CARLSBAD -- After a decade of struggles to assuage environmentalists, raise almost $1 billion and win permits, Poseidon Resources Group will finally answer a critical question: is converting seawater to drinking water a profitable venture in the U.S. when there are cheaper options?
The developer of water infrastructure projects began site work last month on the Carlsbad desalination plant, the largest of its kind in the Western Hemisphere.
When completed in 2016, the facility 33 miles north of San Diego each day will create 54 million gallons of drinking water after drawing it from the salty Pacific Ocean.
Bankrolled by a $922 million JPMorgan Chase & Co. (NYSE: JPM)-led, public-private bond offering -- the biggest U.S. project financing deal of 2012 -- Carlsbad’s chances of success are aided by a 30-year agreement with San Diego’s water authority to buy water from the plant.
If successful, the project could become a model for how to ease a growing water crunch.
“Its success is going to prevent desal from slowing down,” said Tom Pankratz, a Houston-based editor of the Water Desalination Report. “It’s going to eliminate one of the hurdles to projects that are being considered.”
Desalination provides about 50 percent of municipal water in such places as Saudi Arabia, and reverse-osmosis plants including Poseidon’s filter out salt from Spain to China.
Yet until the current U.S. drought, the country has been slower to develop large-scale desalination plants producing at least 20 million gallons of purified ocean water a day.
That’s because in the Middle East, desalinated water is often the “core” or at least half of the domestic supply, while in such places as the United States, Spain and Australia, it’s “marginal, or the supply of last resort,” less than 10 percent in most instances, said Maxime Serrano Bardisa, a water analyst at Bloomberg New Energy Finance (BNEF) in London.
As the Carlsbad plant starts to emerge from near Agua Hedionda lagoon by NRG Energy Inc.’s Encina power station, Poseidon is pushing for a similar-sized desalination facility of about 50 million gallons an hour’s drive north in Huntington Beach.
If both are built, each will surpass in size the Tampa Bay reverse-osmosis desalination facility in Florida to become the largest seawater-purifying plant in the U.S., said Alasdair Wilson, a BNEF analyst.
San Diego must buy
Under terms of Poseidon’s partnership, San Diego County’s water authority will buy at least 40,000 acre-feet of drinking water stripped of sea salt and sediment, enough for 80,000 single-family homes, over the next three decades.
That supply, sufficient for about 7 percent of the 3.2 million residents in the region, gives the San Diego area a buffer from water shortages, its mayor said.
It also shelters Stamford, Conn.-based Poseidon and its backers from risks including demand shortfalls and uncompleted construction.
“You have to give Poseidon credit for getting this permitted,” said Jeff Moser, executive director of the National Water Research Institute in Fountain Valley, Calif.
The company faced concerns about how the deal would be financed, disagreements over terms and costs of the water supply agreement and criticism from environmentalists about the output of salt in the energy-intensive filtering process damaging marine life offshore.
Most of the plant’s discharge will be diluted so the salinity doesn’t impact sea-life.
Poseidon’s partnership with the water authority may also help the company succeed after a similar deal failed a decade ago, leaving a partially-built plant in Tampa.
This time, Poseidon has upfront funding from an infrastructure firm and a contractor experienced in building similar plants.
Poseidon was unable to secure financing for the Tampa Bay desalination facility in 2002 after early construction began.
The city’s water authority ultimately bought Poseidon’s interest in the project.
“Parallels between what happened in Tampa and our project now are tenuous at best,” Poseidon Chief Financial Officer Andy Kingman said.
The failure to finance and build the smaller facility in Tampa Bay isn’t relevant beyond providing lessons learned and history, the CFO said.
A contractor with the seawater desalination background that Israel’s IDE Technologies Ltd. brings to the project wasn’t available a decade ago, Kingman said.
“Having someone right in the middle of it who has experience not only designing them but also running them was important,” he said.
IDE, co-owned by Israel Chemicals and Delek Group Ltd., has a $500 million contract to provide maintenance with Poseidon for 30 years.
Its project works include the Ashkelon and Hadera desalination plants in Israel.
The upfront financing from the bond offering, combined with the water supply agreement, may provide a model across California, which has 12 desalination plants under consideration, according to Sandy Kerl, deputy general manager of the San Diego County Water Authority.
“Everyone’s been interested in looking at what our water purchase agreement looked like, and how this went,” Kerl said.
Under terms of the 200-page agreement, with 300 pages of technical appendices, residents will pay about $5 to $7 a month more for the county to add desalinated water to its supply and build a pipeline to help deliver it, Kerl said.
“It is a well-structured deal with appropriate risk-sharing between the public sector and the private sector,” said Trent Vichie, a senior managing director at Stonepeak Infrastructure Partners in New York, which made the private equity investment.
“We look for assets that have essential uses and this fits the bill,” he said.
The 6-acre Carlsbad site abuts the Encina power station owned by NRG (NYSE: NRG), the second-largest independent power-producer in the U.S. after Calpine Corp. (NYSE: CPN), whose 400-foot smokestack looms over beaches frequented by surfers.
Once built, the water purification facility will depend on power from Encina.
Desalinated water is similar in cost to other new water sources in the San Diego Area such as brackish or recycled water, Kerl said.
The county’s water authority did a study and found that in the San Diego area the cost of desalinated water was comparable to other new local options.
In Huntington Beach, where Poseidon’s proposed desalination plant has attracted interest from Orange County water agencies, residents and environmental groups have been watching the Carlsbad process.
Coastkeeper, which primarily monitors environmental issues, reviewed both the controls to protect marine life and the financial structure of the deal, said Ray Heimstra, associate director at Orange County Coastkeeper.
Because the state is considering new regulations for desalination plants, the Carlsbad plant may face retrofitting costs, he said.
His Coastkeeper branch, which oversees the Huntington Beach area, said it’s concerned about avoiding that potential risk in a water-purchase agreement.
Backers of the Carlsbad plant say the agreement and risk-sharing should shield the county and investors from retrofitting costs for a project that’s creating about 2,300 jobs.
Their water price can go up no more than 30 percent during the contract, and is capped at 10 percent in any one year, Poseidon’s Kingman said.
While potential changes to the system required by regulation may cost as much as $200 million in capital, he said, the shared risk will protect consumer rates.
“It was a fair, negotiated balance of the risk that they have and the risk that we have,” he said.
All new water supplies -- recycled water, brackish water and desalinated water -- will be about twice the cost for current supplies, Kerl said.
The cost increase will buy the area access to a water source that’s not sensitive to regulatory changes in Washington or Sacramento, where political leanings could shift dam operations and local water supplies, she said.
The company’s decade-long permitting efforts resulted in a partnership that could serve as a model for Florida, Texas and California, Poseidon said. “It’s always been a needed project,” Kingman said.
The plant will show whether making salt water potable is viable in the U.S. given that cheaper alternatives exist, said Heather Cooley, co-director of the Pacific Institute water program in Oakland, Calif.
For now, across four-lane Carlsbad Boulevard from Carlsbad State Beach by a road lined by vehicles, many with surfboards mounted to roofs, the beach teems with surfers drawn to the warm-water jetties -- heated discharges from Encina’s power plant.