The Middle East is the most water-scarce region in the world. It is home to nearly 6% of the worldwide population but has only 2% of the water reserves. Improving the water supply is key to the region's social and economic development. Sea water reverse osmosis (SWRO) looks like it may be the key to doing so affordably. S&P Global Ratings expects developers to continue to use project finance structures to fund the construction and operation of projects aimed at increasing the region's water supply through desalination and reuse of treated wastewater. Financing of desalination infrastructure is typically split into two phases: short-term bank financing supports the construction and early operation phase and is replaced with less-expensive bond issuance during the stable operations phase.

Nearly half of the world's desalination capacity is located in the Middle East, with Saudi Arabia alone having an installed capacity of 9 million cubic meter per day. We expect SWRO installed capacity in Saudi Arabia and UAE to increase by more than 7 million cubic meters per day by 2026. State-owned offtakers have placed SWRO at the center of their near-term water procurement plans.

• In Saudi Arabia, the Saudi Water Partnership Company (SWPC) plans to expand its capacity by more than 5 million cubic meters per day by 2026. It will add 13 water plants in the eastern, western, and southern regions.
• In the UAE, the Emirates Water And Electricity Company (EWEC) is responsible for power and water procurement in Abu Dhabi. It has launched a request for proposals next to the existing Mirfa and Shuweihat independent water and power plants (IWPPs), to increase capacity by 150 million imperial gallons per day (MIGD).
• The Dubai Electricity and Water Authority (DEWA) announced plans to increase its installed capacity to 750 MIGD from 470 MIGD by 2030. It recently entered a contract with the Hassyan 120 MIGD reverse osmosis plant, with a water levelized tariff that reached a new worldwide record low.
• The northern emirates, which operate through other procurement entities, have also expanded their water capacity through a project that has recently closed in Umm Al Quwain.

The established public-private partnership framework in the UAE and Saudi Arabia is used to support these projects. It has been banked several times in the past on a limited recourse financing basis and has a strong government backstop.

Choosing SWRO Reduces Operation Phase Risk

SWRO has become the technology of choice for desalination, in part because it is relatively simple to operate. We consider an SWRO plant to be about as complex to operate as a simple gas power plant due to the simple processing systems and the replaceability of the membranes. In addition, SWRO plants do not need to be built next to power generation plants. Thermal desalination plants require extra energy to heat the water, which ties them to thermal power plants and limits where they can be built. The tie to a power plant makes operating and maintaining a thermal desalination plant far more complex. An SWRO plant's processing systems are comparatively simple, although the membranes it uses to filter water and make it potable need regular replacement. As SWRO plants become more common in the Middle East, we expect desalination assets will increasingly be decoupled from the power network.

SWRO plants can also take advantage of excess energy in the grid. Renewable energy feeds into the electricity grid at a variable rate and the excess cannot easily be stored. SWRO plants combined with water tanks can use the power that would have been lost. This makes them operationally more flexible and gives them a smaller carbon footprint.

We view SWRO plants as the future of water desalination, not only in the Middle East, but also worldwide. In recent years, thermal desalination's share of capacity has started to fall. New plants are increasingly using membrane-based technology, which is economically and technically more competitive than a thermal desalination plant.

We believe that the current thermal IWPPs' offtake agreements may not get extended beyond their original term. As membrane technology has improved, it has become the desalination technique with the lowest carbon footprint. More efficient water pumps have improved the energy consumption of membrane technology further. This is eating into the market share for thermal desalination plants that use multieffect distillation and multistage flash distillation technologies.

A Proven Technology With Multiple Providers

In our view, reverse osmosis is a proven technology at scale. Projects can choose from a large number of proficient membrane and system providers, such as Suez, Dow Chemical, Abengoa, and IDE. In addition, throughput has improved over time at existing facilities as better membranes and systems have been developed. We consider the availability of alternative membrane suppliers to be important, given that membranes need to be replaced relatively often. Over a typical 25-year concession, the initial installed membranes could be replaced two or three times.

The assets we have rated that use SWRO technology have demonstrated a strong track record over the past 15 years, and the technology has proved to be highly reliable. This supports our view that the technology is proven and has been tested on a utility scale. In Fujairah, Emirates Sembcorp IWPP desalination units are partially based on reverse osmosis and have a capacity of 67.5 MIGD (see "Emirates Sembcorp Water & Power Co. 'A-' Rating Affirmed; Outlook Stable," published on Nov. 18, 2021). Since the plant started operating in 2004, the SWRO unit has experienced more than 16 years of high reliability. Furthermore, expanding the SWRO capacity also enabled EWEC to decouple the plant from the existing combined gas power plant and instead favor its solar-based capacity.

Energy Efficiency Means More Competitive Tariffs

We view a plant's specific power consumption, which represents the conversion efficiency from sea water to potable water, as a key performance metric, similar to the heat rate factor in gas power plants. For offtakers, half of the water tariff is essentially the cost of the electricity used to desalinate the water. Therefore, a higher specific power consumption could weaken a plant's cash flows. We typically see offtakers passing the efficiency risk to independent water producers (IWPs), above a certain threshold. Anything that improves energy efficiency or reduces the cost of energy therefore reduces the project's risk.

SWRO plants have benefitted from the falling cost of membrane technology and from the downward trend in the cost of electricity in Saudi Arabia and the UAE, which now have the lowest cost of renewable electricity in the world. In recent tenders in Saudi Arabia and the UAE, we have seen water desalination prices fall dramatically, to below US$0.30 per cubic meter from nearly US$1.00 per cubic meter.

Over the next years, we expect SWRO water tariffs to decline further as renewable energy prices fall further; today, the rate is close to 1 U.S. cent per kilowatt-hour in Saudi Arabia.

Construction And Operation Phases Need Different Financing

We expect several IWPs to refinance their existing debt in the capital markets by 2024. Although desalination plants are long-term projects, sponsors typically find it difficult to secure competitive long-term debt for water projects. As a result, even though their offtake agreements are long-dated, and may last up to 35 years, most are built using a mini-perm financing structure and then refinanced soon after the operating phase begins.

Banks in the Middle East tend to increase capital requirements for long-term exposures. The mini-perm financing structure operates like a bridge to bond financing. Bond investors are thereby shielded from the construction risk, and although sponsors have an incentive to refinance their project debt a few years after commercial operations begin, IWPs avoid a hard obligation to refinance their debt.

Given the number of transactions that will start commercial operations within the next two years in Saudi Arabia and UAE, we expect a number of sponsors to bring bonds to market to refinance their initial mini-perm debt. This will diminish banks' exposure to this type of asset and create more liquidity for the upcoming SWRO pipeline.

Measures To Protect The Environment Are Still Needed

SWRO can help meet the rising demand for fresh water, but the technology faces environmental challenges. Plant operators need to mitigate the harms by implementing appropriate measures. Any water desalination process--whether it uses thermal technology or reverse osmosis--is energy intensive and generates a salty and harmful biproduct called brine, which is usually discharged back in the sea. To ensure the brine does not damage the marine ecosystem, operators must run computer simulations to ensure water currents will spread the discharge across a wider area that isn't ecologically sensitive.

Most of the power currently used for desalination comes from thermal power plants, but IWPs have recently started to introduce photovoltaic plants, enabling them to progressively lower the impact of their power usage and to optimize the plant's power consumption. We anticipate that SWRO will have a smaller carbon footprint in the coming years.

Writer: Heather Bayly

Related Research

S&P Global Ratings research

• Emirates Sembcorp Water & Power Co. 'A-' Rating Affirmed; Outlook Stable, Nov. 18, 2021

Other research

• Seven-Year Planning Statement (2020-2026) published on the Saudi Water Partnership Company website
• Beyond Scarcity: Water Security in the Middle East and North Africa, overview booklet published by The World Bank, 2017
• How Much Further Can Water Tariffs Fall? published Nov. 15, 2020, by Informa Markets
• EWEC Forecasts Halving CO2 Emissions from Water and Electricity Production by 2025, published April 28, 2021, by Emirates Water And Electricity Co.
• DEWA Upgrades Water Infrastructure With Pioneering World-Class Projects, published Jan. 24, 2021, by Dubai Electricity and Water Authority