The US Department of Energy loan guarantee program has come back to life.  The loan program office released a new loan guarantee solicitation on April 16 seeking applications for up to roughly $4 billion in financing for innovative renewable energy and energy efficiency projects in the United States that “reduce, avoid, or sequester greenhouse gases.” The Department of Energy wants projects that are “catalytic, replicable, and market ready.” The solicitation does not set a date when part I applications will be due. It suggests that there will be multiple deadlines, with part I deadlines commencing in 2014 and extending into 2015 and with part II application deadlines lasting into 2016.

Percolating Along

As the latest solicitation demonstrates, not only is the DOE loan guarantee program alive, in fact it never died, notwithstanding the best efforts of some corners of Congress.

The agency has not accepted new applications for renewable energy projects for nearly four years since August 24, 2010, and all renewable energy projects qualifying for loan guarantees under the so-called section 1705 program for renewable energy projects were required to reach financial closure by September 30, 2011. Congress authorized section 1705 loan guarantees in 2009 as an economic stimulus measure. The program attracted a lot of unwelcome attention after loan guarantee recipient Solyndra went bankrupt.

However, the loan guarantee program has always been about more than just economic stimulus. The section 1703 part of the program for projects using innovative technologies predates the stimulus and has continued forward, albeit haltingly during the Solyndra hearings.

To be sure, there has not been a lot to show from the original section 1703 applications save one, but it was an important one. DOE closed a $6.5 billion loan guarantee to finance the Vogtle nuclear power station in Georgia on February 20, 2014 based on an $8.3 billion conditional commitment issued in February 2010, following the nuclear solicitation issued on June 30, 2008. This was the first, and so far sole, financing to close under the original section 1703 program.

An important difference between loan guarantees issued under section 1703 and those issued under section 1705 is that the section 1703 program has historically required the borrower to pay all credit subsidy costs at financial close from non-federal funds. Credit subsidy costs are the equivalent of paying a premium to buy credit insurance, and they fund a loan loss reserve held by the Treasury Department.

The latest solicitation is the second call for applications since Solyndra. DOE issued another solicitation on December 12, 2013 for $8 billion of potential financing for “advanced fossil projects.” This was effectively a renewal of a solicitation that was originally offered in September 2008 but that has led to no conditional commitments, much less closed financings.

So, notwithstanding political cheap shots, the loan guarantee program has demonstrated substantial staying power. Indeed, part of the discussions when Peter Davidson succeeded to the role of executive director of the program in May 2013 was that he was being recruited, not as an undertaker to preside over the burial of the program, but to manage its post-Solyndra re-invigoration. That re-invigoration took a step forward with the closing of Vogtle and issuance of the advanced fossil solicitation. It has taken another big step now that the window is about to reopen for renewable energy project financing.

Eligibility

A developer must show three things about his project to qualify potentially for a loan guarantee under the latest solicitation.

First, the project must use a renewable energy system, an efficient electrical generation, transmission or distribution technology, or an efficient end-use energy technology. Second, it must meet section 1703 statutory requirements of avoiding, reducing or sequestering anthropogenic emission of greenhouse gases. Third, it must employ a new or significantly-improved technology as compared to technologies that are already operating commercially in the United States as of the date on which a conditional commitment is issued.

DOE identified five categories to illustrate the sorts of projects that could be eligible.

One is projects that involve advanced grid integration and storage. Examples are solar rooftop systems that incorporate storage smart grid systems incorporating demand response, micro-grid projects that reduce CO2 emissions and stand-alone storage projects that facilitate the use of renewable electricity.

Another category is “drop-in biofuels.” Examples of projects in this category are new bio-refineries that produce gasoline, diesel or jet fuel and modifications to existing ethanol facilities to produce gasoline, diesel or jet fuel.

Waste-to-energy projects qualify. These include projects to produce methane from landfills or ranches via bio-digesters with the gas then used to generate heat and power, and power plants that use municipal solid waste, crop waste or forestry waste as fuel, including potentially by co-firing with fossil fuels.

Another category of potentially-eligible projects is enhancements to existing facilities. Examples are adding generating equipment to existing dams or variable-speed pump turbines to existing hydroelectric facilities and retrofitting existing wind turbines.

The last category is energy efficiency improvements. Examples run the gamut from installing equipment in homes, office buildings and factories to reduce energy usage or to tap waste energy to more ambitious undertakings to stabilize intermittent power to large transmission lines and build smart grids and micro grids.

It is unclear whether these five categories merely illustrate the wider set of technically-eligible projects or rather suggest that technically-eligible applications that fall within these categories can expect to be more favorably received. The solicitation says the examples are merely illustrative, but some language suggests that applications within the areas identified might be more welcome than those that are not.

Credit Subsidy Costs

The Credit Reform Act of 1990 requires that a loan loss reserve be funded at the United States Treasury for every federal loan or guarantee. The amount of the required reserve is the so-called credit subsidy cost of that loan or guarantee. The amount could be paid by a federal appropriation or by the applicant or potentially by a combination of the two. As long-term fans of the DOE loan guarantee program will remember, the credit subsidy costs for all 28 section 1705 loan guarantees that closed between 2009 and September 30, 2011 were covered by appropriations, so the borrowers did not have to pay them.

The latest solicitation indicates that the credit subsidy costs for the latest round will be covered in part by appropriations. The borrowers will have to pay the rest.

The solicitation announces the availability of $4 billion in financing. The text clarifies that this number has two components, the first consisting of $2,500,000,000 drawn from authorizations under the 2007 Appropriations Act ($1,000,000,000), the 2009 Appropriations Act ($317,000,000) and the 2011 Appropriations Act ($1,183,000,000), and the second derived from a $169,660,000 appropriation in the 2011 Appropriations Act to cover credit subsidy costs. The $4 billion aggregate estimate suggests an expectation that the 2011 credit subsidy appropriation will support $1.5 billion in guarantees, implying an average credit subsidy cost rate of 11.3%.

However, there are good grounds to expect a lower average credit subsidy cost per project, which would stretch that appropriation further. Given an inevitable inclination to avoid another Congressional uproar over a failed large loan as was triggered by the Solyndra debacle and the statutory mandate always to find a “reasonable prospect of repayment,” a likely sweet spot for the program will be projects that are innovative, but just barely. Indeed, the program director said that the program is searching for projects on the “cusp of commercialization.” All that, plus the fact that DOE now has a track record of solid performance that did not exist during the early stimulus phase of the program and the existing loan guarantee portfolio overall is performing well, suggests that, going forward, the actual credit subsidy rate could end up well less than the implied 11.3%. If it were 5%, for instance, which all considered does not seem unreasonable, then the volume of guaranteed financing supportable by the 2011 appropriation would rise to roughly $3.4 billion. The amount of financing available under the latest solicitation could end up as much as $5.9 billion when the pay-as-you go authorizations are taken into account.

This tees up a question with which no prior solicitation has had to deal. Previously, all credit subsidy costs for successful applications were either fully paid by the federal government, which was the case for stimulus projects, or had to be fully paid by the applicants. Here, some applicants will qualify for credit subsidy coverage by appropriated funds, and others will be on their own to pay it. Even those that qualify will have to pay their own way if the appropriation is depleted before they reach financial closure.

The solicitation says that additional information on how DOE will allocate appropriated credit subsidy among qualifying projects will be posted to the loan guarantee program website before the first deadline for part I applications.

Fees

The passage of time has brought fee inflation. The program fees include application fees, a facility fee at closing and an ongoing maintenance fee.

The proposed application fees under the latest solicitation include a $50,000 application fee to submit a part I application. If the proposal is deemed worthy to proceed to the next round, then the part II application fee will be $100,000 for projects seeking up to $150 million in DOE-guaranteed financing and $350,000 for applicants who hope to close more than that.

These application fees are up substantially from the stimulus round of renewable energy project loan guarantees. Then the total application fee ranged from $75,000 to $125,000 depending on the amount of the proposed financing, with 25% of that payable with the part I application. Thus, for instance, the cost to submit an initial application for up to $150 million in financing has increased from $18,750 to $50,000. DOE presumably raised the fees to discourage smaller, less capable applicants. A lot of those showed up in the stimulus round and took substantial amounts of DOE staff time away from processing applications that were more likely to succeed. The smaller applicants ultimately fared poorly in that process, and none reached financial closure. If that is the goal, then requiring substantial sponsor technical and financial capacity might be a better way forward than making the program unnecessarily expensive.

If the application reaches financial close, then a facility fee will come due. That is proposed to be 1.0% of the DOE guaranteed loan commitment for financings of up to $150 million. For larger financings, the facility fee would be the same for the first $150 million, plus 0.6% for the portion of the financing commitment above $150 million.

The third, and final, DOE fee is the maintenance fee, which the solicitation “expects” to be $500,000 per year. This fee is up substantially from the $50,000 to $100,000 annual fee for the last round of loan guarantees for renewable energy projects. In the closed section 1705 financings, maintenance fees at the $50,000 end of that range were negotiated, but DOE’s requirements seemed generally to float upwards toward the $100,000 ceiling as the September 30, 2011 deadline approached. The currently proposed maintenance fee is a multiple of anything previously sought by DOE. This fee would add 100 basis points of carrying cost to a $50 million loan, a spread that will rise as a loan is repaid. The fee might be a good target in the current public comment period and at the related public meetings about the solicitation, as it is enough to cover the wages of several DOE employees to monitor a single project.

Each applicant will also be required to cover any fees incurred by DOE for advice from legal counsel, financial advisors, market consultants and independent engineers.

Poison Pill

Some of the appropriations acts supporting the latest solicitation contain a restriction against “double dipping,” such that DOE is not to provide guaranteed financing for any project that, quoting from the solicitation, “will benefit directly or indirectly from certain other forms of federal support, such as grants or other loan guarantees from federal agencies or entities, including DOE, federal agencies or entities as a customer or offtaker of the [p]roject’s products or services, or other federal contracts, including acquisitions, leases and other arrangements, that support the [p]roject.”

The statutory bar prohibiting projects that receive loan guarantee from also benefiting from other federal funds, property or personnel was somewhat ameliorated by the following proviso: The prohibition against double dipping

shall not be interpreted as precluding the use of the loan guarantee authority . . . for commitments to guarantee loans for projects as a result of such projects benefiting from (a) otherwise allowable Federal income tax benefits; (b) being located on Federal land pursuant to a lease or right-of-way agreement [subject to certain enumerated requirements] (c) Federal insurance programs, including Price-Anderson; or (d) for electric generation projects, use of transmission facilities owned or operated by a Federal Power Marketing Administration or the Tennessee Valley Authority that have been authorized, approved, and financed independent of the project receiving the guarantee.

Thus, with the proviso, a DOE-supported project is not precluded from benefiting from tax credits or Treasury cash grants. However, as the solicitation points out, any power project with a federal offtaker need not apply.

Additionality

The solicitation bows to the traditional federal financing concept of “additionality” -– which is the thought that federal financing should make a difference and not just support an enterprise with cheaper funds than are commercially available. In the words of the solicitation: “Applications for loan guarantees for projects that could be fully financed on a long-term basis by commercial banks or others without a federal loan guarantee will be viewed unfavorably.”

One interesting change from the stimulus era is that DOE promises in the latest solicitation not to penalize potentially highly profitable projects. In the stimulus era, the Treasury staff took the position that DOE should not support projects with too high a projected rate of return. Treasury never quite embraced the concepts that technology risk is a risk for the equity as much as or even more than for the debt and elevated projected returns are appropriate to compensate investors for the elevated risk that those returns would never be realized. Projects with high rates of return that were supported by DOE staff found themselves challenged by Treasury as inappropriate for federal financing because, in effect, they were too good. On this point, the solicitation quietly notes:

While DOE will gather information regarding the expected rates of return for investors and developers, given the significant importance of motivated equity sponsors in a transaction, DOE does not anticipate establishing requirements regarding such metrics.

Assuming Treasury is on board with this, this is a welcome step forward.

Applicants will need to comply with a number of federal statutes. They include the National Environmental Policy Act (which requires environmental reviews and clearances of projects before DOE financing can be provided), the Davis-Bacon Act (which requires on-site laborers and mechanics to be paid at least prevailing wages, being a rough equivalent to the compensation received by similarly-situated unionized workers), the Cargo Preference Act (requiring at least 50% of imported cargoes for DOE-financed projects to be carried on US-flagged vessels unless a waiver is given) and the Federal Credit Reform Act of 1990 (which guides the determination and payment of credit subsidy costs). Information provided to DOE will be afforded the protections under the Freedom of Information Act, but also subjected to the related risks of public disclosure.

The solicitation is still a draft. There are 30 days of public comment scheduled, including at a series of public meetings to be held in Austin, Texas (April 21), Denver, Colorado (April 24), Arlington, Virginia (April 28) and the Minneapolis and St. Paul, Minnesota (May 6). Details are available on the loan program office website at http://lpo.energy.gov.