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Rating Action:

Moody's affirms Poseidon's Baa3 ratings; outlook stable

22 Oct 2019

Approximately $713 million of debt securities affected

New York, October 22, 2019 -- Moody's Investors Service ("Moody's") has today affirmed the Baa3 ratings assigned to Poseidon Resources (Channelside) LP's ("Poseidon") Water Furnishing Refunding Bonds, Series 2019 (pipeline bonds) and the Water Furnishing Revenue Bonds, Series 2012 (plant bonds) following the project company's plan to issue a 3-year senior secured bank loan in the amount of $45 million to finance a portion of the construction of the modified intake system project. The bank loan will rank pari passu with the existing plant bonds but will not benefit from a debt service reserve. All bonds were issued on a tax-exempt basis through the California Pollution Control Financing Authority. The rating outlook is stable.

RATINGS RATIONALE

The Baa3 ratings benefit from the 30-year (plus 3-year extension option) water purchase agreement (WPA) with the San Diego County Water Authority, CA (SDCWA Aa2 stable) which has provided for predictable contracted cash flows and a strong cost recovery mechanism even during times of operating challenges, and signals the strategic importance of the project to SDCWA in managing its water supply resources.

Operating performance has recovered from the mechanical coupling failure in August 2017 and train 5 has been put back into service in 2019. However, water deliveries remained at 45,038 acre foot (AF) below the budget of 48,000 AF in contract year 2019 (ending June 30 2019). For contract year 2019, Poseidon reports a total DSCR of 1.6x for both the pipeline and plant bonds. Going forward, we expect total DSCR to be around 1.6x on average starting in 2020.

The biggest near-term challenge for the project remains the construction of a standalone seawater intake system and managing a smooth transition from the current seawater intake system that uses the water pump system of the adjacent Encina power station to a standalone in-lagoon modified intake system with wedgewire fish screens. The modifications will be financed, in part with the additional debt outlined above. Total costs are expected to be close to $104 million and will be funded over a several year period with the remainder likely to be debt-financed. The new system is projected to be fully operational in 2023, following a 2-year pilot testing program. Poseidon will need to control the operating costs of the modified intake system as the WPA contains certain limits that cap the portion of the recoverable permitting and construction capital costs and annual operating costs attributable to the new system. As of August 31, 2019, Poseidon had a $35.7 million standby letter of credit from Wells Fargo Bank, N.A. for the permanent pump shut down reserve (standalone seawater intake system).

On a separate matter, the co-owners of Poseidon Resources (Channelside) LP, Poseidon Water and Stonepeak Infrastructure Partners, have agreed to sell their interest in Orion Water Partners LLC, a joint venture that indirectly owns Poseidon Resources (Channelside) LP, to funds managed by Aberdeen Standard Investments. The transaction is expected to close at the end of 2019. Importantly, the management services agreement with Poseidon Water has been extended through 2024.

Other factors considered in the rating are (1) the scale of the plant; (2) the experience of local authorities in the US with reverse osmosis desalination plants and a long permitting process; (3) proven technology of reverse osmosis desalination plants and the presence in countries in the Middle East, Australia and the Caribbean; (4) the project's back-loaded debt amortization profile; and (5) above average liquidity reserves as of August 31, 2019, which include a 12-month debt service reserve for the plant and pipeline bonds.

RATING OUTLOOK

The stable outlook reflects Moody's expectation that Poseidon will move forward with the design and construction of the standalone seawater intake system as planned. The stable outlook continues to incorporate Moody's expectation that the plant extends its operating track record with an expectation for achieving at least the minimum base water delivery requirement of 48,000 AF per year and that Moody's DSCR remains around 1.60x.

WHAT COULD CHANGE THE RATINGS UP/DOWN

Factors that Could Lead to an Upgrade

- Plant operates according to its specifications with minimal supply shortfalls and an average total DSCR of 1.50-1.60x on a sustained basis

- Successful completion of the necessary changes to the seawater intake system

Factors that Could Lead to a Downgrade

- Plant no longer operates according to expectations

- Total DSCR falls to below 1.4x on a sustained basis as a result of additional debt financing, reserve releases or weak operating performance

STRUCTURAL CONSIDERATIONS

Debt service on both the plant and pipeline bonds is paid out of separate accounts administered by third party trustees. Poseidon Channelside (Resources) LP owns the plant and pays debt service on the plant bonds. Debt service on the plant bonds is secured by the plant's net revenues.

SDCWA makes Installment Payments (on a subordinate basis through the SDCWA Financing Agency) in amounts sufficient to cover debt service on the Pipeline Bonds and SDCWA owns and operates the pipeline. If the plant delivers less water than required, Poseidon needs to pay a proportionate amount of pipeline bond debt service. In contract year 2019 (ending June 30, 2019), Poseidon paid the authority around $2.0 million in shortfall payments.

The pipeline is not pledged as security to pipeline bondholders. Only the plant collateral is shared pro-rata between pipeline and plant bondholders.

Bondholders benefit from traditional project finance features that includes a 12 month debt service reserve. The proposed bank loan will rank pari passu with the existing plant bonds but will not benefit from a debt service reserve fund.

PROFILE

Poseidon Resources (Channelside) LP owns the Carlsbad reverse-osmosis desalination plant located adjacent to the Encina Power Station in Carlsbad, California. The plant received commercial acceptance on December 23, 2015 and has a capacity to deliver up to 54 million gallons of water per day or 56,000 acre feet per year (AFY).

METHODOLOGY

The principal methodology used in these ratings was Generic Project Finance published in April 2018. Please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.

REGULATORY DISCLOSURES

For ratings issued on a program, series, category/class of debt or security this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series, category/class of debt, security or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this credit rating action, and whose ratings may change as a result of this credit rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

Kathrin Heitmann
Vice President - Senior Analyst
Project Finance Group
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
U.S.A.
JOURNALISTS: 1 212 553 0376
Client Service: 1 212 553 1653

A.J. Sabatelle
Associate Managing Director
Project Finance Group
JOURNALISTS: 1 212 553 0376
Client Service: 1 212 553 1653

Releasing Office:
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
U.S.A.
JOURNALISTS: 1 212 553 0376
Client Service: 1 212 553 1653

No Related Data.
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