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11/04/2010

Pure Cycle's "Compelling Advantage" in a Water-Constrained Market


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NYSSA’s upcoming 14th Annual Water Utilities Conference, to be held on December 1st, will focus on those companies that are best positioned to compete in a world where water supply will be increasingly constrained. We recently spoke with Mark Harding, CEO of Pure Cycle Corporation, an investor-owned vertically integrated water company providing water and wastewater services to the greater Denver, Colorado, metropolitan area to find out why he believes water ownership has “a compelling advantage” in its Western market.

Harding notes that the biggest challenge in the West is the reality that water is very often either scarce in areas where it is needed or relatively plentiful in areas far from large population centers. In the case of Colorado, 85% of the state’s precipitation falls west of the Continental Divide, more than 100 miles from 88% of the state’s population in the Denver metro area. Denver and other Front Range cities in Colorado ran out of water decades ago as population growth exceeded the basin’s water supply capabilities. As the region continued to grow, water providers were forced to reach further and further across the Continental Divide to deliver water to customers.

These days, water providers experience increasing difficulty meeting the water demands of their growing communities. Acquiring water rights and developing infrastructure to divert, treat and deliver new water supplies are an enormously expensive proposition and most of the costs are front end loaded. Municipal water providers face a difficult challenge in financing these front loaded projects and inventorying capacities in their systems as they must issue debt to buy water and build infrastructure. If they attempt to do so with general obligation bonds backed by property taxes, they run into opposition from taxpayers who don’t want to foot the bill for new customers. If they go the route of issuing revenue bonds they invariably run into a mismatch between when revenue from new customers will begin and how unknown absorption rates will match their debt service requirement. “There is a real disconnect with predicting growth and matching revenues with these lumpy upfront investments,” says Harding.

Pure Cycle, on the other hand, had the prescience to begin making strategic acquisitions on an equity basis of water rights for more than twenty years and has amassed a very large and valuable portfolio of water throughout the state of Colorado. “Working from the fundamental premise that water will continue to grow in value, the company began amassing a portfolio of water to be able to provide not only the water rights, but also to design, construction, operate, and maintain water and wastewater system to serve customers throughout the greater Denver metropolitan region,” says Harding. Pure Cycle now owns one of the largest unallocated portfolios of water in the Denver metropolitan area completely debt free. “Our debt-free ownership of water, much of which originates at or very near its point of use, provides us greater flexibility to serve developers, home builders, and other area water providers with water and wastewater service without forcing large upfront payments or large commitments to purchase taps,” says Harding.

This puts Pure Cycle in a highly competitive position when developers are contracting for water supply and infrastructure for new development. In the past, before water scarcity became so critical in the region, municipalities competed to attract master-planned community developers through their ability to provide water, along with quality schools, fire, and police. However, as these same localities ran out of water, Harding reports, they turned the tables, demanding that developers bring the water supply before they could be granted zoning for their projects. “That pushed the obligation to the developer and in this market they don’t have the capacity to absorb it,” says Harding.


Water Utilities Conference


Pure Cycle has been able to build a highly profitable business model out of this challenging situation for developers, with its ability to deliver water to developers and homebuilders without forcing them to carry the cost of excess inventories or infrastructure investment before starting their projects. “Because we made these purchases, some dating back more than 20 years, our water supplies are in very attractive locations and can be delivered incrementally and cost effectively,” says Harding.

Developers in turn pay market rates for access to water without having to overextend their purchases far in advance of developing and selling homes. In the last 5 years, reports Harding, the tap fee for connecting a homeowner to water in Denver has skyrocketed from $10,000 per single-family unit to over $25,000.

Pure Cycle’s portfolio will eventually become fully subscribed. As the company adds new connections, each connection or “tap” entitles customers access to a specific amount of water generally defined as 0.4 acre feet of water per year according to Harding. “Once you sell a tap you are responsible for granting access to your water in perpetuity, subject to customers paying for metered water deliveries each month.” In addition to adding new supplies to their portfolio, area water providers are implementing the latest technologies in water conservation and water reuse, recycling effluent water supplies for use in outdoor irrigation water systems.

Pure Cycle customers are required to implement conservation measures like high efficiency fixtures and appliances and the use of rain sensors on outdoor irrigation systems. The company also requires developers to construct dual water distribution systems—one system for domestic in-house water uses and a separate system for outdoor irrigation water uses—ensuring that the water supply is reused to the optimal extent.

Pure Cycle appears well positioned for the greater Denver Metro area’s increasingly water constrained future. “We have an enormous opportunity to help in a very capital intensive industry providing water and wastewater service to developers, home builders and other area water providers on an incremental basis eliminating large upfront capital costs,” Harding concludes. “To be able to deliver water supply smarter and more efficiently is a compelling advantage in the Western market.”

–Susan Arterian Chang is a financial writer and is the content developer for Capital Institute.

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