Fitch Affirms California Pollution Control Financing Auth's 2012 Plant & Pipeline Bonds At 'BBB-'

Fitch Ratings has affirmed the 'BBB-' rating with a Stable Outlook to $559.9M of series 2012 plant bonds and $221.5M of series 2012 pipeline 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.

Key Rating Drivers
Strong Revenue Off-Taker: The 33-year water purchase agreement (WPA) with the highly rated San Diego County Water Authority (SDCWA, rated 'AA+') 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.

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.

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.

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 10 x (plant bonds) and 14x (plant and pipeline bonds) in the first full year of operations (2017), which is manageable if the project is operating at targeted performance levels.

RATING SENSITIVITIES:

• Material construction delays and cost over-runs which prohibit project from meeting rating case financial projections.
• Significant operating difficulties in terms of availability and/or costs which are beyond assumptions in Fitch's rating case would likely result in rating pressure.
• Sustained successful operations post completion above Fitch's rating case could result in upward credit migration.

SECURITY
The plant bonds are secured by net revenues from plant operations. The pipeline bonds are secured by installment 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.

Credit Update
The project is currently 11 months into the construction period with construction of the plant and pipeline beginning in late December 2012. Both the project company (Poseidon Resources or Poseidon) and the independent engineer (Black and Veatch or IE) have represented that the project is a few months ahead of baseline construction schedule and continues to be on track to achieve commercial operation by the guaranteed completion date of Nov. 24, 2015. The plant is currently estimated to be 22% complete and 12,724 of 53,000 linear feet or 24% of pipeline has been installed. Both Poseidon and the IE also represented the project is within budget with the drawdown of construction funds to date 6% below the original plan. There have been no material change orders issued to date.

There has been one material issue comment provided by Poseidon to Kiewit Shea Desalination (KSD) in May 2013, which has been resolved. The material issue comment noted that the flocculation chamber capacity of 726,000 gallons shown in the design drawing did not conform to the volume requirements in the EPC agreement of 826,000 gallons. IDE Americas (IDE), the principal subcontractor for the main process design, believes that the 726,000 gallon basin capacity will still meet all performance requirements in the EPC Agreement. Poseidon has decided to move forward based on KSD's interpretation of the flocculation chamber design requirements under the circumstance that KSD and IDE both provide written acknowledgement that the resolution does not relieve them of their obligations under the EPC and O&M Agreement.

The IE indicated it is difficult to assess the impact of the smaller flocculation chamber at this time. The pilot testing program, expected to begin in the next few weeks, will reveal more about how the plant will perform and whether or not the flocculation chamber will impact the production level of water output. Both Poseidon and the IE indicated operational adjustments can be made to help the plant achieve the required water levels in the scenario that the flocculation chamber is an issue, such as changing filter media or adjusting chemicals. While lower capacity of the flocculation chamber could potentially increase the risk of not meeting the required water levels, Fitch will monitor these developments but believes that the project has sufficient framework in place to mitigate the risk.

Under the terms of the engineering, procurement, and construction (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 $60M, supported by a parent-company guarantee to be used to pay down a portion of the debt.

The project is designed to be a 54 million gallon per day reverse osmosis (RO) seawater desalination plant with 10 miles of 54' water conveyance pipeline. The plant will be 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. For more information, visit www.fitchratings.com.