DOE Loan Guarantees for Advanced Fossil Fuels: They’re Back!
Four years after theDepartment of Energy issued its last solicitation for loan guarantee applications and approaching two years since its last financial closing, the DOE is back into the loan guarantee business with up to $8 billion in guarantee authority to be made available for innovative fossil fuel energy projects.
A draft solicitation for applications, issued July 2, sets a September 9 deadline for industry and public comment, making delivery of a final solicitation likely before the end of the year.
The first public comment meeting at DOE headquarters took place on July 31. Two other meetings are scheduled for August 14 and August 27.
This article explains what types of projects are eligible for loan guarantees and discusses some key provisions and the application process in the draft solicitation.
These loan guarantees will be issued under section 1703 of the Energy Policy Act of 2005, meaning that the "guarantees" are actually an opportunity to borrow directly from the Federal Financing Bank at interest rates that are currently 37.5 basis points above Treasury bond rates. DOE can guarantee loans covering up to 80% of total project costs for the lesser of 30 years or 90% of the projected useful life of the project's major physical assets.
The new loan guarantees will differ from loan guarantees for Recovery Act project financings that closed before September 30, 2011 in three major respects.
First, eligibility is limited to projects that “employ New or Significantly Improved Technology as compared to Commercial Technology in service in the United States at the time the Term Sheet is issued.” (While the Recovery Act program ultimately supported many innovative projects, conventional technologies were also welcome.) Second, with limited exceptions, loan guarantee recipients cannot “double dip” (meaning they cannot benefit from most other kinds of federal support). Third, these project borrowers will have to pay their own credit subsidy costs at closing (a significant cost that has been avoided by all DOE loan guarantee recipients to date thanks to the now-expired Recovery Act funding). Credit subsidy charges are like the premium paid to buy insurance.
These requirements did not apply to any of the approximately $15 billion in loan guarantees issued by DOE through September 2011 under the section 1705 program. Absent further legislation, all future recipients of loan guarantees under DOE's remaining $34 billion in loan guarantee authority will be subject to these provisions, with one exception. In April 2011, Congress appropriated $170 million to pay subsidy costs for energy efficiency and renewable energy projects and later provided that DOE could mix appropriated and borrower funds to pay the credit subsidy costs for such projects. However, no help is available to avoid credit subsidy costs for fossil fuel projects pursuant to this solicitation.
The new solicitation covers both “electrical and non-electrical” fossil energy uses. “Fossil fuels” includes coal, natural gas, oil shale gas, oil gas, coal-bed methane, methane hydrates and “others.” Projects may involve any stage of the full lifecycle of fossil fuel development (resource, process, products and downstream). Projects that employ innovative technologies to improve the efficiency of conventional production processes are within the scope.
DOE has cast a broad net in terms of qualifying technologies. To be eligible, a project must be innovative, (meaning employ a new or significantly-improved technology), be in the United States or a US territory and avoid, reduce or sequester air pollutants or greenhouse gas emissions.
Technologies must not have been deployed in more than three projects active in the United States for more than five years.
DOE is looking to back four types of projects. One is advanced resource development that reduces gas emissions related to the mining or recovery of traditional and non-traditional fossil fuels, such as novel oil and gas drilling technologies, use of associated gas production to reduce flaring, coal-bed methane recovery and underground coal gasification. Another is carbon capture projects that remove CO2 emissions for permanent underground storage or through beneficial reuse, such as CO2 capture from synthesis gases in fuel reforming or gasification processes, flue gases in traditional coal or natural gas electricity generation and effluent steams of industrial processing facilities.
Another project type is low-carbon power systems that integrate fossil fuel electricity generation with CO2 storage or beneficial reuse, such as coal or natural gas oxy-combustion, chemical-looping processes, hydrogen turbines and synthesis gas-natural gas- or hydrogen-based fuel cells.
Finally, projects to make efficiency improvements also qualify. These are projects that reduce emissions-per-product by improving feedstock utilization of fossil-based systems, such as combined-heat-and-power projects, waste heat recovery on industrial facilities and high-efficiency distributed fossil power systems.
The FY 2009 Omnibus Appropriations Act that provided the $8 billion being allocated under the solicitation prohibits loan guarantees to any projects where:
funds, personnel, or property (tangible or intangible) of any Federal agency, instrumentality, personnel or affiliated entity are expected to be used (directly or indirectly) through acquisitions, contracts, demonstrations, exchanges, grants, incentives, leases, procurements, sales, or other transactions or other arrangements, to support the project or to obtain goods or services from the project.
The following federal benefits are carved out from this prohibition against double dipping: federal income tax benefits, leases of federal land complying with certain arms-length requirements and federal insurance programs (such as the Price-Anderson Act under which the federal government provides insurance for nuclear energy projects).
The bar against double dipping will rule out any loan guarantees for projects that have already received DOE grants. It remains to be seen how much deft structuring will be able to mitigate this impact (for example, by developing the project in a different company than the one that received the federal grant). Given that the innovative projects that are the focus of the section 1703 program are the ones most likely to have previously benefited from federal grants, the bar against double-dipping could undermine the effectiveness of the program.
The draft solicitation includes other requirements that are familiar in the DOE loan guarantee program.
For example, the Davis-Bacon Act requires projects to pay all on-site (and certain off-site) construction laborers and mechanics the Department of Labor's prevailing wage for the job category and location. For projects that have DOE financing subsequent to having commenced construction, the Davis-Bacon Act will apply retroactively to the start of construction, but the government has discretion to waive retroactivity if the project starts construction before the decision is made to apply for federal financing.
Unless a project qualifies for a categorical exclusion under the National Environmental Policy Act, it must also complete either an environmental assessment or full-blown environmental impact statement before DOE can decide whether to issue a loan guarantee. An environmental assessment typically takes six to nine months, while an environmental impact statement takes 18 to 24 months.
In addition, any information collected by DOE is subject to disclosure under the Freedom of Information Act. Applicants would be wise not to divulge patentable ideas, trade secrets or proprietary and confidential information to DOE beyond what is needed to explain the project. Although an applicant may restrict DOE's use and disclosure of sensitive data if it specifically identifies and marks the data, DOE recently found itself responding not only to FOIA requests but also to Congressional oversight information requests, which are not afforded the same non-disclosure protections that exist under FOIA and the Trade Secrets Act. The risk of disclosure of information submitted to DOE exists for all applicants and not just successful ones.
Finally, DOE has agreed with the Department of Transportation to require, as a matter of policy, that all ocean transport of cargos destined for section 1703 loan guarantee recipients be carried on US-flag vessels. The US Maritime Administration can grant waivers on a case-by-case basis.
Applications are to be submitted in two parts.
DOE will evaluate part I submissions competitively (to determine which projects are eligible and ready to proceed. Applicants that pass muster will be invited to file a part II submission.
The solicitation anticipates up to six rounds of part I submissions, each by a yet-to-be determined deadline, staggered with six due dates for part II submissions. A project invited to file a part II submission may do so prior to any of the then remaining part II due dates. At the close of each round of part II reviews, DOE will announce the projects selected (again in competition with other projects submitted by the same part II deadline) to proceed to due diligence and negotiation of a term sheet.
The round-specific competitive review of projects suggests a possible incentive to choose with deadline carefully, ideally targeting one seen to provide the least, or weakest, competition. However, it is easy to imagine that a broader competitive review will develop, with DOE reflecting the full actual and expected applicant pipeline. To the extent that proves true, strategically targeting a particularly lonesome part I or part II deadline will be less important.
The required elements of the part I submission include a top-level technical overview outlining the project’s eligibility and potential to reduce greenhouse gas emissions, the status of permitting and evidence that the project could not be fully-financed on a long-term basis absent the DOE loan guarantee.
Applicants must also disclose any past or ongoing lobbying activities "in connection with a commitment providing for the United States to insure or guarantee a loan."
There is no limit to the number of applications an applicant can file, but a single applicant may not submit applications for more than one project using the same innovative technology.
In part II submissions, DOE will look at, among other things, whether the project has a reasonable prospect of repaying the DOE guaranteed loan and whether the loan, when combined with funding from other sources, will cover project costs.
The relative weightings assigned to the assorted financial, technical and policy factors to be considered in competitively ranking applications are blank in the draft solicitation. DOE would welcome public input on appropriate weights.
Participation in this DOE program will not be cheap. The tally begins with a non-refundable $1 million filing fee, payable in two steps: $250,000 for part I and $750,000 for part II. Applicants selected for due diligence review then pay 25% of a non-refundable facility fee on or before signing the DOE-approved term sheet. The remaining 75% is due at financial close. The facility fee is expected to range from 0.5% to 1% of the principal amount of the loan to be guaranteed by DOE.
DOE’s independent consultants and outside counsel fees, as well as any extraordinary expenses related to the project financing, can easily add millions more dollars to the applicant's transaction costs.
DOE also extracts a non-refundable maintenance fee over the life of the guaranteed loan, paid annually in advance. The solicitation anticipates a maintenance fee of $500,000 per calendar year. The first prorated installment is to be paid before the financial closing date.
A separate credit subsidy charge will also have to be paid. It is reasonable to expect that a more innovative project with a higher level of performance risk will have a higher credit subsidy cost than would a project without such risks. A firm, creditworthy offtaker helps in all cases. Many discussions heroically assume an average of 10%, but that is for lack of any real basis for a better estimate.
DOE will provide project sponsors a preliminary credit subsidy cost estimate at the same time as the draft term sheet (after the applicant has paid the $1 million in application fees but before the first 25% of the facility fee is due). The final credit subsidy cost is set immediately prior to financial closing, when it is due in full and payable from equity or non-federal debt. It cannot be paid with the proceeds of the DOE-guaranteed loan or from any other federal funding source.
The New Normal
The solicitation is on a fast track. DOE apparently intends to get the program rolling before year's end. The window for public and industry comment is set to close in early September, and the title page of the solicitation suggests that the solicitation will be issued, and the first round of part I and part II filings will be complete, in 2013.
DOE has not issued a loan guarantee or conditional commitment since September 2011. It has spent a lot of time since then answering to mainly Republican critics in the US House of Representatives.
Nonetheless, the DOE loan guarantee program still has $34 billion in unused section 1703 loan guarantee authority. In addition to the $8 billion earmarked for advance fossil fuel projects, $1.5 billion is allocated to energy efficiency and renewable energy projects, $18.5 for nuclear generation and $2 billion for nuclear projects. Another $4 billion of “mixed” authority remains that canbe used in principle for any of the loan guarantee categories, although DOE notified Congress that it expects to use $2 billion of that authority for nuclear fuel projects so that it can accommodate a second nuclear fuel project.
Absent further Congressional action, all future solicitations will be issued under the section 1703 authority. All will be subject to the innovative technology, double-dipping prohibition and self-pay credit subsidy cost requirements as presented in the fossil fuel solicitation. The sole exception to self-pay of credit subsidy costs would be any lucky developers of renewable energy or energy efficiency projects that manage to tap the surviving $170 million appropriation for credit subsidy costs.