Poseidon’s Desalinization Plant: Dream Water Supply or Draining the Pacific and Taxpayers?

The Carlsbad desalinization plant. Photo: Poseidon Resources LLC
The Carlsbad desalinization plant. Photo: Poseidon Resources LLC
CARLSBAD, CA – High on a hill above this sunny beach town sits a reservoir filled with water pumped from hundreds of miles away. But the price of that imported water is soaring, and supplies are shrinking. Local officials see salvation to the west – a huge new desalination plant that would turn 300 million gallons a day of the sparkling Pacific Ocean into a new, 50 million gallon river of drinking water.

Down below, Poseidon Resources LLC is pushing to complete a dizzying checklist of approvals before heading to Wall Street for project financing. After 12 years of permitting battles, the desalination plant – which could open the floodgates for many others on the California coast – may finally be built.

Best of all, the developers promise, it will cost the public nothing to build.

“We’ve always proposed that it will be privately financed. There’s no public subsidy for the construction of the desalination plant,” said Scott Maloni, a spokesman for Poseidon, which is based in Stamford, Conn.

But dozens of interviews and a review of available records by the Public Education Center’s DCBureau.org shows that while private equity and bonds would be used for upfront construction, southern Californians would pay at least $640 million over 30 years for the project, including as much as $374 million in public subsidies. All that money would repay construction costs with interest, operating costs with overhead fees, and unspecified profits to investors for what would be the largest desalination plant in the Western Hemisphere.

Company and water officials, along with some industry analysts, say it is well worth the price to bring a local water supply to the drought prone region, as population swells and climate change could begin to wreak havoc with the Sierra snow cap. They say despite recessionary woes, the time is right.

But critics say that far from being a New Age answer to water woes, the plant and others like it are costly, unnecessary boondoggles that often malfunction and carry damaging environmental side effects. They argue keeping water prices artificially low through subsidies for costly desalination plants is the wrong approach, and that conservation, recycling wastewater, and other far cheaper alternatives should be tried first.

Peter Gleick, a water policy analyst who has examined desalination projects around the world, castigated the Poseidon project as a series of “financial travesties.”

“Despite the claims of the company, the cost of this plant is going to be borne by not just the ratepayers, but the taxpayers, including taxpayers who will see none of the water,” said Gleick, executive director of the Pacific Institute in Oakland. He said the project was hobbled by high costs and environmental impacts. “This is a case study in how not to do desalination.”

Officials say those charges are unfair. They say every available water source needs to be tapped, including those Gleick cites and new sources like desalination. They say their project is an environmentally friendly trend-setter, and that because the company has handled all upfront risks, they are more than entitled to a fair return down the road.

“I think it is a great example of a public private partnership,” said Skip Hammann, Carlsbad transportation manager, who is overseeing efforts to bring the plant to his city. Carlsbad could buy up to 80 percent of its water from the plant if it is built. “Where the private company is assuming all the risk and delivering water to the city of Carlsbad at no risk to us, for a rate we would otherwise pay, is a pretty simple concept. It’s gotten very complicated along the way, but the concept is pretty simple.”

Poseidon Senior Vice President Peter MacLaggan agreed: “We are guaranteeing a supply of reliable water to customers for the same or less than they would pay for imported water. Why is that not a good investment for the public? They’re going to get higher quality water…and a more important benefit, higher reliability water.”

Steve Ellis, vice president of Taxpayers for Common Sense in Washington, D.C. said he had no qualms with the company making a dollar on a badly needed commodity like drinking water in dry southern California, but he was wary of the tax-exempt financing, the subsidies, and the lack of access to detailed advance information about the company’s costs and profits.

“Our feeling is essentially the financing, the repayment of the costs of construction, all of that needs to be very transparent and very public,” said Ellis, “because otherwise you’re asking the ratepayers and (San Diego) county to buy a pig in a poke, they don’t really know what they’re getting and what the potential costs may be.”

MacLaggan and state finance officials said that information would all be available a few days before a May 25 vote by the California Infrastructure and Development Bank to issue tax-exempt bonds and in a sales offering statement once the project heads to Wall Street for bond monies. They said it cannot all be made public right now because of the pending private sale. MacLaggan and some water officials did provide details on the costs in interviews and draft agreements.

Show Me the Money

The California State Capitol. Photo: Sascha Brück
The California State Capitol. Photo: Sascha Brück
From the beginning, Poseidon officials have promised nine northern San Diego County water districts they would never pay more for the desalinated water than they would for imported water. Poseidon and its equity investors – which have included Warburg Pincus, Citi Sustainable and GE Capital – have poured unknown millions into upfront costs. Those investors will also be last in line to recoup profits, MacLaggan said, under an arrangement that won’t begin for several years.

But there isn’t enough capital available to build the project without major financing. MacLaggan estimated about $300 million is needed to build the plant, a sleek, low slung facility designed to look like an office building. Another $100 million is needed to construct a delivery pipeline, and about $100 million in reserve funds are necessary to ensure any technical problems or other delays can be covered.

Earlier this year, the company won permission from Gov. Schwarzenegger, the state controller and the state treasurer to seek $530 million in so-called private activity bonds, which are not repaid or guaranteed by California taxpayers. They do offer potentially lucrative federal and state tax exemptions for bond purchasers.

Gleick of the Pacific Institute said those exemptions are actually lost revenues that could go into sorely depleted state coffers. But Poseidon and state officials said without the tax exemptions, there would probably be no project, meaning no tax revenues. They said the project would also provide a $37 million annual boost to the local economy – including 2,100 construction jobs, 20 jobs to run the plant, and 400 indirect area jobs.

The local water districts won’t pay a cent until water is being delivered. “We don’t have an obligation or an expenditure until this plant is up and operating,” said Mitch Dion, general manager of Rincon del Diablo water district. ”We’ve kept all the risk on Poseidon…They cannot come back to us or our ratepayers.”

But once the water is flowing, public dollars would begin flowing too. To repay that half a billion dollars in bond debt and other costs while keeping water bills low, Poseidon and the local water districts will rely on major subsidies. Metropolitan Water District of Southern California, one of the nation’s largest wholesalers, in November approved up to $350 million in “incentive” funding to help the nine northern San Diego County water districts obtain a local water supply. Both they and Poseidon are at pains to say the monies will be doled out to the water districts, not the company.

But most businesses have to pay their own utility bills, leases, supplies, interest payments, and other operating and capital costs. Poseidon would be eligible for reimbursement for all of those costs, much of which would not be paid by customers actually receiving the drinking water. A review of the agreement, confirmed by Metropolitan and Poseidon staff, clearly shows that the project’s steep electric bills, hefty upfront design and engineering costs, routine filter replacement, chemicals, and a smorgasbord of other expenses will all be reimbursable via the water districts passing the monies through to the company. Legal bills and public relations costs will not be covered, and Metropolitan’s attorneys “stripped out the 14 percent profit” for equity investors that Poseidon requested, according to MacLaggan.

Metropolitan is requiring a thorough audit the first year of operation, and they and the water districts retain the rights to do annual audits. They also are not liable in case of bankruptcy or sale of the project or the company. That all makes it a safe deal for ratepayers, said Metropolitan general manager Jeffrey Kightlinger. He estimated the incentive program would add between $10 and $20 a month to the average southern Californian’s water bill, and said it was well worth the cost because the region desperately needs more local water supply.

“Taking a step back from the nitty-gritty of public private concerns about profit, the reason we do these local programs, it’s all about diversifying water supply,” said Kightlinger.

Metropolitan has lost a whopping third of its state water supplies in recent
years largely because of court cases and federal agency decisions aimed at protecting the endangered Delta smelt fish. That means less water flowing from Bay Delta rivers and lakes south to greater Los Angeles. Another 600,000 acre feet of water was lost from Colorado River supply because of drought, Kightlinger said. Metropolitan has been forced to make costly side arrangements with Central Valley rice farmers and others who hold senior rights to additional water.

The Poseidon project would only add about 56,000 acre feet, but that’s enough to make a difference, Kightlinger said, providing more than 9 percent of San Diego County’s supply. “We have gone on a crash course to replace water,” he said.

But others say Metropolitan’s nearly 19 million ratepayers, most of whom will never receive a drop of Poseidon’s water, should not have to foot the bills for a facility that will service 300,000 customers.

“That subsidy is funded by a portion of almost everybody’s water bill in southern California,” said Joe Geever, California policy coordinator for Surfrider Foundation, who has fought the project because of marine life concerns. “I mean I live in Los Angeles, 100 miles away, and a portion of the money that’s paying for this project I oppose is coming from my water bill.”

Poseidon’s MacLaggan said that the company would be setting aside 66 acres of wetlands, more than compensating for any marine harm that might occur. He and Kightlinger stressed that residents in Los Angeles could have more water available to them because of reduced demand from northern San Diego.

In addition to the Metropolitan subsidy, Poseidon and the nine water districts are now also seeking more subsidies, up to $24 million, from the San Diego County Water Authority. Those terms are still being negotiated.

Gleick of the Pacific Institute said the latest request was a sign of the project’s true costs.

“’Give me more, more, more, more’ is Poseidon’s game plan, and it really shows clearly the financial weakness of this project,” he said.

In an even thornier request, Poseidon is now also asking the San Diego county authority to serve as a backstop if Metropolitan ever cancels its far larger subsidy. That is a real possibility because of a separate fight between the two agencies over high water allocation prices. The county agency is extremely unhappy with what they see as unfairly high water rates being charged by the wholesaler and has already threatened to sue. If they do, the incentive program automatically dies.

Bond underwriters have zeroed in on the potential loss of $350 million, water district officials said. Those officials are on pins and needles and working hard behind the scenes to get the regional water authority to agree to fork over the $350 million, if necessary.

“Without the guarantees from the water authority, there won’t be the financing, and there won’t be a project,” said Gary Arant of the Valley Center Municipal Water District, which hopes to buy 20 percent of its water supply from the Carlsbad plant. “Yeah, we’re concerned about this because we think it’s a very valuable project for the region as a whole.”

Poseidon’s MacLaggan said water officials have been pointing out to the county water authority that if the plant isn’t built, the agency might have to move up construction of a $100 million plus pipeline to increase water supply.

Bob Yamada, water resource manager with the county water authority, said it would be up to the board, not staff like him, to make the tough decision. “That’s a question the policymakers are going to have to wrestle with. There is still discussion going on about how to respond, and how to deal with this.”

Poseidon has other items it must take care of before a bond sale as well, including obtaining a second rating in addition to the BBB- it got from Standard and Poor’s. That is the lowest investment grade rating, and Geever of Surfrider pointed to it as evidence that the project is an unwise expenditure on anybody’s part, public or private.

But Poseidon’s MacLaggan said the market for low-grade investment bonds was extremely robust, noting that large new sports stadiums and other projects have all been approved in recent months using private-activity bonds.  Some are more cautiously optimistic. Randy Truby, a longtime international desalination products marketer who is based in San Diego, strongly endorsed the Carlsbad project. But Truby, who is also controller and past president of the International Desalination Association, said the global market for new desalters has slowed somewhat because of bank crises:  “There are still a number of plants being built, but absolutely some got delayed, some got cut down in size.”

State banking officials are requiring the bonds to be sold only to large institutional investors or others who can afford minimum increment purchases of $500,000 because they do not want smaller investors placed at risk.

Risky Business

Photo: City of Carlsbad California
Photo: City of Carlsbad California
There are always risks to major infrastructure projects, experts say, both economic and technological. Desalination is widely used across the globe, with more than 2,000 plants operating in a dozen countries, on cruise ships and elsewhere. There are currently much smaller plants in the U.S., including in California. The state’s latest water resource plan concluded that desalination could and should provide about 10 percent of the state’s future water needs.

But large scale plants in the U.S. have faced an uphill battle since Poseidon, its contractors and public water agencies tried to build a plant similar to the Carlsbad project in Tampa Bay, Fla., in the late 1990’s. Tampa Bay’s public water authority ended up buying out Poseidon after the company’s biggest backers went bankrupt, and it struggled to obtain bond financing.

“Tampa Bay gave the desal industry in the U.S. a black eye for several years,” said Tom Pankratz, a Houston-based consultant on desalination plants, who also writes about the industry. He said in his opinion, many parties were responsible for different elements of the Tampa Bay debacle, including “Poseidon’s very aggressive contracting method that relied on lowest price regardless of supplier experience.”

Ken Herd said as a staffer at Tampa Bay Water Authority, he was “right in the thick of it” on the project, particularly after Poseidon was bought out. Herd, now with the Southwest Florida Water Management District, which oversees the Tampa Bay agency, said it took eight long years and an extra $48 million – mostly to pay for rising electricity bills and technical fixes – before the plant finally produced the full, promised 25 million gallons of drinking water.

There were major problems with pretreatment filters clogging up, a key contractor also went bankrupt, and there were other woes, said Herd, who along with Gleick co-authored a National Academy of Sciences report examining U.S. desalination and lessons learned from Tampa Bay.

Herd said despite the early problems, the project “still played a critical role in Tampa Bay water supply,” helping the region replace shrinking supply after wetlands were set aside.  He said every desalination project should be examined on a case by case basis, and it was perhaps impossible to predict up front how high costs of any project truly would be.

Maloni and MacLaggan said Poseidon had done nothing wrong – that the water agency bought them out before the technological problems began. Both said if they had not been bought out, the company would have been forced to make any necessary repairs.

“Our detractors say, oh Poseidon, look at Tampa Bay, buh buh buh, but we were gone before their problems began at that plant,” Maloni said. “And even if the problems were our fault…it wouldn’t have cost the taxpayers a dime because of the way the agreement was set up. And Tampa Bay gave that up.”

Gleick’s Pacific Institute studied ocean desalination in a 2006 report entitled “Desalination, With a Grain of Salt: A California Perspective,” which found operational problems and costly delays with other projects, including in Santa Barbara and Yuma, Ariz.

San Diego County and Poseidon officials are keenly aware of the Tampa Bay experience. Several council members or water district managers traveled to or spoke by phone with local Florida officials.

“It was a calamity of errors,” said Mitch Dion, general manager for the Rincon del Diablo water district.

There are nerve rattling similarities but also key differences between the two projects. Poseidon is once again at point where it is seeking major bond financing for a desalination plant in tough economic times. The company is once again promising to assume all up front costs and provide a critically needed, low-cost alternative water supply at a remarkably low price. The Carlsbad project, like the one in Tampa Bay, will share a site and water stream with a power plant.

But Poseidon and the southern California water districts appear to have followed many of the recommendations made by Herd, Gleick and others in the national report.  Poseidon will set aside nearly $100 million of bond money for ramp-up and reserve funds to cover any unanticipated technical problems or higher than expected start-up costs.

For six years, the company has also had a pilot desalination program running in the lagoon where they plan to build the actual plant. They’ve dealt with record rainy years, which turned the normally blue-green water the color and consistency of coffee grinds. They’ve dealt with large algal bloom “red tides” in the summers after those rains.

All those extreme weather events gave the company and its contractors a chance to fully road test its equipment, MacLaggan said. Just as in Tampa Bay, there have been issues with sediment clogging pre-filtration systems. But MacLaggan said that because of the pilot testing, the company knows up front it will probably need to use an alternate sand pre-filtration process.

Most important, company and water districts say that unlike the Florida plant, this time there is no option in the contracts for public agencies to buy Poseidon out until after the plant is up and running for many years.

That means Poseidon is getting another, even bigger chance to prove it can build a large facility. Pankratz, the desal industry consultant, said the company may have put itself into a short-term bind by bookending itself with written promises not to raise rates, then having to shoulder years of litigation, permitting battles and other upfront work.

MacLaggan somewhat agreed, saying far from receiving a big payday if the bond sale goes through, the equity investors may be plowing money back into the project to keep it moving forward. Bondholders will have first dibs on any available revenues.

“After we close there’s going to be money for construction and debt service, that’s it,” he said.

Investors are counting on the 30 year contracts with the water districts as collateral, providing a guaranteed revenue stream. All capital and operating costs will be added up in a tracking account that is paid off in installments with those ratepayer payments and the subsidies.

But after all is done and paid for, Poseidon’s patient equity investors could see a hefty return down the road. Once prices of desalinated water fall below the price of imported water, perhaps 10 to 12 years into the 30 year contracts, the subsidies cease, and another arrangement kicks in.

By then, if the company’s predictions are correct, prices on imported water will have risen so high, they’ll begin to reap the later part of their contract with the public agencies – splitting the difference between lower desalination water costs and higher imported water costs 50-50 with their customers.

“What this 50-50 split represents is our risk premium. If we’re going to take this upfront risk, we’re going to share in the upside when we’re all saving money on the back end,” said MacLaggan.

A mock up of  the Carlsbad Desalinization Plant. Photo: Poseidon Resources LLC
A mock up of the Carlsbad Desalinization Plant. Photo: Poseidon Resources LLC
In other words, the water districts will pay more than the true cost of the desalinated water at that point. But they and Poseidon say it’s a fair return for deep pocket investors.

“The first 15 years will be pretty lean. The payoff comes in the next 15 years,” said MacLaggan.

And the profit amounts may never be known by the public.

Dion of Rincon del Diablo water district said, “In reality, we will never probably know or see how much an individual has made off the project.”

He added, “If we were willing to assume risk, we could get a lot more information, a lot more transparency. The project isn’t public, the project is private…We can choose not to buy this product. Nobody’s got a gun to out heads saying ‘buy at all costs.’”

 

Janet Wilson, a USC Annenberg Hunt national health reporting fellow, is an environmental journalist based in southern California.

Janet Wilson

Janet Wilson

Janet Wilson is a veteran environmental reporter based in southern California. She can be reached at info@publicedcenter.org

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