California's quest to build a high-speed rail system between San Francisco and Los Angeles suffered a heavy blow Tuesday when a peer-review committee recommended that state legislators not fund the project until major changes are made to the business plan for the increasingly controversial line.

In a scathing report, the California High-Speed Rail Peer Review Group found that the business plan the California High-Speed Rail Authority unveiled in early November offers inadequate information about funding, fails to answer the critical question of which operating segment will be built first and features a phased-construction plan that would violate state law. The group, which is chaired by Will Kempton, recommends that the state Legislature not authorize expenditure of bond money for the project until its concerns are met.

The report deals the latest of several recent setbacks to the project, for which state voters approved a $9.95 billion bond in 2008. Since then, the project's price tag more than doubled and several agencies, including the Legislative Analyst's Office and Office of the State Auditor, released critical reports about the project.

High-speed rail has become particularly controversial on the Peninsula, where several grassroots groups have sprung up in the last two years to oppose it. Menlo Park, Atherton and Palo Alto had filed a lawsuit challenging the rail authority's environmental analysis and the Palo Alto City Council last month adopted as the city's official position a call for the project's termination.

In its letter to the Legislature, the peer review group highlighted some of the same flaws that local officials and watchdogs have long complained about, most notably a deeply flawed funding plan. The project currently has about $6 billion in committed funding and the rail authority plans to make up much of the balance from federal grants and private investments -- investments that would be solicited after the first major segment of the line is constructed. The peer-review group found this plan to be vague and insufficient.

"The fact that the Funding Plan fails to identify any long term funding commitments is a fundamental flaw in the program," the report states. "Without committed funds, a mega-project of this nature could be forced to halt construction for many years before additional funding could be obtained. The benefits of any independent utility proposed by the current Business Plan would be very limited versus the cost and the impact on state finances."

The group also faulted the rail authority's business plan for failing to choose the "initial operating segment" for the rail line. Though the authority has decided to build the first leg of the line in Central Valley, this segment would not be electrified and would serve largely as a corridor for testing the new line. The first "true" high-speed rail segment would be built later and would stretch either north toward San Jose or south toward San Fernando Valley.

Though the peer-review group acknowledged that a phased approach is the only feasible way to build the system, it also found that this plan violates a requirement of Proposition 1A, which mandates that the rail authority identify funding for the first usable segment of the line before construction begins. The Central Valley segment, the peer report notes, "is not a very high-speed railway (VHSR), as it lacks electrification, a CHSR train control system, and a VHSR compatible communication system. Therefore, it does not appear to meet the requirements of the enabling State legislation."

The peer review group also wrote in its letter that the authority should have determined in its business plan whether the first "operating segment" would go north or south from the Central Valley. Its letter states that "it is hard to seriously consider a multi-billion dollar Funding Plan that offers no position on which IOS should be initiated first."

"This indecision may also have consequences in obtaining environmental clearances. We believe that the Funding Plan as proposed should not be approved until the first IOS is selected."

The report reserves "final judgment" on the funding plan because the rail authority's business plan is still in draft form and subject to revisions. But it also makes clear that major changes would have to be made before the project warrants state funding. The letter notes that while legislators could potentially come up with a funding source for the project, without such a source "the project as it is currently planned is not financially 'feasible.'"

"Therefore, pending review of the final Business Plan and absent a clearer picture of where future funding is going to come from, the Peer Review Group cannot at this time recommend that the Legislature approve the appropriation of bond proceeds for this project," the peer group's letter concludes.

The new report presents a potentially devastating blow to the rail authority, which is banking on getting $2.7 billion in Proposition 1A funds for construction of the Central Valley segment. The agency has also received $3.5 billion in federal grants.

The state funds are particularly critical given the lack of private investment and increasing local opposition. The authority had acknowledged that private investment would not start coming in until later phases. Future federal funding is also deeply uncertain at a time when many Republicans in the House of Representatives are vehemently opposing the project.

The rail authority responded to the report by disputing many of its findings and by claiming that it "suffers from a lack of appreciation of how high-speed rail systems have been constructed throughout the world." The authority also said in a statement that the peer-review group's report "makes unrealistic and unsubstantiated assumptions about private sector involvement in such systems and ignores or misconstrues the legal requirements that govern the construction of the high speed rail program in California."

Roelof van Ark, CEO of the rail authority, said in a statement that the recommendation of the committee "simply do not reflect a real world view of what it takes to bring such projects to fruition."

"It is unfortunate that the Peer Review Committee has delivered a report to the Legislature that is deeply flawed in its understanding of the Authority's program and the experience around the world in successfully developing high speed rail," van Ark said.

Rail authority officials also argued that the peer-review group's report could jeopardize federal funding for the project. Thomas Umberg, chair of the authority's board of directors, said the board takes seriously "legitimate critiques" of the rail program, including recommendations that the authority hire more staff.

"However, what is most unfortunate about this Report is not its analytical deficiency, but that it would create a cloud over the program that threatens not only federal support but also the confidence of the private sector necessary for them to invest their dollars," Umberg said in a statement.

The authority's Chief Counsel Thomas Fellenz called the committee's findings about the project's inconsistency with Proposition 1A "unfounded assumptions." The group's legal conclusions, he said in a statement, are not only "beyond the expertise of the authors, but attorneys at the state and federal government level and the legislative author of the bond measure, profoundly disagree."

The authority also submitted an eight-page letter to state Legislators responding to the peer-review group's criticisms. The authority disputed in its letter the peer-review group's finding that the "initial construction segment" in Central Valley would violate Proposition 1A and argued that the group's demand for a long-term funding plan fails to consider how major transportation projects are normally built.

"By this measure, none of the unconstrained regional transportation plans of any transportation authority should be pursued," the letter from Umberg states. "No project, in our experience, has fully identified funding sources for the entire project at this stage and it is both unfortunate and inappropriate for the Committee to apply this test only to high speed rail."