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A Broken Guarantee

Why biorefinery projects may not be afforded a loan guarantee
By Erin Voegele | December 03, 2010

A primary goal of the U.S. DOE’s loan guarantee program is to reduce risk, making clean renewable technologies more attractive to investors. To do this, the loan guarantee essentially leverages private investment by assuring lenders that, should the project fail and the company default on loan payments, the DOE will step in and reimburse the lender for its losses, up to a predetermined percentage.

There are two different DOE loan guarantee programs—1703 and 1705—that those in the biorefining sector may wish to pursue. While the programs are largely similar, there are some significant differences that should be considered. “1703 was created as part of the Energy Policy Act of 2005 in order to support the deployment of innovative technologies that avoid, reduce, or sequester greenhouse gas emissions,” says Jonathan Silver, DOE’s executive director of the Loan Programs Office, in testimony given in September at the U.S. Senate Committee on Energy & Natural Resources hearing. The 1703 program is designed to be cost neutral to the government, and has been executed as a “self pay” program. This means that applicants are required to pay the credit subsidy cost associated with loan guarantees they secure under the program.

“The Section 1705 program was created as part of the American Recovery and Reinvestment Act of 2009, to jumpstart the country’s clean energy sector by supporting projects that had difficulty securing financing in a tight credit market,” Silver says. One notable difference between the programs is that the 1705 program does not require applicants to pay the credit subsidy costs associated with a loan guarantee. However, Silver says in order to qualify for the guarantee projects, construction must begin by Sept. 30, 2011. “DOE’s authority to issue guarantees under 1705 expires on that date, as well,” he says.
While the private sector alone can provide the massive, sustained investment that is required for the widespread and large-scale deployment of new and innovative clean energy technologies, Silver says action in this area has been lacking. “The private sector has not invested in clean energy at the scale necessary to drive meaningful change,” he says. “A fundamental impediment for investors in the clean energy space stems from the relatively high completion risks associated with clean energy projects, including, in particular, technology and execution risks. Private sector lenders have limited capacity or appetite to underwrite such risks on their own, particularly because large-scale clean energy projects are very capital-intensive and often require loans with unusually long tenors. Without the federal government’s financial support, following a careful review of the underlying technology, many promising technologies may not get funded to reach commercial scale or scope.” Silver says the loan programs were designed to address these impediments, and that loan guarantees lower the cost of capital for projects utilizing innovative technologies, making them more competitive with conventional technologies, thus more attractive to lenders and equity investors. “Moreover,” he says, “the programs leverage the department’s expertise in technical due diligence, which private sector lenders are often unwilling or unable to conduct themselves.”


Limitations and Setbacks
Although the goals of the DOE’s loan guarantee programs are admirable, many in the biorefining industry are finding the programs ineffective. Approximately six applications for biofuel projects have been submitted. To date, none have been awarded a guarantee, although several have been awarded for other forms of advanced energy, including nuclear, wind and solar.

There has been a great deal of speculation on why loan guarantee requests for biorefinery projects seem to be stalled. Some in the industry believe its structure stacks the odds against liquid fuel projects. Others sense that the DOE is hesitant to award loan guarantees to biofuel projects due to some embarrassing project failures in the 1970s and ‘80s. Either way, the industry needs to be focused on finding a solution.

One of the foremost complaints from the biorefining sector is that the loan guarantee process is excruciatingly slow, fragmented, and inefficient. BlueFire Renewables Inc. recently moved into the second stage of the application process. “From the time we first submitted the application for the loan guarantee until we were accepted for part two, they did quite a bit of due diligence,” says BlueFire CEO Arnie Klann. “We ended up answering a lot of questions, we had to give them more information, and many times duplicate information because it was either lost or disseminated,” due to the fact that many of the program’s reviewers are contracted from the private sector. “Now we’re in part two and we’re getting those same questions asked again…which is very disconcerting because it’s a time waster.”

The slow advance of the review process is especially frustrating for BlueFire because the company has already been awarded approximately $88 million in DOE grant money for the same project for which it is seeking a loan guarantee. “That involved a very rigorous due diligence process, which is now largely being repeated.” Klann says it would be helpful if some of the due diligence work could be transferred between DOE offices to expedite the process.

In addition, Klann notes that the hurdles and criteria DOE has set for the loan guarantee program are simply not realistic for first-of-their-kind technologies in the biorefining sector. One example is the requirement that applicants have long-term off-take agreements for both product and feedstock. The requirement handicaps liquid fuel projects when compared to renewable electricity projects. This is because such off-take agreements are common in the power sector. Liquid fuels are bought and sold as commodities on the spot market, however. Klann says BlueFire has managed to put these agreements in place, but notes many other projects have struggled to meet the requirement.

The Sept. 30 drop-dead date for the 1705 program also poses a problem. The program has a longer timeline than many other funding programs authorized by the Recovery Act, Klann mentions, which has decreased some of the DOE’s urgency in reviewing applications and issuing guarantees. It is also problematic because it’s delaying projects that are shovel-ready. “We could be sitting here, literally, another 11 months before we have a loan guarantee. The question is how do you sustain all your permits, all your contracts? We have contracts that are time sensitive, particularly for the construction of the project. The price will change…If the department moves too slowly on this program, many projects are that are shovel-ready are going to die, and the companies supporting them are going to die.”


Complicating Financial Matters
The loan guarantee programs, first and foremost, are designed to help jump-start commercial technologies that will serve the nation’s best interest, says Michael McAdams, president of the advanced biofuels association. “If the whole point of having a loan guarantee program—from a policy standpoint, according to congress—is to try to deploy these new technologies for national objectives, then the program needs to have a different set of requirements than a commercial bank,” McAdams says. “The way the program is currently functioning, there is not a significant differential between the requirements of a commercial bank and the requirements of this program. Period.”

Many investors that want to be involved in biorefinery projects are depending on loan guarantees to come through. It is possible that delays in the program could turn some investors off biofuels, impacting not just the projects that were relying on them, but the industry as a whole.

“There is a time-value to the money, and if investors don’t see their returns coming in the way they want to see them coming in, they are not going to continue to invest,” Klann says. “That seems to be lost on the government programs. Think about it like an investor, you are betting your money—and your shareholders’ money in many cases—that the government is going to do what they say they are going to do. When they can’t perform under a reasonable schedule, the equity investors are going to see a loss, potentially, in their investment and they are not going to want to invest again.”


Finding a Solution
Although several problems with the loan guarantee program need to be fixed from the perspective of the biorefining industry, McAdams notes that applicants can’t forget they have to take on the responsibility of submitting strong applications for viable projects. “It’s one thing to have a government program trying to incentivize the advanced technologies that are moving forward, but the advanced technologies also have a responsibility to deliver an economically verifiable business plan to the government, to be funded.”

However, the way the loan guarantee program is currently structured, even strong, viable projects many not be able to meet the DOE’s benchmarks. In late September, the ABFA teamed up with the Algal Biomass Organization and the Biotechnology Industry Organization to write a letter to President Obama and the administration outlining three specific changes that could improve the program in the short term.

First, the organizations ask that the criteria mandated “reasonable prospect of repayment” be clarified. The letter states that it seems the DOE has interpreted the requirement to mean “certain prospect of repayment,” which is counterproductive to the program’s goals of commercializing first-of-kind technology. The groups also asked that the renewable fuel program be recognized as a mechanism of long-term market certainty in the absence of off-take agreements for finished product. Second, the organizations asked that the 1705 program to be extended to benefit the rapid development of new technologies that have come into play within the past year. Finally, the group has asked that monies borrowed from the program be restored and that a portion of those monies be set aside and dedicated to biorefinery projects.

Whether these requests are met remains to be seen. In the meantime, McAdams stresses the importance of all sectors of the renewable fuel sector banding together to push for improvements to the loan guarantee program as well as other federal biofuels policies. “To help overcome problems with the loan guarantee program, and other issues like tax policy, that the renewable fuel sector faces, it is going to be increasingly important for all sectors to band together and support one another,” McAdams says. “The real enemy here is foreign oil. We need to be working together. The biofuels industry needs to have a conversation where we can collectively walk into the White House, sit down across from the president and say, ‘If you did X, Y and Z, here is the number of renewable gallons we could provide, here are the number of jobs created, and here is the timeframe in which we can do it.’ We’re not prepared right now collectively to have that conversation. That needs to change.”


Author: Erin Voegele
Associate Editor, Biorefining
(701) 850-2551
evoegele@bbiinternational.com

 

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