The US Army Goes in Search of Electricity
Renewable energy developers are angling to supply up to $7 billion in electricity to the US Army under long-term power purchase agreements. The Army released a request for proposals last August. Developers who are interested in bidding had until October 2012 to submit their credentials and a maximum price for kilowatt hours at which they are prepared to sell electricity. Developers who make the first cut are expected to be awarded MATOCs or multiple award task order contracts. The developers will then be allowed to bid on specific projects as the projects are announced in the future.
The Army is not expected to announce the qualified bidders until the third quarter 2013. At least four projects at individual Army bases are expected to be put out for bid in the meantime.
The Army also asked for expressions of interest by late August 2012 from companies who are interested in entering into separate “energy savings performance contracts.” The companies upgrade air conditioning and heating systems, lighting and boilers, improve windows, install solar panels and make other improvements and charge the Army a percentage of the energy savings over time.
The US Department of Defense has set a goal of relying on renewable energy for at least 25% of its total energy consumption by 2025.
Many larger renewable energy developers have hired specialists to focus on government contracting. A panel of them talked at a conference on November 30 in Washington about the Army solicitation. The following is an edited transcript.
The panelists are Nate Butler, manager of government programs at SunEdison, John Finnerty, government channel manager for Standard Solar, Robert Franson, a vice president of Energy Investors Funds, Kevin Johnson, manager of mergers and acquisitions and federal markets for Acciona Energy North America, David McGeown, a principal with McGeown Associates, a consultancy that is assisting the US Department of Defense, and Kevin Prince, project development manager for federal programs for SunPower Corporation. Many of the panelists had served in the US military or, in the case of David McGeown, in the Royal Air Force reserve in Britain. The moderator is Keith Martin with Chadbourne in Washington.
MR. MARTIN: More than 600 people showed up at a pre-proposal conference in late August hosted by the Army. That is a lot of people competing for a limited number of projects. If this were a utility solicitation, would you bother to bid in such a crowded field?
MR. JOHNSON: The solicitation is for multiple technologies. For Acciona, if it were a wind solicitation, yes, we absolutely would bid. We feel very competitive in the wind field. If it were solely a solar solicitation with 600 competitors, we probably would not bid. My guess is that the 600 respondents will probably whittle down to around 300 for wind and solar. The numbers for other technologies will be much smaller. The number of respondents for geothermal should be a handful. The number for biomass should be fewer than 25 to 50 bidders.
MR. BUTLER: The MATOC is structured in a way that compels people to team up where they might not have done so otherwise. Few companies can meet the experience requirements by themselves, especially if they want to go across multiple technologies. We expect solar to have the biggest field. It is worth it for a company like SunEdison to participate, notwithstanding the large field, because of the potential rewards at the other end. Ideally, we would have liked to have seen more culling of the field instead of letting everyone who walks in the door remain in the hunt.
MR. MARTIN: One of the gripes that larger developers have had in the renewable energy sector as a whole is the two guys with an Avis card who underbid everybody else but then cannot deliver. How great a problem do you see this in such a crowded field?
MR. PRINCE: There are experience hurdles that must be met in the Army solicitation in terms of building, operating and financing systems, so the 600 will eventually turn into a smaller number. When the individual projects come out for bid, we will look at each project on its own merits. The three questions we ask first for any project are who is the offtaker, what does the interconnection look like and what is the site access status? We also look at the evaluation criteria and experience hurdles. We will be interested in whether bids are evaluated based on present value.
All of these factors are weighed as we assess whether to bid. If we identify risks, or if the Army is evaluating based on lowest initial cost or if no offtaker has been identified — for example, where the Army is merely allowing us of otherwise underutilized land to build a project — then we will not bid. Lack of an offtaker is a set up for a stranded project. The project will be awarded, but the developer will not be able to finance or build it.
The Defense Department needs to recognize that there are different levels of experience among developers in financing projects with long-term government offtake contracts. This is on top of differences in construction experience.
MR. MARTIN: Rob Franson, do you think a possible strategy is to try to pick up projects from winning bidders who are unable to perform? I don’t know whether it is possible to take over a contract like that.
MR. FRANSON: In general, EIF would not want to step into a project that we had not fully negotiated or developed.
To answer your earlier question, look at the request for proposals that the Army released recently to supply power to Fort Detrick. I do not think that a firm like EIF would bid into a project with such a relatively small dollar amount knowing that we were going to be competing against 200 or more bidders.
MR. MARTIN: Are the other services besides the Army expected to come out with their own solicitations? If so, when, and are they expected to use the same process as the Army?
MR. MCGEOWN: The other half of my life is serving the US Department of Energy and you have now given me the opportunity to advertise that there was a draft large-scale renewable energy project development guide for federal agencies posted to the DOE website in the spring. We have spent two years listening to the community to put together a process that is repeatable and reliable, so that a 28-year-old analyst who works for you can look at one of these solicitations and say: “I know where to find the answer to that question. It is in section 173, paragraph 2.” It would be wonderful if all of the Services use a process similar to that. The Army has adopted that and will be coming out with the Army version of it, and we are actively talking with the Air Force and Navy, but at the moment everybody has his or her own process.
MR. MARTIN: There was an interesting quote in North American Windpower magazine about the Army RFP. It said, “Developers looking to bid on the Army’s RFP should know that the process and requirements differ substantially from those of utility and commercial contracts, and working with the government presents both advantages and disadvantages.” What are the main points senior management should know about this opportunity? Let’s say you are drawing up a few bullet points for senior management to temper expectations.
MR. FINNERTY: Everybody gets excited when he or she sees the headlines and the size of the opportunities, but the whole process takes a long time. The scope is for different types of renewable energy projects. Solar projects are just one of several categories. Each solar request for proposals will need to be evaluated independently. We are a growth company. We have to focus our resources and select an RFP that our team can close in a reasonable period of time. For some of the RFPs, our best strategy may be partnering with other key players. Focusing on our key strengths engineering, procurement, construction and operation and maintenance will deliver the best results for our partners and the Defense Department.
MR. MARTIN: Kevin Johnson, what is the main point on your list for senior management?
MR. JOHNSON: Acciona competes globally. Our corporate headquarters are in Madrid, Spain. We are active in more than 30 countries on five continents. The main point for senior management is what it is reasonable to expect as a return on DoD projects. We are not going to see the 25% annual equity returns that are on offer in South Africa. The return is a function of the electricity price we will have to charge in order to win bids. Nevertheless, we feel the DoD procurements are a good opportunity for us to reach scale in the US market. Acciona has done very well working in government markets in infrastructure projects in Spain. We have a long-term view. The return, timing and pricing expectations are the key things that we talk about.
MR. MARTIN: What are your return expectations?
MR. JOHNSON: We expect a 10% return on equity invested.
MR. MARTIN: Kevin Prince, what is the main point you would make to senior management?
MR. PRINCE: The Army RFP has more in common with a utility development timeline than a commercial deal. You have to be comfortable, when undertaking a federal project, with the federal acquisition regulations for government contracts and the risks that are associated with the entire government contracting process. Everyone sees the headlines that the Army has underway a $7 billion procurement. I got so many emails from executives within the company asking, “Hey, are you aware of this?” The figure $7 billion makes people ask how much we can get. What the $7 billion actually means for solar projects is much smaller than $7 billion. We are all still learning what the Army wants. We have to manage expectations for the Army solicitation with our senior management.
MR. MARTIN: What do you think the amount is for solar?
MR. PRINCE: The figure $7 billion is the total PPA payments over 30 years across all technologies. Solar is somewhere between 60 and 150 megawatts in capacity.
MR. MARTIN: Do you agree with Kevin Johnson that a 10% discount rate to arrive at a value is probably the right figure?
MR. PRINCE: I think it depends on the project and the characteristics of the project. The federal government is the offtaker. It has the land. It pays high rates for electricity. Those are attractive features. The government is a strong credit and has strong site access and control. However, you are competing against commercial and utility deals for scarce capital to build. It depends on the deal, but the appropriate discount rate could be within range.
MR. MARTIN: The Army received nearly 800 comments on its draft RFP. People raised a number of issues. Let’s start with the expected term of the power contracts. How long are they expected to run?
MR. BUTLER: The Army has authority to enter into power contracts of up to 30 years. However, I do not expect a lot of contracts to be 30 years; 20 to maybe 25 years is more of a sweet spot for us both. A developer does not get much more benefit from taking the term out further.
MR. MARTIN: David McGeown, there was some speculation that the contracts might be limited to 10 years. Do you see that happening?
MR. MCGEOWN: No.
MR. MARTIN: What happens to the project when the power purchase agreement ends? Have you been given any indication you will be able to leave the project in place and sell electricity to the grid? Can you remove it? Who pays the cost to dismantle?
MR. BUTLER: We usually see a requirement to remove the project and restore the government’s property at the end of the contract term. There are a lot factors that go into deciding what to do at the end of the term. What you say in the contract can affect not only how the government scores your bid, but it can also affect your ability to claim tax ownership of the project during the contract term and, therefore, your ability to finance the project if the contract requires the project be turned over ultimately to the government.
MR. MARTIN: Does anybody see any end-of-term issues with the contracts that are on offer?
MR. FRANSON: We would not usually finance a project that has a firm end date so that we are basically factoring in a dismantlement of the project. We develop projects with the intention of selling those projects to someone else at the end of the existing power purchase agreement. The assumption is that the project will sign a new contract to sell its output to someone else at a certain point. For example, EIF used to be the 100% owner of the Black River generation project at Fort Drum that was recently sold to a firm that is converting it into a biomass project. That project used to sell power to the Army and eventually came off contract. The project continued to sell power off base for probably 15 or 20 more years.
MR. MARTIN: The Army does not want to pay more than the retail rate it would pay the local utility for electricity. Renewable energy is more expensive to produce than electricity from fossil fuels. Does this retail rate cap leave enough room to operate in parts of the country where the retail rate is set by coal or natural gas?
MR. PRINCE: In order to make the economics of project work, we look at the three Rs: rates, resource and rebates. You don’t need all three to make a project work, but you need a least two out of three. There are only a few installations where the economics work today. Over time as our cost reduction strategies kick in and the price of conventional power increases, we see that list expand. These assets have useful lives well over 25 years. It is important to look at the net present value of savings over time and not just the initial cost.
MR. FINNERTY: The Army is no different than anyone else in wanting to pay less than the local grid rate for electricity. In addition to a low price, the Army needs nearly 100% reliability to support critical missions around the clock without interruption. The amount of electricity and the 100% reliability the Army requires are rapidly exceeding the ability of local utilities to deliver.
The focus on meeting a retail rate cap needs to be balanced with the added costs to deliver the required near 100% reliability and power security to a given base, even during grid failure events, that is being asked from renewables.
MR. MARTIN: How great a complication is it that the Army wants to keep any renewable energy credits or RECs? It wants a lower price but also to keep a subsidy that is supposed to help the generator be competitive.
MR. PRINCE: Life would be a lot easier if the developer could keep the RECs.
MR. FINNERTY: The Army has been clear that its goal is to purchase electrons at the best price. Solar developers have been able to deliver very competitive and sub-grid rates for many projects. RECs play a critical role in our ability to deliver competitive prices. Choosing to retain the RECs in service territories with low electricity prices and low or non-existent SREC markets can significantly complicate our ability to beat the local grid rate. Developer and finance teams are delivering innovative solutions. We need to match project innovation with contract innovation on the government side. There should be flexibility based on locality.
MR. MARTIN: The payments from the Army are expected to be subject to annual appropriations. How do you arrange long-term financing for a project with a non-appropriation clause in the power contract?
MR. BUTLER: If a homeowner gets in trouble, one of the last bills he or she will fail to pay is the utility bill. Similarly, if a military base gets into trouble, the base will not allow the electricity to be shut off. You have the benefit of the federal government being able to print more money to pay its bills. However, all of that said, non-appropriation is a risk, and we have to get our investors comfortable that the clause is very unlikely to be invoked because we are providing an essential service.
MR. PRINCE: Appropriation risk is something with which experienced federal contractors are used to dealing. Most government contracts have appropriations risks. There are several clauses in the federal regulations that are unique to federal procurement. Termination for convenience, Buy American and non-appropriation clauses are just a few examples.
Enhanced Use Leases
MR. MARTIN: Many of these projects are expected to be built on the base itself using underutilized government land under an EUL or enhanced use lease. The US military will reserve the right to terminate the lease for national security reasons. How great a complication is this?
MR. JOHNSON: It is definitely a risk. The risk can be mitigated by requiring the military to pay a termination value. The Fort Detrick RFP establishes a good precedent. Basically, we will need a termination value schedule in place before the project can be financed.
MR. MARTIN: The military has not been willing in the past to agree to a fixed termination value schedule if it takes the project for national security reasons. Have you had any indication this policy has changed?
MR. MCGEOWN: Yes. As a consultant, I cannot talk to policy. However, there has been a consistent theme with the last three questions. An anecdote comes into my head: I am a pilot and we get lots of automated weather stuff, but the rule is “look out the window.” I wonder if everybody in this business would look up from the Power Points and “look out of the window.” We are doing something that has never been done before. It is new to the federal government. Federal government acquisition is an extraordinarily complex and time-consuming process, and we have to make it fit into what the development community wants to do quickly.
When we get into the negotiation about RECs, we will have to see if the project will work the way the Army proposes to handle things. In the next year, we will begin negotiations and you will tell us the truth about what works and what does not work.
Government contracts have clauses about termination for convenience and equitable adjustments that utility and renewable developers generally don’t come across. The experts in the Department of Defense contracting offices know this stuff backwards and forward, and firms could probably make a few bucks on a white paper on what it means for financing. Our analysis suggests the banks will see how the federal government will compensate them in the event of a termination or pulling out prior to the end of the PPA. Banks will see that there is the ability within the rules for lenders to be satisfied that they can get out somewhat whole.
MR. MARTIN: How do lenders take possession after a default under the enhanced use lease?
MR. BUTLER: Ideally, they don’t. We expect the lease to include a right for the lenders to step in and fix something if it goes wrong. Government contracts do not typically include such a right. However, we think it is doable within the federal acquisition regulations. The lender needs the right to replace the developer should the first one fail. If the lender does not have this right and the contract terminates, then everyone loses. The lender loses money, the developer is out and the government does not get the electricity it needs.
MR. MARTIN: Do you expect the Army to buy all the output or just what it needs? Do you expect to be able to sell any excess electricity to the grid? Do you expect to be able to build a larger project than the Army requires and earn additional revenue by generating electricity for export?
MR. FRANSON: If the base wants to take 100% of the output, that’s great. If it does not want to take it, then we will need the ability to sell that power off-base to a utility. It would be even better if the base will allow us to build a bigger project and generate electricity from the start for export.
MR. PRINCE: It is the responsibility of the developer to look at the load data for the base and size of the system for the best economics or net present value. Utilities buying from larger scale projects generally do not want any excess electricity sold to someone else. There is usually a requirement from investors that 100% of the output be purchased whether or not the base consumes it. The issue of generating more electricity than the base needs might be resolved by establishing a baseline for consumption, calculated on historical usage, and if the purchase falls below that baseline, then there would be some sort of equitable adjustment.
MR. MARTIN: What happens if the project is curtailed? Will the Army pay for the electricity anyway?
MR. BUTLER: The contract should explain what happens if the project is curtailed. The answer will depend on who caused the curtailment and the reason that it happened. If it is a government-caused issue, then that might be a government liability. The contract will also have to allocate liability where the project is curtailed due to force majeure or a problem with the transmission grid. As long as you know what will happen, you can manage the risk. It is only where you do not know what will happen that the real problems begin.
MR. MARTIN: Some utility contracts increase the electricity price if the project misses deadlines to qualify for tax subsidies. Do you expect the Army to allow such adjustments?
MR. FINNERTY: It would be wonderful if they did, but we have not seen that flexibility.
MR. JOHNSON: We could also run up against the retail rate cap. What we are seeing is that the utility sets the price of electricity in a particular location.
MR. MARTIN: What other issues do you see with the Army
MR. BUTLER: I would say to the Army that the cleaner the process, the better. If you can avoid it, do not add to the requirements as we go along. Have realistic expectations for the value of what you are bringing to the table, whether it is land, sunlight, biomass or wind. It makes it hard when we bid at one price and on one set of terms and then there are lots of things on which we also have to give. It makes it more difficult for a project to be successful.
Time is another big deal for us. You have incentives that are running out all the time. You have financing where rates come and go and if we can move quickly and get the best terms, the government benefits. Timing is a lot bigger issue than I think the government appreciates.
MR. PRINCE: The Army is operating under two types of authorities. It has section 2922a, which authorizes it to purchase electricity, or it has EUL authority, which allows it to lease underutilized land to earn revenue. It is usually an either-or situation. There is not enough value in the deal to get revenue from the land and also to get electricity savings. That is an important consideration.
MR. MARTIN: Are there other issues with the procurement?
MR. JOHNSON: There is a bit of a fatigue factor for those of us competing globally. There is a hurry-up-and-wait pattern to military procurements. It is hard to keep the management teams, both here and abroad, engaged and ready to react when we sit for a while and then, suddenly, an RFP comes out right before Thanksgiving or over the holidays.
MR. MCGEOWN: I have one that relates directly to each of the procurements, but is my big nightmare because I am often the one saying, “This is not going to work.” It is a general comment that may not relate to my fellow panelists, but when we see 150 people come talk to the military brass about what they can do, we hear too much rubbish. Tell the truth. Equally, if you think what the Army is requesting is nonsense, tell the top brass. Tell them what it takes to get these deals done, and we will go and get some deals done.
MR. MARTIN: The North American Windpower article said there were both advantages and disadvantages to bidding into a DoD procurement compared to a utility RFP. What are the advantages?
MR. BUTLER: I think number one is marketing. The government pays up to $4 billion a year for electricity. That’s a big payoff even if you can get a small part of that. I would say the barriers to entry are high, but once you clear those, it can be a less crowded field. The fact that the Army procurement has hundreds of applicants is not typical for a government or DoD procurement. Once you figure out how to work with the DoD, I think you can make a business of it.
MR. MARTIN: Rob Franson, you get the last word. What’s the advantage of this?
MR. FRANSON: The main advantage is the potential for five to 10 years’ worth of transactions using the same template. However, unfortunately there are still a lot of issues that need to be resolved before we can participate in this space.