E–Fund Budgeting Practice Raises Several Issues

Our review of the department’s E–Fund budget proposal finds that the amount requested in the budget is likely to provide a more accurate estimate of the resources needed in the budget year than has been the case with past estimates. However, we are concerned about the expanded use over time of the E–Fund by the department—in particular, its practice of charging day–to–day operating costs not related directly to a large incident to the fund. The practical consequence is that expenditures that would normally be required to be justified in the legislative budget process would escape the Legislature’s oversight and budgetary review. We elaborate on these concerns below.

Budgeting of E–Fund Has Historically Underestimated Expenditures. Figure 11 shows by how much the budgeted E–Fund amounts and actual expenditures for emergency fire suppression have underestimated actual expenditures for the last five years. Beginning with the 2009–10 budget year, the administration has changed its methodology to estimate E–Fund costs by using the average of costs from the most recent five years. Given this, the estimate for the E–Fund should more closely reflect the likely costs to be incurred.

Use of the E–Fund Has Been Expanding. Our review finds that, over time, CalFire’s E–Fund expenditures have been expanded by the administration to include costs that are not incurred as a result of a large–fire incident. These costs include:

• One–Half of the Aviation Program’s Budget. One–half of the costs of CalFire’s aviation program are generally supported from its base budget, but one–half comes from the E–Fund under a longstanding departmental budget policy. This means that even if there were no large incidents in a given fiscal year, one–half of the costs of the aviation program would be charged to the E–Fund. However, if an aircraft is used for a specific large incident, then any additional costs (such as fuel and retardants) are charged to the E–Fund. One exception is CalFire’s contract for a large air tanker—a DC–10—that recently had been supported exclusively from the E–Fund. (See the box below for a full discussion of the budget issues associated with the DC–10 air tanker.)
• Four–Person Staffing. As discussed above, CalFire’s base budget contains funding for three firefighters per engine. In recent years, CalFire—under an executive order issued by the Governor—has increased staffing on fire engines to four in targeted areas during peak fire season (generally June to October) with resources provided from the E–Fund.
• Tahoe Fire Station. The California–Nevada Tahoe Basin Fire Commission recommended in its response to the Angora Fire (a 2007 wildfire that burned 3,100 acres and 250 structures on the western side of Lake Tahoe) that CalFire establish a seasonal fire station to improve initial attack on wildfires. The CalFire has implemented that recommendation under an executive order and supported this fire station activation through the E–Fund.

DC–10 Contract Demonstrates How Emergency Fund (E–Fund) Hinders Legislative Oversight A series of events involving a California Department of Forestry and Fire Protection (CalFire) contract for large air tanker services demonstrates how the current approach to the E–Fund makes it more difficult for the Legislature to ensure its budgeting choices are implemented. “Call–When–Needed” Contract. For many years, CalFire had a contract for securing large air tanker services for its firefighting activity on a call–when–needed basis. Under this arrangement, the contractor would agree to deploy a firefighting plane that was requested by CalFire within 24 hours, if it was available and not in another state (or country). This contract was tapped if needed to supplement the department’s own fleet or large air tankers operated by the federal government. “Guaranteed Availability” Contract Initiated in 2006. Since 2006, CalFire has contracted with a private firm for a DC–10 air tanker capable of dropping 12,000 gallons of retardant or water on wildfires. The contract cost of around $7 million per year is charged entirely to the E–Fund. Prior to 2006, CalFire had relied on large air tankers operated by the federal government. However, this resource became unavailable after most of the federal fleet was grounded following a number of accidents. Under the initial multiyear contract entered into by CalFire, the contactor guaranteed that the DC–10 would be available to respond within 20 minutes of a request from CalFire during a specified fire season period (generally June through October). The contract covered fuel and pilot expenses and specified a daily rate for the aircraft to be used exclusively by CalFire. Contract Cancelled in 2009. As part of the budget–balancing actions taken in July 2009, the Legislature reduced CalFire’s E–Fund budget by $6.7 million and directed CalFire to cancel the contract for the DC–10, which the department did immediately. In part, the Legislature’s action reflected concerns about whether the DC–10 was a cost–effective firefighting resource to the department. The CalFire then reverted to a previous call–when–needed arrangement for hiring the DC–10. CalFire Found Call–When–Needed Arrangement Unsatisfactory. The department found that the call–when–needed daily rate was significantly more expensive than the daily rate it had paid under the guaranteed availability contract, even though this represented a reduced commitment by the contactor. Moreover, even at this higher rate, CalFire found that the DC–10 was not always available to meet its firefighting needs. The department then acted, pursuant to an executive order by the Governor, to issue an emergency contract for 90 days (to the end of the fire season) for exclusive use of the DC–10 under the same terms as the original contract for which the Legislature had stricken funding. 2010–11 Budget Restores Funding for an Air Tanker Contract. The Governor’s budget proposes to restore $7 million of funding for the air tanker contract (for which there are now two aircraft types available—a DC–10 and a Boeing 747). Rather than allocating the whole contract cost in the E–Fund, however, as it has proposed in the past, the department would split support for this contract equally between the base budget and the E–Fund, based on the department’s historical practice of allocating funding for the aviation program. The CalFire is currently in the process of issuing a three–year contract for these services that would run from June 2010 to October 2012. LAO Comments. Although our analysis found that CalFire has acted within its administrative authority with respect to the DC–10 contract, the department’s use of the E–Fund mechanism for this purpose means that legislative intent regarding CalFire expenditures has not always been followed. Although the Legislature chose not to fund the DC–10 contract last year, the administration later proceeded to use E–Fund resources for this purpose. This situation also demonstrates the gaps in legislative oversight that result from this budget practice. The Legislature has never reviewed this contract on its merits in the annual budget process. Moreover, CalFire has not presented a budget change proposal, the customary documentation required to justify budget requests, even though part of the funding for this purpose in 2010–11 would come from the department’s base budget as well as the E–Fund.

Figure 12 shows the total costs of these different cost items paid for under the E–Fund over the last five years.

Current E–Fund Budgeting Practice at Odds With Original Legislative Intent. As stated previously, if there were no large–fire incidents in a given fiscal year, expenditures from the E–Fund in that fiscal year should in theory be zero. However, the assumption in the administration’s budget plan is that certain significant ongoing firefighting costs we have identified would be paid for from the E–Fund even if the state had a year in which it avoided fire emergencies. For example, the staffing costs of the Tahoe fire station are costs that are not related to a fire emergency. We believe this budgeting practice is at odds with the Legislature’s original policy intent that the E–Fund be devoted to paying for costs associated with large–incident emergencies.

Legislature Not Given Opportunity to Review E–Fund Expenditures. The practical consequence of this budgeting practice discussed above is that the Legislature is not being given the opportunity to review the E–Fund expenditures that should more appropriately considered as part of the department’s base budget. If subjected to legislative review, some of these expenditures might not have been approved by the Legislature based upon cost–effectiveness concerns or a lack of workload justification. The Legislature might also have chosen to support some proposed expenditures found to have merit from an alternative funding source. The current use of the E–Fund by the department undermines the ability of the Legislature to exercise appropriate oversight of these expenditures.

Recommendations to Improve Legislative Oversight

Given the concerns discussed above, we recommend that the Legislature make two changes to the budgeting of CalFire’s E–Fund, with the intent of improving the Legislature’s oversight over CalFire’s budget:

• Require day–to–day expenditures currently charged to the E–Fund to instead be justified under the department’s base budget.
• Improve the budget act controls on the E–Fund appropriation item.

We discuss both of these proposed changes below.

Increase CalFire’s Base Budget and Decrease E–Fund Budget. We recommend that the Legislature increase CalFire’s General Fund base budget appropriation for 2010–11 by about $60 million (our estimate of day–to–day costs inappropriately charged to the E–Fund), with a corresponding reduction of $60 million in the E–Fund appropriation. We recommend that the Legislature direct the administration to provide the Legislature, in conjunction with the Governor’s May Revision, a more precise estimate of the amount of funding that should be shifted from the E–Fund to the base budget to implement this change in budgeting policy. Also, the administration should detail the changes in position authority for seasonal firefighters that should be implemented commensurate with this funding shift.

As noted above, we recommend that whatever amount of funding that is reduced from the E–Fund in the budget year be added to the base budget appropriation. This will provide needed certainty to CalFire that all funding that is needed will be available for the current fire season, which generally runs from May to October. That is, as CalFire will be hiring seasonal firefighters and entering into a contract for the very large air tanker in the current year, our recommended budget adjustment should not impede CalFire’s planning for the full fire season that extends into the budget year.

However, given that many current E–Fund expenditures have never been subjected to the normal budget review process, we recommend that this funding issue be revisited in 2011–12. Specifically, the administration should be directed to provide budget change proposals in 2011–12 to fully justify this additional base–budget spending. Consistent with this approach, any staff positions shifted into the base budget for the budget year should be established on a limited–term basis and any new contracts funded from these monies should not commit state funding beyond the budget year.

Going Forward: Increasing E–Fund Spending Accountability. In tandem with these budgetary changes, we recommend that the Legislature take further steps to ensure that E–Funds are spent solely for large–incident firefighting costs. To accomplish this, we recommend the Legislature adopt statutory language that (1) explicitly specifies what types of expenditures are allowed from the E–Fund and (2) requires that any other expenditures be supported from the department’s base budget, where they would be subject to annual appropriation in the Legislature’s regular budget review process.

Other Issues

Tranquillon Ridge Project Merits Legislative Authorization

The Governor’s budget assumes either State Lands Commission (SLC) approval or legislative authorization of a lease for the extraction of oil and gas from state–owned tide and submerged lands off the Santa Barbara coast known as Tranquillon Ridge. In the analysis, we provide more detailed information on the Tranquillon Ridge project, discuss some of the key policy issues that have been raised concerning the project, and assess the reasonableness of the revenue assumptions contained in this budget proposal. We also offer our recommendations on how the Legislature should proceed on this matter.

Background: Tranquillon Ridge and State Policy on Offshore Oil Production

Project Description. Plains Exploration and Production Company (PXP), a Houston–based oil and gas company, has applied for two offshore oil and gas leases covering the Tranquillon Ridge Oil Field, which is located in state waters directly offshore from the Vandenberg Air Force Base in Santa Barbara County. As shown in Figure 13, PXP plans to use their existing platform, Platform Irene, which is located in federal waters, to slant drill 14 wells from the existing structure into state waters in order to access and recover an estimated 40 million to 90 million barrels of oil over a 14–year period. The oil that would be produced from Tranquillon Ridge would be measured separately on the platform and then transported through existing pipelines to a processing plant in the city of Lompoc. There, the oil would be processed to pipeline quality and shipped to refineries through the All–American pipeline.

Legislative Policy Has Prioritized Coastal Protection. Since a major oil spill occurred near Santa Barbara in 1969, California has enunciated a policy that prioritizes the protection of coastal resources over the development of new offshore oil supplies. Over the years, the Legislature has added prohibitions against the leasing of additional offshore areas. In 1994, with the passage of the California Coastal Sanctuary Act, the Legislature generally prohibited any new leases in state coastal waters, with some limited exemptions discussed below. Consistent with this policy, the Legislature has also adopted a series of resolutions opposing new leases in federal waters. The SLC has not approved a new lease since 1968, and since 2001 has similarly adopted numerous resolutions opposing new leases in federal waters. Both the legislative and SLC resolutions often cite the state’s record of not approving new leases.

Project Falls Under Statutory Exemption Allowing for New Offshore Oil Leases. One exception to the 1994 California Coastal Sanctuary Act that permits offshore oil drilling in state waters is commonly referred to as the “drainage” exemption. Under this exemption, new drilling is allowed if the SLC, which has authority over leasing in state waters, determines that (1) state oil or gas deposits are being drained by means of producing wells upon adjacent federal lands, and (2) the lease is determined to be in the best interests of the state.

The SLC commissioned an independent study to determine whether the proposed Tranquillon Ridge project constituted such an exemption. The study confirmed that such drainage of both natural gas and oil from offshore areas within the state’s jurisdiction is occurring due to production from Federal Well A–28, as shown in Figure 13. In addition, the study found that water—which helps pressurize the oil reservoir in state waters—is also being drained. Drainage of this water decreases the productivity of oil production in state waters. Specifically, the study estimates that due to the loss of water, the ability to produce 1.4 million barrels of oil from Tranquillon Ridge has been jeopardized.

Governor’s Budget Proposal

Proposed Use of Lease Revenues. The administration estimates that the proposed Tranquillon Ridge lease agreement would generate $1.8 billion in revenues for the state over the lease’s 14–year term. The budget assumes quick action to approve the lease in the current fiscal year, so as to generate a fixed up–front payment of $100 million from the lessee in 2009–10 once permits are acquired. The administration proposes to (1) deposit $79 million of the revenues from the up–front payment in the General Fund, where they could be used to support various state programs, and (2) earmark the remaining $21 million to be used in the budget year to restore previous General Fund program cuts in DPR. The budget proposes to use an estimated $119 million in oil lease revenues in 2010–11 for DPR support costs that would otherwise be borne by the General Fund. The administration also proposes language in the budget bill that would backfill the parks program with additional General Fund support in the event that the lease revenues were less than anticipated.

The administration proposes to use the lease revenues in future years to fund state parks. For this purpose, the administration has proposed a statutory change that would require up to $140 million of Tranquillon Ridge revenues annually to be deposited in the State Parks and Recreation Fund to support state park operations. (Any revenues received in excess of $140 million would be deposited into the General Fund.)

How New Proposal Differs From Governor’s 2009–10 May Revision Proposal. The Governor offered a generally similar Tranquillon Ridge proposal as part of his 2009–10 budget plan that, ultimately, was not approved by the Legislature. The May Revision version differed from his current proposal in two major respects. First, because the SLC had previously taken administrative action to reject the project, the Governor had proposed that the Legislature adopt legislation that would in effect have overridden that decision. In contrast, this year’s budget proposal assumes either that the SLC will approve the project (which is being resubmitted to the SLC for its consideration) or that the Legislature will authorize it in statute. Second, the May Revision proposal did not dedicate the revenues from the project for any particular purpose. As discussed earlier, the new version of the proposal dedicates the ongoing revenues from the project to fund state parks.

Key Policy Issues

Three major policy issues concerning the approval of the Tranquillon Ridge lease agreement have been raised:

• The risk of oil spills.
• The potential precedent that may be set in support of increased drilling in federal and state waters.
• The potential unenforceability of certain environmental concession provisions in the lease agreement and in a “side agreement” between the lessee and an environmental organization.

We further explain and comment on each of these issues below.

Oil Spill Risk. One policy concern that has been raised with the Tranquillon Ridge proposal is the fact that an increase in the volume of oil production inherently increases the probability of an oil spill. The Environmental Impact Report (EIR) which was prepared by Santa Barbara County for the project found that, if oil were produced from the project for 14 years, the probability of an oil spill during that period associated with Platform Irene would increase from a current 5.4 percent to 11 percent.

However, the volume of the oil spill that could result under this estimate of risk is small compared to the 1969 spill. According to the EIR, the potential worst–case oil spill size related to the Tranquillon Ridge project is estimated to be 7,929 barrels. In comparison, the 1969 Santa Barbara oil spill, which has been attributed to a wellhead blowout, was estimated to involve approximately 80,000 to 100,000 barrels.

Even a spill of small volume however could have a significant impact on coastal resources under certain situations. However, we note that, since the occurrence of the Santa Barbara spill, technological advancements have increased the safety of oil production and new regulatory programs have been established to prevent and respond to oil spills.

Potential Precedent for More Offshore Drilling. As noted earlier, the SLC has often cited the state’s record of not approving new state leases in state waters in its opposition to new leases in federal waters. Some opponents of the Tranquillon Ridge project have raised the concern that the approval of this new lease could open the door to additional drilling in state and federal offshore waters.

It is unlikely that approval of Tranquillon Ridge would lead directly to additional drilling within state waters because there are no circumstances similar to Tranquillon Ridge in which drainage is occurring in state waters as a result of production in federal waters.

There is no way to determine at this time whether approval of Tranquillon Ridge could impact federal policy and lead to additional drilling in federal waters offshore of California. However, the approval of new federal leases in the future could potentially create new drainage situations in state waters akin to Tranquillon Ridge. These too would, in theory, be allowable under the statutory exemption contained in the state law governing such situations.

Enforceability of the Third–Party Agreement. As a condition of its support for the project, a Santa Barbara environmental group (the Environmental Defense Center [EDC]) has entered into a written agreement with PXP that attempts to establish and enforce a date upon which oil production in both state and federal waters near Tranquillon Ridge would be terminated. While the agreement has not formally been made public by the parties to the agreement, the document has been reviewed by SLC staff and the state Attorney General. Public testimony by various private parties and public agencies at a past SLC hearing on Tranquillon Ridge indicates PXP agreed to shorten the time period that it would produce oil from Tranquillon Ridge to one–half the time of the typical lease period for such oil production. The PXP also apparently agreed to a shutdown of production of other wells located in federal waters at a set time in the future.

Both the SLC and the Attorney General have questioned the enforceability of the production termination dates in the PXP–EDC agreement. They note that the U.S. Federal Minerals Management Services (MMS) would need to “sign off” on any termination date, and that the likelihood of such federal action is uncertain. Due to its policy of requiring production to continue as long as recoverable oil remains at an established drilling site, MMS could reject the inclusion of end dates in PXP’s application to use Platform Irene for the Tranquillon Ridge project.

Our analysis indicates that these concerns are legitimate. If it chooses to approve this project, in our view, the Legislature should not assume that federal offshore oil production near Tranquillon Ridge will end within the timeline cited in this agreement.

Our Assessment of the Lease Revenue Projections

Projected Revenues Overly Optimistic. As we discussed above, the Governor’s budget assumes that an advanced royalty payment of $100 million would be paid to the state in 2009–10, with $119 million in full–year royalty revenues in 2010–11. In so doing, the administration has assumed a March 2010 project approval date for the project.

Based on our review of the situation, we believe such quick approval of the project is unlikely. It is more reasonable to assume that project approval—which entails SLC approval plus other separate state and federal agency approvals—would occur at a date that is several months later. This means that it is unlikely that the advance royalty payment would be collected in 2009–10, although it could occur in the budget year.

In addition, it typically takes several months for newly drilled wells to begin to produce oil. This lag time means that the budget’s assumption for a full year of royalty revenues in the budget year from Tranquillon Ridge also is overly optimistic. The revenues from the project could easily be tens of millions of dollars less than assumed in the budget plan.

Revenue Projections for Future Years Are Inherently Uncertain. Given that future oil prices are inherently difficult to predict due to their volatility, so too is it difficult to predict potential revenues from the Tranquillon Ridge lease beyond the up–front payment. The amount of oil produced for the energy market is primarily driven by the price of oil, making it difficult to predict the amount any particular producer is willing to pump in any given year. This, in turn, determines the amount of royalty revenues that would be generated from any particular production site. The budget assumes that, over the planned 14–year production period, Tranquillon Ridge will generate $1.8 billion for the General Fund. However, given the above considerations, this revenue projection is highly uncertain, and could easily range higher or lower by hundreds of millions of dollars or more over the lease period.

Analyst’s Recommendations

On Balance, the Project Merits Approval. The Legislature must weigh significant policy and fiscal trade–offs in considering the Tranquillon Ridge project. On the one hand, a certain amount of risk is inherent with the proposed activity, even with the advancements that have been made in drilling technology and the ability to respond to spills. However, a decision to allow the project to proceed would be consistent with the Legislature’s current statutory policy, which is to permit an exemption from the general ban on any new offshore oil and gas leases if it is found that state resources are being drained from adjacent federal facilities. Moreover, this project provides the opportunity to gain significant and much–needed revenues for the General Fund that could help to preserve state programs that it considers to be a high priority. Analyzing these potential risks and trade–offs, we find, on balance, that the Tranquillon Ridge project merits legislative approval.

Reject Tie Between These Revenues and Support for State Parks. The administration has proposed to dedicate the ongoing revenues generated from Tranquillon Ridge offshore production to support for state parks. If the Legislature decides to approve the project, however, we recommend that it maintain flexibility in the potential use of revenues received from Tranquillon Ridge. In other words, we recommend that the revenues generated from the project be deposited into the General Fund, where they could be allocated each year in keeping with the Legislature’s funding priorities, including, if it so chooses, support for state parks. We believe the Legislature should shy away from unnecessary actions that would lock up these revenues for specific programs. In addition, as we noted earlier, the revenues derived by the state each year from Tranquillon Ridge production could vary significantly from year to year depending on economic conditions, such as the price of oil. That makes it particularly unwise to dedicate these monies to support a program such as state parks that would benefit from fiscal stability.

For these reasons, we recommend that the Legislature not approve the Governor’s proposed statutory change dedicating Tranquillon Ridge revenues to fund state parks.

Other Recommended Actions. If the Legislature does decide to approve the Tranquillon Ridge project, it should explicitly authorize the project in legislation, as was proposed by the Governor last year, rather than assume that the SLC will approve it administratively. The SLC’s prior decision to disapprove of the project means that future approval by SLC would be uncertain. Enactment of new legislation to authorize the project would ensure that these revenues are available to balance the state budget.

In so doing, the Legislature should seek updated estimates from the administration as to the likely timing of the project and the amount of revenues that would be generated from it in the current and budget years. For the reasons we cited above, we believe more realistic estimates are warranted and necessary to ensure sound budget decisionmaking.

Finally, should the Legislature choose to authorize the project, it should do so if possible through urgency legislation that would maximize the revenues available to provide a state budget solution in the current and budget years.

A Framework for Evaluating Resources Bond Spending

In a resource–constrained fiscal environment, proposals to spend the proceeds of state general obligation bonds in the budget warrant extra scrutiny by the Legislature. This is for two key reasons. First, bond expenditures come attached with a General Fund cost in terms of debt–service. The state needs to manage and contain these General Fund expenditures, as they compete with and potentially crowd out other legislative funding priorities. Second, given recent history, it is possible that the state will not have sufficient access to the bond markets in the budget year to sell all the bonds that would be needed to fully support all of the bond expenditures contemplated in the budget. Therefore, it will be important that the bond expenditures reflected in the final budget act be well–justified, be an appropriate funding source for the activity in question, and reflect legislative priorities.

In the sections that follow, we provide an update on the status of the fund conditions of various resources general obligation bond measures. (Our numbers incorporate the Governor’s various bond expenditure proposals.) We provide a framework for the Legislature to evaluate the Governor’s budget proposals and offer recommendations to ensure proper oversight of these expenditures.

A Status Report on Resources Bond Funds

$21 Billion in Resources Bonds Approved Since 1996. Between 1996 and 2006, voters approved seven resources bonds totaling $20.6 billion (Propositions 204, 12, 13, 40, 50, 84, and 1E). In addition, the Proposition 1B transportation bond allocated $1.2 billion for air quality purposes and the Proposition 1C housing bond allocated $200 million for local parks.

$3.2 Billion Would Remain Available for Future Appropriations. As shown in Figure 14, about $3.2 billion is projected to remain available under the Governor’s budget plan from the seven resources general obligation bond measures at the end of 2010–11 for appropriation in future years. As the figure shows, funds are substantially depleted from five of these measures. The funds remaining available for appropriation in future years are mainly for (1) flood management, largely in the state’s Central Valley and Delta regions (including about $1.5 billion of Proposition 1E funds) and (2) various water quality and water management programs (including about $750 million of Proposition 84 funds). Relatively few funds remain available for state and local parks–related purposes and for land/habitat conservation, restoration, and acquisition—activities carried out mainly by the state’s several land conservancies and the Wildlife Conservation Board.

$800 Million of Resources Bond Spending Proposed for Budget Year. As shown in Figure 14, the Governor’s budget proposes about $800 million of bond expenditures from these resources bonds. A majority of these expenditures are proposed for flood management and water management activities carried out by DWR. (In addition, the Governor’s budget proposes $230 million from the Proposition 1B transportation bond for air quality projects in the state’s major transportation corridors.)

Evaluating Bond Proposals

As discussed further below, we recommend the following framework to guide legislative evaluation of the Governor’s bond spending proposals:

• Evaluate each proposal to see whether it meets a set of specified criteria before allowing any bond expenditure to be incorporated into the 2010–11 budget plan.
• Set priorities for the expenditure of the bond funds in the event that bond market conditions do not permit all bond–spending proposals to be funded.

Resources Bond Expenditure Criteria. We think that it is important to consider the timing of the Legislature’s evaluation of bond expenditure proposals. Although the Governor’s January budget includes many requests for new appropriations and reappropriations of bond funds, the bulk of the administration’s resources bond–related requests are often submitted as proposed amendments to the budget plan in April and May (mainly as reappropriations) and acted upon during the May Revision process. For this reason, a comprehensive evaluation of proposed bond expenditures should occur upon the submittal of the complete package of bond expenditure proposals.

In its evaluation of proposed bond expenditures, we think that the Legislature should apply a number of basic criteria before approving any expenditure.

First, as with any budget request, we think that the administration should provide sufficient detail in terms of the description and justification for the proposal to enable the Legislature to make an informed decision about its merit. Lacking such information, we recommend that the request be rejected.

The project should address a current programmatic need and, consistent with prior statutory direction, be used for capital purposes—particularly for projects that provide benefits over a number of years. The department proposing to spend the funds on a capital project should be ready to spend the funds and capable of completing a project as proposed with the bond resources requested as well as other available funds.

Finally, the Legislature should consider whether bond funds are the most appropriate funding source for the activity in question, or whether there are alternative funding sources available. For example, the application of the beneficiary pays funding principle may suggest that funding from the direct private beneficiaries of the state expenditure is appropriate. Alternatively, federal or local funds may be available that should be used instead of state bond funding.

Applying the Criteria. We applied these criteria to the bond–related requests submitted as part of the Governor’s January budget proposal. We raise concerns about bond budget requests in two write–ups elsewhere in this budget analysis—“Implementation of the New Legislative Water Package” and “The Davis–Dolwig Act—Fundamental Reform Still Needed.” We outline our concerns about other specific bond budget requests in our Summary of LAO Findings and Recommendations on the 2010–11 Budget, a Web–based list which can be found at our Web Site, www.lao.ca.gov.

Prioritizing Bond Expenditures in a Difficult Fiscal Environment. In our office’s previous reports and testimony to the Legislature regarding the state’s current fiscal situation, we have recommended that the Legislature identify priorities among bond–funded projects. This is particularly important given the likelihood that the state will not have sufficient access to the bond markets in the budget year to sell all the bonds that would be needed to fully support all of the bond expenditures contemplated in the budget. In 2009, this situation resulted in the postponement of the offering of some bonds for sale by the state. This, in turn, significantly delayed a number of state bond–supported projects. Some of these delays are continuing to occur, and more such problems are likely, at least in the near term.

When such constraints interfere with bond–supported expenditures, the current practice is that the administration allocates the available funds according to its priorities. For example, according to DOF, the administration has prioritized certain bond sales used to support state program operations and over capital outlay purposes. The administration has also prioritized projects that address fire/life/safety and public health deficiencies, leverage other funds, or provide an immediate economic stimulus and create jobs.

Legislature Should Set Its Priorities. We think that the Legislature should provide direction to the administration on the Legislature’s priorities among the resources bond appropriations which it approves, in case some portion of these appropriations cannot be spent due to problems with accessing the bond market. The Legislature might list the particular projects that are its top funding priorities, and then provide its highest priorities for the balance of the appropriations, expressed at a relatively high level. For example, these priorities for the balance might include funding projects which provide direct public safety benefits, or those which create state revenue opportunities (such as projects at fee–generating state parks).

Improving Accountability for DWR’s Bond Spending

Substantial Bond Funding Has Been Allocated to DWR. Over the past ten years, various bond measures have allocated over $15 billion of their funds to DWR, with a majority allocated by two measures from 2006. Several billions of dollars remain available from these bond funds for future appropriation to DWR. In addition, the Legislature and Governor recently enacted a measure to place an $11.1 billion general obligation water bond before the voters in November, some of which is allocated to DWR.

Concerns About DWR’s Capacity to Manage Large Volume of Bond Funds. These recent increases in the availability of bond funding for DWR are unprecedented in their magnitude. This has led to concerns about the department’s capacity to effectively manage such a high level of funding. A 2007 Bureau of State Audits examination of the Proposition 1E Flood Protection Corridor Program found a number of problems with the way the department administered the program, including poorly defined grant selection criteria, poor monitoring of grants, and a concern that the state overpaid for a particular land acquisition related to flood control. A recent update of the audit found that a number of these concerns had not yet been addressed by the department.

Difficult to Track Department’s Bond Expenditures. Our analysis of these programs indicates that it is difficult to account for how bond funding has actually been spent by the department. This is due in part due to the department’s practice of administratively shifting funding between different projects and programs. It is not clear that, in all cases, these funding shifts were in line with the Legislature’s original funding intent. This practice was particularly evident during a period in 2008–09 and 2009–10 in which bond sales had stopped because of the state’s fiscal problems and difficulties in the municipal bond market.

Comprehensive DWR Bond Audit Warranted to Improve Accountability. Given the concerns outlined about the DWR’s management of general obligation bond funds, the Legislature may want to request a Joint Legislative Audit Committee review of all of DWR’s general obligation bond–funded programs. An audit should focus on ways to improve the efficiency and usefulness of the department’s bond expenditure reporting to various state control agencies (such as DOF) as well as the Legislature. We recommend that this audit review be conducted in time to assist the Legislature with its 2011–12 decisions about DWR bond expenditures.