WATER: Desalination financing gets extension

WATER: Desalination financing gets extension Poseidon says funding should be in place before end of June
By: Bradley J. Fikes

CARLSBAD ---- Months after preliminary construction began on its desalination plant, Poseidon Resources Corp. said it expects to borrow the money necessary to complete the project before the end of June.
Stamford, Conn.-based Poseidon says it expects to get the plant operating by the original projected date, the end of 2012. Located next to the Encina Power Station, the plant will have the capacity to make 50 million gallons of drinking water a day, 9 percent of San Diego County's consumption.

However, Poseidon also said it had to get a two-month extension on state authorization to sell $530 million in tax-free bonds, because it was still completing the final terms of its 30-year contracts with local water agencies. The previous deadline was April 27, said Peter MacLaggan, a Poseidon senior vice president.

Meanwhile, the water agencies say they're still fairly confident the plant will be built.

"I don't think it's the end of the world," said Kimberly A. Thorner, general manager of Olivenhain Municipal Water District, one of the contracting water agencies. "Obviously, we need the water sooner rather than later, but I'm still hopeful that everything is moving forward."

Olivenhain and eight other local agencies and cities have signed binding agreements to buy the water, once it becomes available. However, some items have yet to nailed down for a final contract, such as a guarantee of a price subsidy, MacLaggan said. This isn't expected to be troublesome, he said, but buyers of the tax-free bonds want to see all the details in writing before plunking down their $530 million.

Metropolitan Water District, Southern California's water wholesaler, has offered a subsidy of up to $250 per acre-foot to bring the desalinated water's cost to the agencies down to that of traditional water sources. An acre-foot is about 326,000 gallons, or about what two families of four use in a year.

Yet Metropolitan's approval was hedged ---- if the subsidy is challenged by a member agency, it may be canceled. One of Metropolitan's member agencies is the San Diego County Water Authority, the county's main water importer.

The water authority is also a party to the Poseidon deal. So if the authority changed its mind and opposed the subsidy, that could conceivably invalidate it.
Poseidon is asking for a backstop guarantee from the water authority to make sure the subsidy is available, MacLaggan said.

Investment grade

The bonds' tax-free status was granted in January by the California Debt Allocation Committee, or CDLAC (pronounced "SEED-lack"). The committee grants tax exemptions for projects deemed to be to the state's benefit. In this case, the benefit would be a new and reliable supply of water for drought-vulnerable San Diego County.

The committee reauthorized the tax-free bonds at a March 24 meeting, giving Poseidon until late June to complete the sale, MacLaggan said. Because they're tax-free, the bonds can be sold at a lower interest rate to investors than taxable bonds, lowering the cost of the project and hence the cost to agencies buying the water.
Standard & Poors has rated the bonds at BBB-, the lowest level of investment grade status. Investment grade bonds are considered to be safer, even for unsophisticated buyers. Investors consider investment-grade bonds more reliable than so-called "junk bonds," which are highly speculative and meant for well-informed, risk-tolerant buyers.

A committee staff report stated that Barclay's Capital, Poseidon's financial adviser, said the market for such low investment-grade bonds is strong.

"In its ratings analysis, Standard & Poors evaluated the strength of the project and all of the project counterparties, including equity sponsors, contractors, the operator and all nine of the water districts entering into purchase agreements," the staff report stated. "Through its review of Standard & Poors' analysis (as summarized in its Rating Determination Letter), CDLAC staff believes that their conclusions were sound."
Poseidon had initially considered attempting to get an even higher rating by buying bond insurance, MacLaggan said. However, the cost of the insurance outweighed the benefit, so that idea was scrapped.

Construction delayed

Poseidon began construction in November with its own funds. But that was mainly a formality to ensure its building permit from the California Coastal Commission didn't expire. So far, Poseidon has torn down structures and prepared the land for construction.

The delays were not a surprise, said Greg Blakely, water utilities manager for the city of Oceanside.  "It's a novel project," he said.

Now the deal-makers are taking a closer look at the project's revenue sources to make sure they're guaranteed, said Gary Arant, general manager of Valley Center Municipal Water District. He said that scrutiny is to be expected as the time draws near to make a funding commitment.

"Public agencies have ways of ensuring they can fund projects," Arant said. "It's a little different when you have a private company."

Sweetwater Authority is willing to be patient, said Jim Smythe, operations manager for the authority, which serves the South Bay region of San Diego County.

"Everything's fine," Smythe said. "Of course they've had numerous delays, but it's not as if we're sitting here waiting for water."

Oceanside, Olivenhain, Sweetwater and Valley Center are four of the nine agencies that have agreed to buy water from the Poseidon plant.

The others are the city of Carlsbad, Santa Fe Irrigation District, Vallecitos Water District, Rincon del Diablo Municipal Water District, and Rainbow Municipal Water District.