San Diego’s 18-Year Wait to Drink Sea Water May Hinder Deals

By James Nash | December 14, 2015

The largest ocean desalination plant ever built in the Western Hemisphere is finally generating drinking water — and revenue — 18 years after it was proposed in Southern California. Some investors say it wasn’t worth the wait.

Poseidon Resources Corp. this month will begin commercially desalinating saltwater from the Pacific Ocean at its Carlsbad, California facility, which is designed to supply 50 million gallons of drinking water each day. That’s enough for 7 percent of San Diego County, home to 3.2 million people. A local municipal agency will buy at least 48,000 acre-feet of water from the plant annually under a 30-year contract.

Proposed in 1998, the project was beset by legal and regulatory challenges that held up construction until the end of 2012. The specter of similar delays may scare off future investors and underscores the difficulties western U.S. states confront as they rush technology common in the Middle East to their fight against a historic drought that may have been worsened by climate change.

“We realized there would be certain political risks, but not at this level,” said Rob Deutschman, vice chairman of merchant bank Cappello Group Inc. and an early financial backer of the project. “It required far more equity capital and development capital than we anticipated. In hindsight was it a good investment? Probably not.”

Executives from Poseidon and other companies involved in the project, including IDE Technologies Ltd., Kiewit Corp. and NRG Energy Inc., spoke at a ceremony Monday morning to dedicate the plant. Since the facility began drawing ocean water last month in a test phase, it’s already produced 1.5 billion gallons (5.7 billion liters) of potable water, according to a press release from the companies.

The project was financed with $734 million of municipal bonds sold in December 2012 through a private placement. Equity investors such Deutschman provided another $180 million.

Reverse Osmosis

The plant sucks water out of the Pacific, filters it through sand and gravel to remove impurities, then pushes it under intense pressure through more than 16,000 reverse-osmosis membranes, which allow only water molecules to pass through and filter out salts and other minerals.

Israel and other Middle Eastern countries have purified saltwater for decades for crops and drinking. Until now, the largest U.S. desalination plant was in Tampa, Florida,providing 25 million gallons (95 million liters) a day.

San Diego County is weaning itself from reliance on imported water, which accounts forabout 57 percent of its total. Independence comes with a cost: The desalinated ocean water costs about twice as much as supplies from elsewhere.

The project drew scrutiny and opposition from the onset, as surfers and environmentalists predicted it would degrade the coastal ecology by changing the water temperature and killing billions of marine organisms in its intake valves. The California Coastal Commission and other agencies took six years to approve the plant, which withstood 14 lawsuits and appeals.

Deutschman, who described himself a “major” investor but declined to give numbers, said it seemed like a safe bet in the early 2000s, given the state’s cyclical plague of droughts. San Diego is the second-driest of the 10 largest U.S. cities, behind Phoenix. After waiting years for some return on his capital, Deutschman said he wouldn’t recommend desalination to other investors.

“We’re hoping the state works on some of these issues, otherwise these projects won’t be attractive to investors going forward,” he said.

Investor Patience

Poseidon Chief Executive Carlos Riva said he envisions “several more Carlsbads” along the western U.S. coast. The company already has proposed a similar-sized desalination facility 60 miles (97 kilometers) up the coast in Huntington Beach. The state’s Coastal Commission is scheduled to review that application in early 2016. If approved Poseidon could go to the debt market by the end of that year. The company has said the plant could be online by 2018.

The California State Water Resources Control Board in May approved the first statewide regulations for permitting desalination plants, and Governor Jerry Brown won approval at the ballot box last year of a $7.5 billion water bond that includes $100 million to help municipalities pursue such projects.

Investors in the Carlsbad facility are about to be rewarded, although modestly, said Andrew Kingman, a Poseidon executive vice president. “We’re still going to have a good return for people who have been with us for the long term,” he said.

Veterans of the legal fight against the plant said future desalination projects likely will confront even more scrutiny and litigation, as advances in treating storm runoff and wastewater have undercut the need for tapping the ocean.

“We learned a lot with Carlsbad, and that’s one of the reasons it’s only going to get harder for them,” said Marco Gonzalez, a suburban San Diego lawyer who represented local environmental groups including Coastkeeper and the Surfrider Foundation in lawsuits against the project. “Carlsbad was the first of its kind and it was as much about lobbying as it was about science. If anything, we need heightened levels of review, not less.”

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