WATER:

Nation's largest desal project faces financing hurdles

The second in a series on financing energy and environment projects. Click here for the first part.

SAN FRANCISCO -- Desalination's transformation into a viable, mainstream water technology has long hinged on nettlesome fights over permits and politics. But with the largest proposed seawater conversion plant in the United States poised to be approved this week in San Diego, there is another problem: money.

The proposed $300 million plant, which would be built next to a coastal power station in Carlsbad, Calif., has long been viewed as a symbol of desalination's plight in the United States. The project developer, Poseidon Resources Corp., has been winding its way through a maze of state and local agencies for six years, battling community groups, environmental organizations and wary politicians who fear desalinated water will mean added expense and environmental damage.

But that picture could change if the San Diego Regional Water Board votes for final approval. The stakes are high for desalination as many in the industry consider the plant a test case that could trigger a wave of development, especially in thirsty California.

"A lot of people who like desalination are looking to the Carlsbad plant to break the ice," said Peter Gleick, a leading water resources expert and president of the Pacific Institute.

At Poseidon, officials are optimistic about the vote and have turned their attention to finding the money to build the facility. The shift comes at an inopportune time for the company given a national credit crunch that has made financing for water and energy projects difficult across the board.

But executives at Poseidon, which is partially owned by Citigroup Inc.'s Citi Sustainable Development Investments, insist their financial prospects are solid despite the economic uncertainty. The company recently sent its financial package to a short list of lenders looking to play in the fledgling market, and according to Scott Maloni, a vice president at Poseidon, "a half-dozen proposals" were returned.

Though he refused to identify prospective lenders, Maloni said "all the big players still standing" are intrigued by the company's model. He said he expects to secure an 80-20 debt-to-equity deal within six weeks of gaining the permits to break ground by the end of the year.

"They're household names," Maloni said of the potential lenders. "That's all I can say."

But some question whether it is that simple. For one, Citi Sustainable Development is reportedly looking to break with Citigroup to distance itself from the commercial bank's financial woes. Whether the loose affiliation with Citigroup could hurt Poseidon's ability to raise capital is unclear.

Moreover, experts contacted for this article were skeptical about Poseidon's prediction of a loan package within six weeks. Tom Pankratz, director of the International Desalination Association, said such a deal would fly in the face of an international trend of stalled projects.

Pankratz noted that larger desalination projects in Saudi Arabia, the United Arab Emirates and Australia have been left flailing for financial partners at crucial junctures. He doubted Poseidon's reality would be different.

"Right now, financing is difficult for any large project, and desalination plants are no exception," Pankratz said. "For them to say six weeks in this financial climate, that sounds optimistic to me."

The common thread in the Australia, United Arab Emirates and Saudi postponements is the difficulty in getting private financing. The Saudi Arabia plant, for instance, was initially to be funded with 60 percent private capital and 40 percent from the Saudi government. But after developers from Malaysia backed out, the Saudis, who badly need water, were forced to step in and assert 100 percent government control.

"They'll probably sell off bits of it when the markets settle down," said Pankratz, noting that the state government in Victoria, Australia, also was forced to intervene when a project in Melbourne had trouble raising money.

For their part, Poseidon executives say they have no interest in pursuing public money. Maloni said the plan is to stick to 100 percent private financing, which he thinks makes more sense given the current conditions and what he described as healthy interest from creditors.

As for ties to Citigroup, Maloni said all indications point to the sustainable development arm staying with its parent. Besides, he argued, the bank is a minority investor (at 12 percent) and unlikely to affect the bottom line.

"Its status as an investor ... will have no bearing on the financing of the Carlsbad project," Maloni said.

From boutique to mainstream

Regardless of its short-term financing problems, experts appear to believe desalination's time is due to arrive in the United States despite its large appetite for energy and the associated expense. The Carlsbad plant could herald that arrival.

David Zetland, a postdoctoral fellow at University of California, Berkeley, who blogs about water issues at aguanomics.com, said the project is misguided because cities in the San Diego region could pursue cheaper options like water recycling. But he nevertheless expects Poseidon "to make a killing."

"The reason they're going to make a killing is because they're going to try and build 10 or 20 plants along the coast of California," Zetland said.

Gleick agrees that other water options are available, especially conservation. But the hard truth is investors are more excited about building big plants with potentially big returns than they are about conservation, which Gleick believes sends the wrong signal to municipalities that have agreed to buy Poseidon's expensive water.

Desalination, to Gleick, makes sense in places like Israel, Australia or Saudi Arabia -- where efficiency has been maxed out and supplies are short -- but California has not yet approached that level of desperation, he said.

In San Diego, Gleick argued, "they would have to raise the price of water less if they demanded conservation."

"It's premature at this point to be building desalination plants in California," he added, repeating his call for conservation and efficiency. "It's hard for me to understand why these water agencies are signing these contracts."

Barry Nelson, director of the Natural Resources Defense Council's Western Water Project, took a broader view. Nelson said water prices in California are bound to rise in the coming years given the pressures of drought, climate change and a growing population. That means alternatives like desalination will get more attention, especially as the agriculture sector struggles to find new means to keep farmers in business.

"Desal has gone from out of the mainstream to the expensive edge of the mainstream," said Nelson, explaining that the technology was considered "boutique" as recently as 10 years ago. "It's a remarkably appealing technology, but it's expensive. It's now on the expensive edge of the mainstream."

Nelson said NRDC has yet to take a position on the Carlsbad plant.

As simple as raising prices?

So does desalination make sense economically in the United States? In Zetland's view, the answer is: only as a last resort.

Repeating an argument he often makes on his blog, Zetland says that the need for desalination plants would be eliminated if water districts were willing to simply raise the cost of water. Doing so would send signals to consumers to stop wasting.

Politicians and regulators, he said, lack the courage needed to boost the price of water because their constituents are used to paying incredibly low prices. "There's so much slack in the Southern California system," he said, estimating that the average Southern Californian uses 120 gallons a day, compared to 35 gallons a day in Australia where government leaders have stepped in to boost the cost of watering your lawn or taking a bath.

"There's constant, constant downward pressure on prices" in California, Zetland said. "If San Diego raised the price of water this month, they would not need a desal plant next month."

Gleick sees a more complex dynamic at work and called the pricing explanation oversimplified. He said water districts in San Diego likely want a local, regional supply of water they can count on, rather than relying on pipelines coming from the Colorado River or Northern California.

"The idea of a perfect market for water is a ridiculous idea," said Gleick, explaining that it is difficult to move water, which is heavy, over hundreds of miles. The water districts in San Diego are fully aware of the cost they would pay for desalinated water, he added.

"They're not idiots," he said. "They're familiar with economics."

Still, Gleick admits he is baffled by decisions to sign contracts with the Carlsbad plant rather than encourage conservation. "They feel more comfortable buying from a centralized plant than dealing with 10,000 customers who have an inefficient washing machine," he said. "I don't understand why they're doing it."

Zetland countered with a simple explanation: Politicians are not willing to make hard choices.

"The economics of water," he said, "have never been as important as the politics."