DOE Nuclear Loan Guarantees: Part Deux
The draft solicitation recently issued by the US Department of Energy breaks new ground for support of the US nuclear energy industry through the loan guarantee program.
The new solicitation will welcome small modular reactors (in contrast to a 2008 solicitation that focused on large-scale nuclear projects), reduce certain regulatory requirements for eligibility, streamline the application process, and reduce some fees.
The new draft solicitation proposes to redeploy capacity that was originally offered in 2008 in two separate solicitations, but that went largely unused. One offered $18.5 billion in loan guarantees for advanced technology nuclear generation facilities. The other offered $2 billion for front-end nuclear fuel processing facilities.
The new solicitation will cover both industries, again allocating $2 billion to nuclear fuel processing and offering $10.6 billion for assorted nuclear energy generation projects. That $10.6 billion is roughly the difference between the $18.5 billion originally offered for generation projects in 2008 less the $8.33 billion allocated to the construction of two new reactors at the Vogtle nuclear power plant in Georgia, the one nuclear project to close under the 2008 solicitation.
While the resources are largely carried forward from 2008, the terms of the solicitation have evolved. The new draft solicitation explicitly extends eligibility to small modular reactors and plant uprates and upgrades, which were not mentioned in the 2008 nuclear generation solicitation, though not explicitly excluded. There are also other innovations, such as with respect to eligibility and fees.
Emerging from Solyndra
Nearly three years passed since the high-profile bankruptcy of Solyndra and the sunset of the “section 1705” loan guarantee program created by the American Recovery and Reinvestment Act, each of which occurred in September 2011, without the DOE loan guarantee program closing any further financings or even having any windows open for new energy project applications.
However, there has been a recent flurry of signs of life. In February 2014, DOE closed a $6.5 billion financing for the Vogtle nuclear power plant in Georgia providing funds for the construction of two new reactors (with a further $1.8 billion committed to the project). Vogtle is a complex and costly project using technology being deployed in the US for the first time. As such, it was a strong candidate for a program designed to bridge the gap between technical viability and mainstream commercial acceptance. In another milestone for the loan guarantee program, on July 1 of this year, DOE issued a $150 million conditional commitment in support of Cape Wind, the nation’s first offshore wind project.
In December 2013 and July 2014, DOE released two new solicitations. The first, for advanced fossil energy and carbon-capture projects, is open for applications until October 30, 2015. The second, for renewable energy and energy efficiency projects, is open for applications until December 2, 2015. And now comes the new draft solicitation for more nuclear projects. The program is back open for business. How that business will go remains a question.
Elephant in the Room
While the draft solicitation contains welcome improvements, challenges remain, including how to deal with credit subsidy costs. That issue was reportedly responsible for scaring away several applicants under the 2008 nuclear power generation solicitation.
Credit subsidy costs are risk premiums, akin to insurance premiums, sufficient, on average, to compensate the government fully for any projected losses from making a loan or issuing a guarantee. They are required by the Federal Credit Reform Act of 1990 to be paid to the Treasury Department from non-federal funds, so, unless commercial co-financing is available, it is an equity charge. Further, the amount due is not determined until about a few days prior to closing. Thus, a potentially substantial equity cost is unknown, at least with precision, until just before it must be paid.
Relatively little data exists to help estimate the range of credit subsidy costs that would apply to projects under the loan guarantee program. The stimulus-related “section 1705 program’ ultimately supported 28 loan guarantees totaling $15.1 billion, requiring a total credit subsidy cost of about $1.9 billion (an average rate of just over 12.5%), all funded by the US government.
The section 1705 program, while encouraging clean energy technologies, was primarily passed as an economic stimulus during the economic turndown of 2008 to 2009, and provided an appropriation to cover credit subsidy costs. The draft nuclear solicitation is pursuant to the original section 1703 program, which extends back to the Energy Policy Act of 2005 and has been substantially unfunded, forcing borrowers to pay their own credit subsidy costs. Vogtle was, and Cape Wind will be, the first DOE loan guarantee program projects to be responsible for covering their own credit subsidy costs, though the rate determined for Vogtle was 0%. Cape Wind’s credit subsidy cost has not been publicly disclosed.
In March 2011, Congress enacted a modest credit subsidy cost appropriation of $169,660,000, but it appears that these funds will be used to support renewable energy projects. In any event, DOE has been clear that it does not expect to provide coverage of any credit subsidy costs under the upcoming nuclear solicitation.
Credit subsidy costs are in the first instance calculated by DOE, but are then reviewed and confirmed (or not) by the Office of Management and Budget. Rumors abounded in the early years of the loan guarantee program that the energy staff at OMB did not trust the DOE to implement a loan guarantee program sensibly and were inclined to inflate credit subsidy costs to protect the taxpayers from likely project failures. The breathtaking speed with which Solyndra (the DOE loan guarantee program’s first project to close) collapsed following financial close did little to reassure OMB.
Concerns have also been expressed concerning other sources of a risk of upward bias in the determination of credit subsidy costs. As the projects supported under the stimulus, which include all of the energy projects closed to date except Vogtle, had to close by September 30, 2011, both borrowers and DOE were anxious to meet that deadline. Some closings were delayed while prospective borrowers waited for DOE and OMB to agree on the appropriate credit subsidy cost in the final days before closing. Since those costs, once determined, were fully paid by a Congressional appropriation, both borrowers and DOE were more concerned about timing than the amount of credit subsidy costs. Congress had initially appropriated more funding than DOE appeared to need, so DOE’s incentive was to move the process through OMB quickly rather than to fight hard to minimize the amount that was calculated. This dynamic has led to a concern that earlier loan guarantees may have set precedents with relatively high credit subsidy costs that will carry over into determinations made for projects, such as those under the coming nuclear solicitation, that must pay their own credit subsidy costs.
However, there are some grounds for optimism. While loan guarantee program projects besides Solyndra have failed, their numbers have been small. Overall the performance of the portfolio has been terrific, with, notwithstanding the huge hit taken with Solyndra, a loss rate less than 3% in a program dedicated to finance technologies that are deemed too risky for commercial lending. That track record should support more modest credit subsidy cost determinations.
A good sign in this arena is that the credit subsidy cost recently determined for the Vogtle project was 0%, though that was more a function of strong corporate backing than programmatic track record.
Apart from Vogtle, Constellation Energy’s Calvert Cliffs project proceeded the farthest in the DOE nuclear loan guarantee process, having applied and moved well into the diligence process before withdrawing in October 2010, motivated, at least in part, by an unexpectedly large projected credit subsidy cost of 11.6% on a $7.6 billion loan, yielding an additional equity charge at closing of about $880 million.
It is interesting to explore why the numbers played out so differently for Calvert Cliffs and Vogtle, since the credit subsidy cost can be a make-or-break proposition for the feasibility of DOE financing. While OMB’s calculation mechanics are not public knowledge, some relevant factors distinguishing Vogtle and Calvert Cliffs are evident. Calvert Cliffs was being developed as a non-recourse project financing; Vogtle was structured as a full-recourse project, with the massive Southern Company balance sheet and smaller (but still substantial) Oglethorpe balance sheet backing the loan guarantees. Vogtle is located in Georgia, which allows costs of plant construction to be passed on to customers before completion, whereas Calvert Cliffs was proposed in Maryland, which requires construction to be completed first. Additionally, Calvert Cliffs was proposed as a merchant plant, while Vogtle benefitted from long-term take-or-pay power purchase agreements.
The DOE loan guarantee program is designed to support innovative projects that are having trouble getting financing on reasonable terms in the commercial market. Yet allocating a high risk premium to these types of projects in the form of credit subsidy costs takes what is expected to be an unmanageable private market risk premium and shifts it to an upfront payment, discouraging the very projects the program was designed to assist. Whether credit subsidy cost requirements end up being more like Vogtle or the early estimates for Calvert Cliffs may determine whether the nuclear solicitation leads to effective support of any projects.
Nuclear reactors of any size, including small modular reactors (defined as 300 megawatts or smaller), uprates (improvements or modifications to existing operating reactors to operate more efficiently), and upgrades (improvements or modifications to reactors that are to reactivate them or to prevent their shutdown) are all eligible under the draft solicitation.
Of the total $12.6 billion in loan guarantees offered, $2 billion are allocated to front-end nuclear fuel processing projects (for example, advanced technology uranium conversion, uranium enrichment and nuclear fuel fabrication). While no partitions of the remaining $10.6 billion are made, three kinds of projects specifically cited here — small modular reactors, uprates and upgrades — were not previously mentioned, so a notable development in the draft solicitation is its specific indication that DOE is willing to consider extending loan guarantees for such projects.
In what may be of particular interest to the small modular reactor industry, the draft solicitation lowers the regulatory hurdles facing applicants. The previous nuclear solicitation was only open to projects that had applied for a combined construction and operating license with the Nuclear Regulatory Commission, or those that would be ready to do so in a short time period (12 days after the part II application due date). The previous solicitation also required projects to use NRC-approved reactor designs or ones that were included in filed applications already accepted for technical review by the NRC.
The new draft solicitation does not prescribe any NRC licensing requirements as preconditions to project eligibility, other than that borrowers must have filed for, or have obtained, required regulatory approvals prior to execution of loan guarantees, with specific licensing requirements to be addressed on a case-by-case basis. DOE’s stated rationale for this change to the NRC requirements is to provide eligibility to a broad range of reactor technologies and to offer flexibility regarding reactor technology and site location.
However, note that, in what appears at least to be confusing drafting, a separate part of the draft solicitation defines eligible “nuclear power facilities” as projects and their associated nuclear reactor designs that are either under NRC licensing review or under the NRC pre-application phase for certification, construction permit, or combined construction and operating license review.
In what may be another benefit for small modular reactors, the draft solicitation says DOE will look favorably on projects that will have a catalytic effect on the commercial deployment of future advanced nuclear energy projects that replicate or extend their innovative features. While this could extend to any advanced nuclear technology being deployed commercially for the first time, small modular reactors in particular may be good candidates for such consideration given their emphasis on modularity and standardized design.
Part of the application process requires submitting a description of the applicant’s prior experience successfully implementing similar projects of the same scale. In a note that will help developers of technologies that have yet to be successfully implemented at the same scale, the draft solicitation offers an alternative. Applicants may instead provide a detailed description of facts sufficient to demonstrate that the applicant has the necessary expertise.
One aspect of the draft solicitation that may make sense for developers of large nuclear, uprate, upgrade, and front-end fuel processing projects, but that might be frustrating to developers of small modular reactors, is a limit of only one project using the same technology per project sponsor. Unfortunately, this limit comes directly from the loan guarantee program regulations.
The draft solicitation contemplates multiple rounds of applications, with applicants providing part I submissions, which will be reviewed competitively against one another, and with qualifying applicants being invited to submit part II applications.
This presents two key items that differ from the previous nuclear solicitation, in which applicants were ranked based on their initial applications (and possibly re-ranked based on updates to other pending applications).
First is a potential first-mover advantage. DOE has indicated that all part I submissions will be competitively evaluated against all others submitted during the corresponding round of review. Applicants presenting strong projects in earlier rounds may well enjoy an advantage of being compared against fewer competitors for a larger allocation of loan guarantees.
DOE has indicated that part II submissions may be filed at any time after DOE invites an applicant to do so, subject to the final part II deadline, but that all part II submissions received during each round of part II review will be competitively evaluated against one another. It is unclear how these rounds will be structured but, as with the part I submission, it is possible that there will be a first-mover advantage to applicants that complete and submit their part II submissions (which are quite voluminous) sooner than their competitors.
More generally, given a program anxious to demonstrate its post Solyndra validity and viability, the early entrants are likely, all else equal, to receive particular attention and support from DOE.
While DOE has specified that it may defer consideration of a part II submission to a later round, DOE has not said whether the same rule will apply to part I submissions, or if applicants rejected at the part I step would be allowed to edit their applications and reapply in later rounds and, if so, whether they would be required to pay the corresponding fee. However, DOE said in a presentation posted on its website that “pending applicants” (apparently referring to surviving applicants from the 2008 solicitations that have not withdrawn their applications) would not need to reapply under the draft solicitation or pay fees unless they wish to modify their proposals significantly.
The second notable change to the application process is a reduction of application costs. The part I submission contains overall descriptions of the project and the involved parties to determine eligibility, as well as business and financial plans and technical information about the project. While it entails some detailed analysis, it does not require the same level of detail required by the part II submission, which includes submission of detailed project cost analysis, financial and technical information (including drafts or executed copies of various contracts and agreements), financial, O&M and decommissioning plans, engineering reports, a proposed term sheet for the guaranteed obligation, and a preliminary credit assessment for the project from a nationally recognized rating agency.
Under the previous solicitation, the sole part II due date was less than three months after the part I due date, requiring applicants to begin preparing part II submissions before learning the fate of their part I submissions. However, under the new draft solicitation, applicants whose part I submissions are deemed worthy of further consideration can pick an earlier or later part II deadline for finalizing their applications. While applicants may need to begin parts of their part II submissions earlier to ensure timely completion, certain items may be able to be delayed until after DOE invites the filing of a part II submission. Flexibility with respect to choosing a part II deadline has an immediate benefit over the previous solicitation because a large fee is due along with the part II submissions.
Applicants will now have the option of knowing that their part I submissions have been accepted before incurring this fee.
Specific dates and time frames were not included in the draft solicitation. However, the form and related discussion suggest that there will be multiple part I and multiple part II deadlines, with applicants free to mix and match their chosen deadlines however best fits their circumstances. This suggests that aggressive developers will be able to seize a first-mover advantage, while more conservative developers will be able to apply knowing that they will not incur the expense of filing or preparing a full part II submission unless their part I submission is approved.
The fee structure for applicants under the draft solicitation reflects increases to some fees but drastic reductions in others, including reduced fees for projects requesting smaller loan guarantees (another move that may encourage application by developers of small modular reactors).
The part I application fee is $50,000, down from $200,000 in 2008. A further application fee, payable with the part II submission, is $100,000 for projects seeking a guaranteed loan up to $150 million or $350,000 for projects above that threshold. The part II application fee in the 2008 solicitation was $800,000. In total, the reduction in application fees alone is $400,000 (or $650,000 for smaller loan guarantees).
However, facility fees under the draft solicitation have risen from 0.5% of the guaranteed obligation to the sum of 1% of the first $150 million of guaranteed debt plus 0.6% of any additional amounts. While the amount of the fee has become more onerous, the timing of its payment has been improved. Previously, the facility fee was due upon commencement of negotiations of a draft term sheet or, if earlier, the issuance of a term sheet, although it has never been clear how it would be possible for that to happen earlier. Under the draft solicitation, 25% of this fee is paid on or prior to the issuance of a conditional commitment, with the remaining 75% payable by the financial closing date.
An annual maintenance fee is also payable to DOE for post-closing monitoring. This amount, previously estimated to be between $200,000 and $500,000 per year, has increased now to an expected $500,000 per year, regardless of the size of the project.
These fees are in addition to the payment of the credit subsidy cost as well as the fees and expenses of DOE’s outside counsel and independent consultants during the due diligence process and payments to DOE for DOE’s time or expenses incurred while monitoring the loan (for example, in connection with reviewing requested amendments and waivers).
The public comment period for the draft solicitation concluded October 30. The nuclear solicitation is expected to be issued by the end of 2014.