OREANDA-NEWS. November 11, 2015. Fitch Ratings has affirmed the ratings for the following bonds issued by the California Pollution Control Financing Authority (CPCFA) on the behalf of Poseidon Resources (Channelside) LP (Poseidon) and the San Diego County Water Authority (the authority) for the Carlsbad Desalination Plant and associated pipeline at 'BBB-':

--\\$530.3 million series 2012 plant bonds;
--\\$203.2 million series 2012 pipeline bonds.

The Rating Outlook is Stable.

RATING RATIONALE

The rating affirmation reflects near construction completion with minimal delays, satisfactory performance progress and the near-term expectation of commercial operation. The rating also reflects: a strong revenue off-taker, SDCWA ('AA+', Outlook Stable), which has entered into a long-term water purchase agreement under a take-if-delivered contract; and, Fitch's view on the counterparty risk of the contractor guarantor (Kiewit Infrastructure Co. [Kiewit]) which guarantees final completion and performance of the project. In addition, projected solid financial metrics indicate the project can withstand reasonable stress in the form of higher operating costs and/or lower production levels.

KEY RATING DRIVERS

Revenue Risk: Stronger
Strong Revenue Off-Taker: The 33-year water purchase agreement (WPA) with the highly rated SDCWA provides revenue stability under a take-if-delivered contract. SDCWA has agreed to purchase a minimum of 48,000 acre feet (AF) per year, subject to availability. The WPA grants Poseidon a 1,630 AF unscheduled outage allowance, which builds in additional cushion. Water desalination is part of SDCWA's long-term strategy to diversify water sources and provide drought-proof supply.

Cost Risk: Midrange
Solid Cost-Recovery Framework: The operating and maintenance (O&M) agreement and the WPA provide a very robust recovery framework for most eventualities including inflation, normal operations and major maintenance, capital requirements (including regulatory mandates), and high levels of electricity pricing.

Completion Risk: Stronger
Mitigated Risk for Construction and Operations: Reverse-osmosis (RO) technology has experienced technical problems in other projects, which have resulted in production levels below projected capacity. However, the engineering, procurement, and construction (EPC) contractor and the O&M service provider bring significant worldwide water-desalination experience to the project and adequate security given the risk. The 40% parent guarantee from Kiewit and the EPC agreements' required payment and performance bonds, are also mitigants to construction risk.

Debt Structure: Stronger
Fixed-Rate Debt with Adequate Legal Covenants: The debt is fully amortizing, with a fixed rate and a term of nearly 32.5-years. The restrictions on equity distributions prior to achieving stable operation (1.35x) and in the event of a power plant shutdown, as well as the 1.25x forward- and backward-looking equity distribution test and the 1.35x additional bonds test for discretionary purposes provide adequate protection to lenders at the investment-grade level. Debt structure is unique in that if defined delivery measures are not met the pipeline bonds become the financial responsibility of the project company to the extent the project underperforms.

Moderately High Leverage: Initial net debt/cash flow available for debt service (CFADS) is elevated at 10x (plant bonds) and 14x (plant and pipeline bonds) in the first full year of operations, which is manageable if the project is operating at targeted performance levels.

RATING SENSITIVITIES
Negative - Material construction delays and cost over-runs which prohibit project from meeting rating case financial projections.

Negative - Significant operating difficulties in terms of availability and/or costs which are beyond assumptions in Fitch's rating case.

Negative - Fitch's view of weakening credit quality of the EPC contractor guarantor through project completion.

Positive - Sustained successful operations post-completion above Fitch's rating case could result in upward credit migration.

SUMMARY OF CREDIT

Credit Update:

The project is approximately three years into construction, and completion delays as well as added costs are minimal. The plant and the pipeline are over 99% complete. Receipt of the state drinking water permit is pending; upon receipt of the permit, a 30-day final testing period begins and at successful completion, commercial operation will begin.

The guaranteed completion date will be missed by an estimated two weeks; however, the EPC contractor expects the plant to be fully commissioned upon completion of the final 30-day performance test period. Commercial operations would then begin, almost one year ahead of the deadline under the WPA. Start of the final 30-day test period will begin with receipt of the state drinking water permit, expected imminently. To the extent additional delays were to develop, draws on the project's security package may be necessary.

The \\$20 million construction contingency (3% of original project costs) has been utilized and the expected value for remaining open change orders is estimated at \\$2.2 million with funding to be provided from reserves or additional equity contributions.

Under the terms of the EPC contract, the contractor must be in compliance with guaranteed performance levels and meet all minimum performance criteria with respects to production water output, chemical consumption, power, and water quality. Failure to achieve the guaranteed performance requirements would result in a formula-driven damages payment, up to \\$60 million, supported by a parent-company guarantee to be used to pay down a portion of the debt.

Under Fitch's stress case analysis which assumed water produced during the test period only reaches 1,473 million gallon per day (MGD) (6% less than the guaranteed performance level of 1,564 MGD), liquidated damages payment equal to \\$40.3 million will be used to pay down debt and the minimum purchase commitment will be reduced to 45,200 AF per year. Coverage under the stress case scenario produces coverage of 1.43x in 2017 and averages 1.50x.

The project is designed to be a 54 MGD RO seawater desalination plant with 10 miles of 54-inch water conveyance pipeline. The plant is located next to the Encina Power Station within the city of Carlsbad, California. Seawater for the plant will be drawn from the cooling water discharge of the power station, and wastewater will be returned into the ocean using the power station's existing discharge canal.

SECURITY

The plant bonds are secured by net revenues from plant operations. SDCWA's contractual obligation to purchase the plant's water is an O&M expense of SDCWA; the water purchase is subject to availability.

The pipeline bonds are secured by instalment payments by SDCWA, net of any amounts owed by Poseidon as Contracted Shortfall Payments for Poseidon's failure to meet minimum delivery requirements of product water. Under a shortfall, Poseidon is to pay the Contracted Shortfall Payment for pipeline bond debt service.