New Grants and Loan Guarantees in the Energy Bill

New Grants and Loan Guarantees in the Energy Bill

August 01, 2005

The new energy bill that President Bush signed on August 8 offers project developers a number of interesting financing and funding opportunities such as loan guarantees, production incentives, grants and other forms of financial support.

There are subsidies for clean coal and coal gasification projects, new hydroelectric facilities added to existing dams, ethanol projects that use cellulosic biomass or sugar — rather than corn — as the feedstock, biofuels projects and integrated-gasification combined-cycle power plants. Some of the subsidies will help pay the capital cost of the projects. Others are operating cost subsidies.

The energy bill merely “authorizes” the US Department of Energy to help private developers pay the cost of these types of projects. There is a two-step process in Congress before a government agency can actually spend money. First, the spending must be “authorized” as has been done in the energy bill. Second, the money must then be formally “appropriated” in a later appropriations bill. The energy bill is only the first step of the process.

This does not necessarily apply to the loan guarantees. Although the government might end up having to spend money on account of a guarantee, the Department of Energy can start making the loan guarantees described in the energy bill without waiting for an appropriation if the borrower whose loan is guaranteed pays the government for the estimated losses the government may incur as a consequence of a loan default.

Ethanol

The energy bill authorizes the US Department of Energy to guarantee repayment of loans to build new plants for making ethanol and other byproducts with commercial potential from municipal solid waste or cellulosic biomass. Ethanol is a fuel that can be used directly in vehicles or blended with gasoline. The “municipal solid waste” whose use the loan guarantees are supposed to encourage is refuse from waste treatment and waste supply plants and other solid, liquid or gaseous material resulting from industrial, commercial, mining and agricultural activities. It does not include domestic sewage refuse. “Cellulosic biomass” is any organic matter available on a renewable basis, including, in addition to municipal solid waste, trees, wood and wood residues, plants, grasses, agricultural residues, other fibers and animal waste.

The federal government will guarantee up to 80% of the cost of each project but, there is no limit on the amount of debt the government is authorized to guarantee per project or under the entire program.

Each applicant will have to show that his or her project cannot be financed on reasonable terms without the guarantee, that there is reasonable assurance of repayment — collateral valued for at least 20% of the amount of the loan is required — and that the loan bears a reasonable rate of interest. The loan cannot have a term longer than 20 years.

In addition to the construction financing program just described, the energy bill also directs the Energy Department specifically to guarantee up to four demonstration projects to show the commercial viability of producing ethanol from cellulosic biomass or sucrose. One of the four projects must use cereal straw and another one must use municipal solid waste as feedstock. Each project should be able to produce at least 30 million gallons of ethanol each year. Each such guarantee cannot exceed $250 million per project and can cover up to 80% of the estimated cost of the project. The remaining 20% of project cost must be covered by equity commitments.

Finally, the bill also authorizes loan guarantees of up to $50 million per project for financing up to 80% of the estimated cost of projects to produce ethanol from sugar cane, bagasse and other sugar cane byproducts.

Other Renewables

Biofuel and hydroelectric projects also qualify potentially for federal funds.

The federal government will provide grants for integrated biorefinery demonstration projects to be selected by the Department of Energy. Total grants under the program are limited to the following amounts: $100 million in 2007, $125 million in 2008 and $150 million in 2009.

The department is supposed to look for projects that use a wide variety of feedstocks and apply biomass technologies for a variety of uses, like making liquid transportation fuels, high-value biobased chemicals and substitutes for petroleum-based feedstocks. Projects selected should be able to operate without direct financial assistance after construction and be of a type that can be easily replicated. These are demonstration grants and not operating subsidies.

The energy bill gives the Department of Energy separate authority to provide operating subsidies — called “production incentives” — to companies that produce cellulosic biofuels. “Cellulosic biofuels” are fuels that are produced from cellulosic feedstock such as residue from trees and plants, grass or industrial waste. A cellulosic biofuels producer qualifies for the incentives as long as he or she is located in the United States, meets all permitting requirements and satisfies certain financial criteria to be established by the Department of Energy.

The production incentives are expected initially to be an amount per gallon of cellulosic biofuels, with the amount still to be determined. They will then shift to a reverse auction system. The first reverse auction will be held one year after the first 100 million gallons of cellulosic biofuels have been produced in the United States, but no later August 8, 2008. A reverse auction works as follows. Bids are solicited from producers for the amount of production incentive they require on a per gallon basis in order to produce an estimated annual output in gallons. The bid for the lowest level of production incentives on a per-gallon basis will be the first to receive an award; the second lowest bid will receive another award and so on. Each recipient will receive the performance incentive requested in the auction for each gallon produced and sold by a project during the first six years of operation.

The awards will be limited as follows: not more than 25% of the funds committed within each reverse auction can go to a single project, not more than $100 million may be spent on production incentives in any one year and not more than $1 billion may be spent over the lifetime of the program (which has not yet been determined).

Hydroelectric projects that are put into service in the next 10 years might qualify also for production incentive payments from the Department of Energy.

To qualify, the new plant must generate electricity for sale and be an addition to an existing dam or conduit. The dam or conduit must not require any enlargement of impoundment or diversion structures to install the new turbines. The amount of the payment is 1.8¢ per kilowatt hour (adjusted for inflation beginning in 2006). The payments run 10 years after a project is put into service, but cannot exceed $750,000 per project per calendar year.

Fossil Fuels

The energy bill authorizes a series of grants, loan guarantees and other assistance for projects that use fossil fuel.

The United States has more than 500 billion tons of coal reserves out of which 275 billion tons are considered economically recoverable. These reserves are sufficient to satisfy US coal demand for the next 200 years at current levels of consumption.

The bill gives the Department of Energy authority to make grants to coal gasification projects. Total grants cannot exceed $200 million a year over the period 2006 through 2014. The bill gives examples of the types of coal gasification projects that Congress has in mind. They are combined cycle, fuel cells and turbine combined cycle, coproduction, hybrid gasification and combustion projects. The Energy Department will set minimum emissions and thermal efficiency levels that projects will have to meet in order to qualify for funding.

There is no set minimum or maximum dollar amount for each grant, but the federal government will fund only up to 50% of the cost of a project. The rest must come from non-federal sources unless the Energy Department determines that the project will only get built, given the technological risks, with a larger share of federal funding. In general, the department will be looking for projects that reduce gasification costs, improve the competitiveness of coal vis-à-vis other fuels, and demonstrate methods and equipment that could be applied to at least 25% of US power plants. The bill also authorizes loan guarantees for at least five petroleum coke gasification projects. No other details are given for this program.

Assuming money is appropriated, the bill directs the Department of Energy to make a grant for a coal integrated gasification demonstration project in a western state that is 4,000 feet above sea level. The project must show that it is able to use a variety of coals mined in the western United States and with different energy contents (from 9,000 to 13,000 Btus). A separate “rifle shot” provision in the bill directs the department to provide loan guarantees for an  integrated-gasification combined-cycle, or IGCC, power project with a capacity of at least 400 megawatts that will produce power at competitive rates in a deregulated market.

The bill also includes “rifle shot” loan guarantees for a coal-fired power plant to be built in the upper Great Plains with a heat rate of less than 7,000 Btus/lb and that uses advanced integrated-gasification combined-cycle technology. The project that Congress had in mind will combine production with wind and other renewables, minimize or sequester emissions of carbon dioxide and provide hydrogen for nearby fuel cell demonstrations. It is expected to produce at least 200 megawatts of electricity at competitive rates and meet the same technical criteria as for clean coal power projects.

Finally, the bill authorizes the Department of Energy to pay up to 50% of the cost of clean coal projects. The department is authorized to make grants or loans or enter into cooperative agreements. It will come up with criteria to qualify. Priority will be given to projects that use equipment and processes that have been developed and applied but are not yet cost competitive.

Technological Innovation

The bill creates another new loan guarantee program to help finance energy projects that avoid, reduce or sequester pollutants and gases emitted by power plants and other sources by using innovative technology. “Sequestration” is the process of capturing and permanently isolating gases and other emissions that otherwise would be released into the atmosphere. Sequestration projects that use currently-available technology are expensive. The goal of the program is to encourage development of new or significantly improved technology that will bring down the cost.

Congress identified 10 categories of projects across a wide ambit of energy sources and carriers that are eligible for the loan guarantees: renewables, fossil fuels, nuclear energy, hydrogen fuel cell technologies, carbon capture and sequestration, efficient electrical and end-use energy technologies, facilities for fuel efficient vehicles, pollution control and oil refinery projects. Gasification projects are also mentioned as potential beneficiaries. Four types of gasification projects qualify: integrated combined-cycle projects, industrial gasification projects that gasify coal, biomass or petroleum coke to produce synthesis gas for use as fuel or feedstock, petroleum coke gasification projects and coal-to-oil liquefaction projects.

The federal government will guarantee up to 80% of the project cost. There is no limit on the individual or total amounts that will be guaranteed under this program; however, the term of each loan being guaranteed cannot exceed the lesser of 30 years or 90% of the projected useful life of the physical assets being financed.

How Will Guarantees Work?

The new federal loan guarantee programs will have the same structure as private sector guarantees: the federal government, acting through the Department of Energy, will guarantee payment of certain debt obligations owed by a borrower to a lender. The guarantee will be backed by the full faith and credit of the US government. This ought to let the project borrow at a government borrowing rate.

Many guarantees are issued by parent companies for the debt of their subsidiaries (the so-called downstream guarantees) or by affiliates of a borrower (cross-stream guarantees). When the guarantee is issued by a party unrelated to the borrower, such as in the case of a federal loan guarantee, the guarantor usually requests assurance of repayment of the underlying loan. Many times reasonable assurance of repayment can be obtained from a borrower’s income stream as well as from the collateral pledged as security for the loan. As with all guarantees, if the borrower fails to pay the debt when due, the lender can demand payment from the guarantor, in this case the federal government. After paying on the debt, the federal government “steps into the shoes” of the lender and has the right, among other things, to recover from the borrower.

It is common in federal loan guarantees to request the borrower to pay a fee in consideration for the government’s guarantee commitment and also to cover its administrative expenses. Also, in many cases the terms and conditions of the underlying loan agreements cannot be changed without the consent of the federal government. All these rights and duties will be negotiated in the guarantee agreement.