LOS ANGELES — The San Diego County Water Authority battled nearly 10 years to get environmental approvals and the right financing package to build a desalination plant.
The $1 billion Carlsbad desalination plant came online in December amid a four-year drought, and officials say the long struggle was worthwhile.
"It has been operating well and providing water, which has been utilized and has clearly made a difference for this region and the ability to sustain the population and economy by having access to water," said Sandy Kerl, SDCWA's deputy general manager.
The desalination investment is one sign that the 24-member water wholesaler is well-managed, said an investor who believes the authority's next deal will receive a hearty welcome from the municipal bond market.
The state's recent announcement of permanent water restrictions serves as a reminder to investors that California's drought is likely to continue, but "we believe that SCDWA is well positioned," Tom Schuette, partner and co-head of portfolio management at Gurtin Fixed Income.
The authority plans three financial transactions by early June – $340 million in 2016AB long-term water revenue refunding bonds; $86 million in a 2016 S-1 five-year, short-term refunding note; and $50 million in extendable commercial paper.
"We believe San Diego County Water Authority has strong fundamentals and the refunding is likely to find a receptive market," Schuette said.
He cited the Water Authority's investment in diversifying its supplies and a sufficient cushion of stored water in reservoirs. He also said its cash levels both buffer the Authority's budget if conservation clips revenues more than expected, and provide the flexibility to seek new solutions for long-term water supply.
"Many of the wholesalers have built healthy balance sheets and are at the forefront of finding incremental solutions to the drought that when combined will make a dent in the long term reliance on the Sierra snowpack," Schuette said. "The larger wholesalers and the bigger retail systems are not sitting back and waiting for the state to come up with a silver-bullet solution that solves the drought."
The San Diego authority's desalination initiative resulted in the Claude "Bud" Lewis Carlsbad Desalination Plant in Carlsbad, which was honored April 22 with a Global Water Award as the Desalination Plant of the Year for 2016 by Global Water Intelligence, publisher of periodicals for the international water industry.
The award, announced at the Global Water Summit in Abu Dhabi, goes to "the desalination plant, commissioned during 2015, that represents the most impressive technical or ecologically sustainable achievement in the industry."
The $1 billion Carlsbad plant was financed through a 30-year water purchase agreement between plant developer and owner Poseidon Water and the SDCWA for the production of up to 56,000 acre-feet of water per year.
Under the agreement, Poseidon secured funding for plant construction, most of which came from the December 2012 sale of $734 million of bonds through the California Pollution Control Financing Authority, of which $203 million were tax-exempt governmental bonds issued on behalf of the water authority and $530 million were tax-exempt private activity bonds for Poseidon.
It's the largest seawater desalination plant in the nation.
IDE Technologies, an international water treatment company, operates the plant. Construction was carried out by Kiewit-Shea Desalination.
Three main components comprise the desalination project: the desalination plant adjacent to NRG Energy's Encina Power Station on Agua Hedionda Lagoon; a 10-mile pipeline that connects to the Water Authority's regional distribution system; and upgrades to Water Authority facilities for distributing desalinated seawater throughout the region.
The Carlsbad plant is a major piece of the Water Authority's multi-decade strategy to diversify the region's water supply portfolio, Kerl said.
It utilizes reverse osmosis membrane technology to produce approximately 10% of the region's water supply; it is a core supply regardless of weather conditions; and it is blended with water from other sources for regional distribution.
With next month's advance refunding, the Water Authority hopes to achieve between $50 million and $55 million in net present value savings.
Market conditions have improved since March, when present valued savings were estimated at $42 million, said the authority's finance director, Lisa Marie Harris.
“We are cherry picking maturities” on the long-term bonds, Harris said. The short-term note “is considered a refunding, but it is a five-year note that expires. We are actually refunding the note for a new note."
Current senior lien ratings are AA-plus, Aa2 and AA-plus from S&P Global Ratings, Moody's Investors Service and Fitch Ratings, respectively. Subordinate lien ratings are AA, Aa3 and AA. The rating agencies have yet to issue ratings on the specific issuance.
The sale includes a $50 million subordinate commercial paper issue that replaces a short-term note.
"A five-year maturity is recommended to tap into strong investor demand in this part of the yield curve," according to a March 15 Water Authority staff report. "However, to provide some additional flexibility in the structuring of the notes the maximum approved maturity will be August 2022, which has the potential to extend the notes' maturity to six years."
The proposed maturity range is expected to provide a low cost of funds and diversify the water authority's renewal/rollover risk when taking into account the expiration of the new and existing liquidity facilities, which expire in one and two years, the report said.
Citi is the underwriter on the Series 2016A refunding bonds. Financial advisors are Montague DeRose and Associates and Acacia Financial Group. Bond counsel is Orrick, Herrington & Sutcliffe.
The proposed Series 2016A does not increase the amount nor extend the life of debt being refunded, according to a March 16 staff report on the proposed bond sale.
Debt service on the proposed Series 2016S is expected to remain near the level of debt service paid on the Series 2011S-1 bonds. Increasing Series1 extendable commercial paper to $100 million from $50 million is expected to reduce annual bank fees by $175,000.
These are separate transactions from the refunding. The extendable commercial paper issuance is a conversion of $50 million in tax-exempt commercial paper to $50 million of extendable commercial paper, for a total of $100 million of extendable commercial paper.
The finance team for the subordinate lien water revenue refunding bonds Series 2016S-1 is Morgan Stanley as underwriter with the same financial advisors and bond counsel as the senior debt.
"Generically, the market should remain firm, as munis continue to have a supply/demand imbalance — continued inflows to mutual funds and negative net supply," said Peter Block, managing director, Ramirez & Co. Inc. "High grade new issues, especially for infrequent issuers, are extremely well subscribed and I expect that to continue for the next month or two."
The water authority does not plan to issue new money until 2017 – and then it will likely be less than $100 million, Harris said.
"We are really on the downslope of our capital improvement plan," Harris said. "The desalination plant is operational and we raised the San Vicente Dam in 2014."
The San Vicente Dam Raise Project was the largest piece and final major element of the Water Authority's $1.5 billion Emergency Storage Project, a system of reservoirs, interconnected pipelines, and pumping stations designed to ensure a six-month supply of water for the San Diego region in case imported water deliveries are interrupted – for instance, by an earthquake. About one-third of the reservoir's new capacity – 52,000 acre-feet – is for emergency use. The project also provides 100,000 acre-feet of "carryover" storage to be filled during wet years and tapped in dry years.
The San Vicente Dam Raise added 152,000 acre-feet of water storage capacity to the reservoir, enough to serve more than 300,000 homes for a year. The dam raise project cost $416 million. Related projects that include a surge tank, a pump station and 11 miles of large-diameter underground pipeline brought the overall cost to $838 million.
The newly added storage volume is greater than any reservoir in the county. Capacity in the enlarged reservoir is shared by the city of San Diego and the Water Authority, which also share the cost of operating the expanded reservoir.
Harris said the authority will now be focused on operations and maintenance.
The Water Authority funds its capital improvement plan with a combination of long-term fixed-rate debt, variable rate debt and available cash. As of Jan. 1, 2016, outstanding debt consists of $1.7 billion in long-term debt comprised of certificates of participation and revenue bonds, $360 million in variable-rate debt comprised of tax-exempt commercial paper and extendable commercial paper and $86.6 million in subordinate medium-term notes.
The authority has executed four long-term debt refundings that yielded a total savings of $85 million in debt service on a present value basis over the past five years. In addition, the short-term debt portfolio has been restructured to take advantage of low short-term rates, lower tax-exempt commercial paper liquidity facility costs and to introduce extendable commercial paper to the debt portfolio.
