The Inflation Reduction Act and DOE loan programs
The Inflation Reduction Act upsizes the existing US Department of Energy loan programs.
It also establishes new programs for transmission projects and for revamping existing energy facilities to enable cleaner operation and to remediate associated environmental damage.
More Subsidized Lending
The Act authorizes another $40 billion for so-called section 1703 loan guarantees. These are loan guarantees, but are typically structured as direct loans from the Federal Financing Bank to finance projects that use innovative technologies. The new authority roughly triples the volume of available funding.
The Act also appropriates $3.6 billion to cover the credit subsidy cost for guarantees issued pursuant to the new capacity, resolving a "self-pay risk" that had discouraged use of the program for the past decade. Credit subsidy cost is basically a premium the borrower must pay to compensate the government for the risk that it might not be repaid.
Financing is subject to a requirement of no double dipping.
The Act also appropriates $3 billion to cover the credit subsidy costs of direct loans to finance new factories to make low-emissions vehicles and vehicle components. There is no cap on this type of federal lending. The program's existing $25 billion cap was repealed, permitting the program to lend whatever amount can be supported by the $3 billion credit subsidy appropriation.
The authorized capacity to make loans to finance energy projects for Indian tribes increased from $2 billion to $20 billion, supported by a $75 million appropriation for credit subsidy costs. Congress increased the maximum allowed guarantee percentage from 90% to 100%, which allows access to lower-cost financing.
The Inflation Reduction Act creates a new program to finance three types of energy infrastructure projects.
One type is projects that retool, repower, repurpose or replace existing energy infrastructure that has ceased operations. Another is efforts to enable operating energy infrastructure to avoid, reduce, use or sequester air pollutants or greenhouse gas emissions. The third type is projects to remediate environmental damage associated with energy infrastructure.
The Act authorizes up to $250 billion in loans for such projects, supported by an appropriation of $5 billion to cover the related credit subsidy costs.
Finally, the Act appropriates $2 billion to fund the credit subsidy costs of direct loans to build new transmission lines or to modify existing lines that have been designated by DOE as necessary in the national interest. No cap on the debt applies other than the amount that can be supported by the credit subsidy appropriation.
The key development in all this may be the $3.6 billion appropriation (less up to $108 million for administrative expenses) to fund credit subsidy costs for loan guarantees for energy projects that embody innovative technologies.
Borrowers from most federal lending programs never hear about credit subsidy costs since that fee, which is required to be paid as a risk premium to offset any expected losses to the government from making a loan or issuing a loan guarantee, is typically covered by funds appropriated to the lending agency.
Title XVII, as amended in 2020, now requires that fee to be paid by DOE with appropriated funds to the extent available or, if none is available, then by the borrower.
Since the September 30, 2011 statutory sunset of full funding of credit subsidy costs with appropriated funds under the American Reinvestment and Recovery Act in 2009, borrowers have had to assume that they would be responsible for paying the credit subsidy cost of a DOE-guaranteed loan, which cannot be paid with funds borrowed from or otherwise provided by the federal government. The credit subsidy cost became in effect an additional equity requirement payable at closing. Although credit subsidy calculations are not publicly announced, rumors have them ranging from as low as 0% for the Vogtle nuclear power project to above 30%. The risk of a substantial additional equity requirement was made all the worse because the amount required would not be known until shortly before financial close.
The Energy Act of 2020 amended title XVII to require the DOE to pay all credit subsidy costs to the extent that it had available appropriations.
The Advanced Clean Energy Storage hydrogen project in Utah, for which a $504.4 million DOE-guaranteed financing closed June 8 this year, was the first beneficiary of that amendment, but, without the Inflation Reduction Act, there would have been little appropriated funds remaining available to cover the credit subsidy costs for other projects. The fresh appropriation has taken this issue off the table.
Increased Lending Capacity
The several DOE loan guarantee programs have together carried roughly $40 billion in unutilized capacity — consisting of $22.4 billion for section 1703, $17.7 billion for advanced technology vehicle manufacturing (ATVM) and $2 billion for tribal energy projects — for more than a decade.
Until financings closed in recent weeks for the Utah hydrogen project and Syrah Technologies (in the ATVM program) and with the exception of three closings for the Vogtle nuclear power project, no section 1703 or ATVM financing had closed since September 2011.
No tribal energy project financing has ever closed.
Since Jigar Shah's arrival in March 2021 as executive director, the Loan Programs Office has worked aggressively to build a pipeline of qualifying projects, with so much success that concerns arose that the program's capacity would be insufficient to fund that pipeline. Trebling the available section 1703 resources — and apparently with flexibility to allocate those new resources as needed among the active solicitations for renewable energy and energy efficiency, fossil energy and nuclear energy — alleviates that concern.
The volume of loans and guarantees that can be supported by the new credit subsidy appropriations is necessarily uncertain, depending on the perceived riskiness of the financings. For the new title XVII appropriation to suffice to fund the new capacity fully implies an average credit subsidy rate of 8.73%.
That may be high. The new credit subsidy appropriation together with roughly $110 million (assuming for lack of a better number a credit subsidy cost of 10% for the Utah hydrogen project) could support the total authorized capacity, meaning the existing $21.9 billion plus the new $40 billion, at an average rate of 5.8%. This average may be in the right ballpark to support the authorized loans.
Before the Energy Act of 2020, DOE capped the self-pay amount of credit subsidy cost at 7%, promising prospective applicants that any credit subsidy cost above 7% would be covered by a small reserve of appropriated funds still available to DOE.
While the 7% cap applied, the question was raised whether this was more of a psychological than practical hedge, because the applicable credit subsidy cost for projects that received DOE support might well be expected not to exceed 7%. For lack of clear guidance of what the ultimate credit subsidy cost might be determined to be, 5% was a popular proxy for sponsors' modeling purposes. Even that 5% was often thought to be conservative, meaning there was cause to hope for a lower average rate. Still, if going forward 5% were the actual average credit subsidy rate, then the new section 1703 appropriation would suffice to support $69.8 billion in loan guarantees, meaning all of the new capacity plus $29.8 billion, which substantially exceeds the prior unused capacity.
Unfortunately, the Inflation Reduction Act appears to constrain use of the fresh title XVII credit subsidy appropriation to support the pre-existing authorization.
It provides that the new appropriation is "for the costs of guarantees . . . using the [new $40 billion in] loan guarantee authority . . . ." That could mean that the program once again has two tiers of capacity — the new authorization where the government pays and the pre-existing authorization where the sponsors are responsible to pay anything beyond the roughly $110 million unused credit cost subsidy. That would most likely result in the roughly $21.9 billion in capacity that has gone undeployed since the American Reinvestment and Recovery Act subsidy expired in 2011 continuing to go without takers, at least to the extent the existing minimal pre-Inflation Reduction Act credit subsidy appropriations are exhausted.
This constraint contrasts, and arguably conflicts, with the title XVII ammendments to the Energy Act of 2020, which provided that any credit subsidy cost would be paid by the government to the extent appropriated funds are available. ("Except as provided in paragraph (2), the cost of a guarantee shall be paid by the Secretary using an appropriation made for the cost of the guarantee, subject to the availability of such an appropriation.") The exception applies where "sufficient appropriated funds to pay the cost of a guarantee are not available."
So, what does "available" mean? Here, the program has potential extra appropriated funds available, but by the language in the Inflation Reduction Act, the extra funds may not be available to support the pre-existing $21.9 billion in unused title XVII capacity, even though it has the identical policy purpose as the new appropriation and expanded capacity.
It would be unfortunate for the program not to have the flexibility to use the new appropriation to support the full breadth of section 1703 capacity. Perhaps the new language can be interpreted in a way to provide it.
Cost of Funds
It will be interesting to see how another variable in all of this plays out.
The "credit-based interest spread" or, as now called by DOE, the "risk-based charge" is a new guarantee fee that arose in a 2017 update to the DOE loan guarantee rules. This fee, which ranges from 0% for a loan rated AA or higher up to 1.625% per annum for a loan rated B-, is to be paid periodically over the life of the loan.
This new fee was a throwback to an idea raised at the title XVII program's inception. The program's purpose is to provide financing notwithstanding innovative technology that could undermine the availability of commercial funding. The goal could have been to offer financing at rates that would correspond to commercial debt for non-innovative energy projects. Since the Federal Financing Bank provided loans at 37.5 basis points above the government's borrowing cost, which was cheaper than any commercial bank or bond market option, the staff considered imposing a guarantee fee to cover the spread between Treasury rates and commercial borrowing costs for comparable non-innovative projects.
Ultimately DOE decided against imposing such a fee, concluding that it should not undermine an apparent Congressional intention to subsidize innovative projects.
The consequence was a feeding frenzy of projects, many of which, at least once the financial crisis had passed, were solid candidates for commercial debt, but worked creatively to incorporate something innovative so as to qualify for the DOE program. This provided the DOE a pipeline of projects that were indeed innovative, but sometimes just barely.
The risk-based charge was initially opposed by prospective program participants who saw it as making the program more expensive. In fact, once the program had entered an era of self-pay for credit subsidy costs, a guarantee fee offered a potential advantage to borrowers. It offsets the credit subsidy cost, and a better reaction was that it enabled credit subsidy costs to be paid over time rather than up front, in effect financing at least some of it.
Although the models used by DOE and the Office of Management and Budget to determine credit subsidy costs are secret, the statutory basis for calculating the credit subsidy cost is not.
The credit subsidy cost is the projected cash flow out from the government because of a call on the DOE guarantee, minus expected receipts for fees paid to the government, plus estimated recoveries on a defaulted loan.
If a periodic guarantee fee were assessed and paid over the life of the loan, the present value of that projected payment stream would reduce the credit subsidy cost. A sufficient guarantee fee could totally offset the up-front payment of credit subsidy cost. Any such fee would at least reduce the amount of the credit subsidy cost payable at closing.
Whether the scheduled amounts would suffice to obviate the credit subsidy cost entirely seems doubtful, but any good sense of that would depend on its application in actual projects, and for the five years following the adoption of this fee, no deals under title XVII closed except for the Utah hydrogen project, but that closed in the wake of the direction in the Energy Act of 2020 to use all remaining appropriations to fund credit subsidy costs. Although no announcement was made, the DOE presumably paid a substantial part of its remaining $161 million credit subsidy appropriation to cover the credit subsidy cost for that financing.
How will all this work going forward?
The "new" guarantee fee may have been in the sponsor's best interest when faced with the up-front payment of credit subsidy cost, but the availability of appropriated funds to cover credit subsidy cost going forward will dispel any enthusiasm for that fee.
The original argument for a guarantee fee could still be seen to have policy merit. DOE will need to decide whether to offer borrowers the cheapest funding possible by foregoing that fee or possibly to reconsider whether the most efficient way forward is to offer innovative projects funding on terms that do not penalize the innovation, but that are not cheaper than non-innovative projects could achieve from banks or in the capital market. Stay tuned.
White House Oversight
The Inflation Reduction Act imposes new oversight by the White House.
The DOE loan guarantee programs have always required interagency input. Financing terms are run by the US Treasury for its blessing. The proposed credit subsidy charge has to be cleared by OMB just before closing.
The Inflation Reduction Act introduces a new layer of oversight from no less than the President of the United States. It provides that:
"None of the amounts made available under this section for loan guarantees shall be available for any project unless the President has certified in advance in writing that the guarantee and the project comply with the provisions under this section."
This raises two issues. One is complying with the relevant provisions. The second is obtaining the President's certification that you have done so.
As to the first, the relevant provisions consist of a broad prohibition against double dipping.
Projects receiving a loan guarantee should not benefit from any other "federal funds, personnel or property." The restriction, which first arrived in a 2009 appropriation, is both broad and fuzzy. For instance, every project receiving a loan guarantee will have benefitted from the time and effort expended by the federal personnel in the Loan Programs Office working on the transaction. Presumably that is not meant to be prohibited. Clarifications were needed in 2009 and have been repeated in the current law.
Specifically permitted — meaning excluded from the double-dipping prohibition — are tax benefits, use of federal land (where cash rent is paid at fair market value), use of transmission lines owned by the Tennessee Valley Authority or Federal Power Marketing Administrations and nuclear incident insurance. Federal grants are not carved out.
That could be problematic for the section 1703 program. DOE is an important source of grant funding for developing innovative energy technologies. Projects using the very technologies that were deemed worthy of grants could arise as good candidates for the section 1703 program, but be disqualified for double dipping. DOE's inclination in the wake of the 2009 appropriation was to interpret this restriction narrowly. If the grant went to one company, but the borrower of the DOE-guaranteed loan was, as it typically would be, a newly-established special-purpose project company distinct from the grantee, then the borrower had not itself received the grant and so no double dipping had occurred.
The lack of projects taking advantage of the 2009 appropriation has led to little development in the last decade of policies for interpreting this double-dipping limitation, but the program and the applicants have a shared interest in this provision not becoming an impediment to deserving projects, so ways forward will likely be found.
With respect to the second issue, how will the President be in a position to certify a project's compliance?
He or she will not be. With the legislation only hours old at the time of this writing, it is not clear how this will be managed. There is good precedent for such Presidential functions being delegated to a relevant Cabinet member. For example, the statute of the Export-Import Bank of the United States provides that the bank can only consider commercial aspects of a proposed loan unless the President specifically directs it to take into account certain policy concerns such as nuclear proliferation, chemical or biological warfare and environmental issues. The President delegated exercise of that authority to the Secretary of State, where it lies today.
Here, similarly, the responsibility that the Inflation Reduction Act assigns to the President could be delegated to the Secretary of Energy, who would make the necessary finding based on the diligence undertaken by the Loan Programs Office. This new interagency hurdle should be easily cleared.
The Inflation Reduction Act provided a fresh $3 billion (less up to $25 million for administrative expenses) appropriation to cover the credit subsidy costs of direct loans for advanced technology vehicles and their components.
It also removed the $25 billion authorization cap, so the $17.6 billion remaining from the original 2009 authorization of $25 billion is now moot. Under the Inflation Reduction Act, the DOE is free to provide as much financing as the available credit subsidy will support. The available credit subsidy consists of both the new $2.975 billion plus the amount remaining from 2009 appropriation, which was $4.2 billion before the recent $102.1 million Syrah financing.
Allocations of credit subsidy to individual transactions are not announced by DOE, but 25% might be a reasonably conservative guestimate for Syrah Technologies.
Congress assumed 30% when the program was established and it appropriated $7.5 billion to support a $25 billion authorization. The Congressional Research Service reports that $3.3 billion was used for the original $8.4 billion in ATVM loans that were made, which were the only loans made prior to Syrah Technologies. The average rate for those loans was a high 39.3%. Yet those loans were all made on the heels of the 2008 financial crisis, and $5.9 billion of the total $8.4 billion was allocated to a Ford Motor Company loan in September 2009, which, at the time, was widely seen as a bail out.
Today's environment for ATVM investments, an industry that has advanced in the decade since those original loans, is more propitious. Applying a probably conservative 25% credit subsidy rate to the Syrah Technologies loan would suggest a credit subsidy requirement of $25.5 million. Deducting that from the $4.2 billion in credit subsidy for the ATVM program remaining prior to that transaction, would suggest credit subsidy of about $4.175 billion remaining from the original 2007 appropriation. That, together with the $2.975 billion from the Inflation Reduction Act, suggests about $7.15 billion in credit subsidy available for ATVM loans going forward.
Just how much financing that credit subsidy amount will support depends on the projected riskiness of each transaction. The original Congressional expectation of 30% would suggest up to about $23.8 billion in available ATVM financing. An arguably more likely rate of 10% would imply up to $71.5 billion.
Whatever the average rate, the ATVM program has the capacity to be an important source of capital for converting the country to a cleaner transportation fleet.
Tribal Loan Guarantees
The tribal energy loan guarantee program offers loan guarantees for loans made to an Indian tribe or a "tribal energy development organization" to provide electricity on Indian land.
A tribal energy development organization is an organization that is wholly or partly owned by one or more Indian tribes and engaged in the development of tribal energy resources.
No loans have been made to date under this program.
A key impediment to this financing was a 90% cap on the amount of the guarantee. The Inflation Reduction Act eliminates that cap, which not only avoids commercial lenders accepting a degree of borrower risk in these loans but also opens the program to funding from the Federal Financing Bank, which reduces both fees and interest cost. These improved terms should make this program more effective.
The tenfold increase in the size of the program from $2 billion to $20 billion in the Inflation Reduction Act, with an additional $75 million appropriated to cover credit subsidy costs, may also help by encouraging larger projects.
The $75 million credit subsidy appropriation complements the original, unused credit subsidy appropriation of $8.5 million, resulting in a total credit subsidy cost budget of $83.5 million.
This would suffice to fund the credit subsidy cost for the $20 billion authorization at an average rate of about 4.2%. That might be on the low side, meaning that the program could run out of appropriated funds before it runs out of capacity. But this in any event provides for a substantial expansion of a program that has yet to close its first loan.
As with the section 1703 program, the term of these loans can be up to the lesser of 30 years or 90% of the projected useful life of major physical assets, and loans can fund up to 80% of eligible project costs.
These loan guarantees are also subject to the double-dipping limitation that applies to the section 1703 program, the new section 1706 guarantees, and the new transmission facility financing program.
The Inflation Reduction Act establishes a new "section 1706" loan guarantee program to offer financing to clean up existing energy infrastructure used for generating or transmitting electricity or producing, processing and delivering fossil fuels, fuels derived from petroleum or petrochemical feedstocks.
It offers loan guarantees for up to 30 years for projects that do one of three things.
One is to retool, repower, repurpose or replace energy infrastructure that has ceased operations. To qualify, any fossil-fuel power plant must "avoid, reduce, utilize, or sequester air pollutants and anthropogenic emissions of greenhouse gases."
Another type of undertaking that will qualify for a section 1706 loan guarantee is one that enables operating energy infrastructure to "avoid, reduce, utilize, or sequester air pollutants or anthropogenic emissions of greenhouse gases."
Projects to remediate environmental damage associated with energy infrastructure also qualify.
The $5 billion of credit subsidy appropriated to support the authorized program ceiling of $250 billion suggests an average credit subsidy cost rate of 2% to support the authorized amount fully.
This seems low. This program is likely to run short of credit subsidy appropriation before the ceiling is reached. There is plenty of money to test whether the program can be effective. If it proves itself, then credit subsidy appropriations can always catch up.
Unlike the section 1703 program, there is no innovation requirement. However, these guarantees are subject to the same double-dipping restriction as the section 1703 program.
The Inflation Reduction Act includes a $2 billion appropriation to fund the credit subsidy costs of direct loans for the construction or modification of electricity transmission facilities that have been designated by DOE as necessary in the national interest.
That appropriation was made without a corresponding maximum authorization, so DOE is free to lend as much as that credit subsidy appropriation will support, which suggests up to $20 billion if the average credit subsidy cost rate is 10% or twice that if the average rate is 5%.
The program is for "non-federal borrowers," which means that state and local government borrowers as well as private entities would qualify.
These loans are to be on "such terms and conditions as the Secretary determines to be appropriate." However, as with the section 1703 program the loan term cannot be longer than 90% of the projected useful life of the financed facilities and in no event longer than 30 years.
The loan cannot exceed 80% of project costs.
It cannot be subordinate to other financing, and the same double-dipping restriction will apply.
All loans must be fully disbursed by September 30, 2031.
Like other programs that provide access to Federal Financing Bank funding, applicable interest rates will be a small margin above the US Treasury's borrowing cost for obligations with similar average maturities.
This new funding is in addition to the up to $5 billion in loan guarantees for high-voltage direct current (HVDC) systems, transmission to connect offshore wind and facilities sited along rail and highway routes that DOE announced in April as available from the section 1703 program in combination with the tribal energy loan guarantee program.
The statute does not specify where within DOE this program should be housed, but, given its nature as a credit program whose terms mimic the section 1703 program and the existing transmission project loan program, it belongs in the Loan Programs Office and so presumably its implementation will be assigned there.
Applications for section 1703 financing are made pursuant to detailed outlines provided in three outstanding solicitations. One is focused on renewable energy and energy efficiency projects, one on fossil-fuel energy projects and one on nuclear energy projects. The solicitations can be found at https://www.energy.gov/lpo/services/solicitations.
The process for applying for the new section 1706 program remains to be determined by DOE, but it is likely to follow a path similar to that for section 1703, subject to three requirements specified in the statute.
The three requirements are the applicant must submit a detailed plan describing the proposed project, an analysis of how the proposed project will engage with and affect associated communities, and, if the applicant is an electric utility, an assurance that the utility will pass on any financial benefit from the guarantee made under this section to the customers of, or associated communities served by, the electric utility.
The transmission facility financing application process remains to be announced, but it can be expected to parallel the DOE's other loan and loan guarantee programs.
The DOE Energy Infrastructure Grants
The DOE has traditionally provided grants to support energy-related research.
Recent legislation has provided very substantial grants to support the construction of clean energy infrastructure. Such grants authorized last November by the Infrastructure Investment and Jobs Act are currently being offered for competitive application on the web page of the DOE Energy Efficiency and Renewable Energy (EERE) office.
The Inflation Reduction Act adds to that by offering grants for plant and equipment in support of reducing greenhouse gas emissions from transportation and industrial production. Each recipient will be required to fund at least 50% of the relevant project's cost.
Reducing Factory Emissions
The Inflation Reduction Act appropriates $5.812 billion (less $200 million reserved for administrative expenses) to fund financial assistance (including not only grants but also potentially direct loans, rebates or cooperative agreements) on a competitive basis to carry out projects to accelerate progress to net-zero greenhouse gas emissions for domestic, non-federal, non-power industrial or manufacturing facilities engaged in energy-intensive industrial processes, including retrofits, upgrades and operational improvements and related engineering studies.
DOE will prioritize projects based on the extent of expected greenhouse gas emissions reductions, the extent to which the project would provide the greatest benefit for the greatest number of people in the general vicinity of the facility, and whether the recipient participates, or would participate, in a partnership with its customers.
The Inflation Reduction Act provides DOE with $2 billion for grants to manufacturers to fund a portion of the costs of projects for the domestic production of efficient hybrid, plug-in electric hybrid, plug-in electric drive, and hydrogen fuel cell vehicles and their respective components. Priority will go to the refurbishment or retooling of manufacturing facilities that have recently ceased operation or will cease operation in the near future.
Applications will be pursuant to information provided on a portal maintained by DOE's "EERE Exchange" (located at https://eere-exchange.energy.gov). Interested parties need to register, which will provide access to current funding opportunity announcements. Grants offered by the Infrastructure Investment and Jobs Act are there now. The Inflation Reduction Act grants can be expected to follow in due course.