Peel the shrimp and set aside, reserving the shrimp shells.
In a large saucepan, bring the water to a boil over medium heat. Add the shrimp shells and reduce the heat to medium-low. Cook for 15 to 20 minutes, stirring occasionally. Cool the shrimp stock, and strain. Discard the shells.
In a large saucepan, bring 3 1/2 cups shrimp stock and 1/2 teaspoon salt to boil over medium heat. Add the grits, stirring well. Add the butter and stir until melted. Cover, and reduce the heat to low. Cook until thickened, stirring occasionally, about 15 to 20 minutes. Add the Velveeta, and stir until melted. Set aside and keep warm.
In a large skillet over medium heat, add the chorizo and cook until browned and crumbly, about 5 minutes. Remove the chorizo, to a plate or bowl, leaving the drippings in the skillet. Add up to 3 tablespoons olive oil, if necessary. Put the skillet over medium heat, and add the onion. Cook for 4 minutes, then add the red pepper and jalapeno, and cook, stirring frequently, for 3 minutes. Sprinkle with the flour, stirring constantly for 3 minutes. Gradually add 2 cups of shrimp stock, stirring to scrape the bottom of the skillet and to prevent lumps. Stir in the cooked chorizo, and increase the heat to medium-high. Bring the mixture to a boil, and cook until slightly thickened. Add the shrimp, and cook until they turn pink, about 2 to 3 minutes. Remove the skillet from the heat, then add the cream and lime juice. Stir in the green onion, cilantro and remaining 1/2 teaspoon salt, and pepper. Transfer the grits to a serving platter and spoon the shrimp mixture over the top. Garnish with green onion and serve.
Recipe courtesy of Ann Piscitelli, Nokomis, Floria (PD Mag, Dec. '08, pg. 41)