Bogged Down

Will improvements to the U.S. DOE's Loan Guarantee Program be enough to drag cellulosic projects out of the financing muck?
By Kris Bevill | December 27, 2010

Descriptions of the U.S. DOE Loan Guarantee Program range from "promising" to "complete failure" depending on who you ask and whether they are applicants in the program. Renewable Fuels Association President Bob Dinneen speaks passionately on the topic and has consistently called out the DOE for unresolved problems within the program. The rigorous application process clearly puts cellulosic biofuel projects at a disadvantage, he says, and makes it nearly impossible for first-of-a-kind projects to be commercialized. The bill "is largely seen as a complete failure to date in terms of bringing next generation biofuel technologies to the marketplace," Dinneen wrote in a September blog post confronting the DOE. The RFA has repeatedly called for the program's reform, but has received little response from the DOE.

Applicants such as BlueFire Renewables Inc. and Fulcrum BioEnergy Inc. have the most hands-on experience as cellulosic producers attempting to acquire financing, but they hold back from publicly criticizing the program while their applications are still pending. What they will say, however, is that they remain hopeful their applications will be accepted and that the November advancement of Fulcrum's application to the term sheet negotiation step is a promising sign for the cellulosic industry.

"The DOE program is a very valuable program to kick off this new industry of ethanol production," says Rick Barraza, vice president of administration at Fulcrum. "It's been a lot of hard work to apply but I think the DOE has been cooperative. It's a very rigorous program and is a lot of work for companies. We think we were successful with DOE because we came to the table with a very attractive project for a number of reasons." Fulcrum has applied for approximately $70 million from the loan guarantee program, 60 percent of the project's total cost. The proposed Sierra Biofuels Plant near Reno, Nev., is expected to produce 10.5 MMgy of municipal solid waste-based ethanol and will also produce 16 megawatts of electricity. The company filed its initial application for a DOE loan guarantee in 2009. The second part of the application was filed in early 2010. In order to advance to term negotiations with the DOE, Fulcrum had to acquire long-term feedstock and offtake agreements, prove its gasification technology to the DOE, sign a contract with an engineering, procurement and construction firm, acquire the necessary permits for construction and show proof of equity capital. "It's been a long and hard effort with the DOE and we're glad we're to this point," Barraza says. "We realize there is more to do and we are not done, but we've reached an important milestone."

"That was, I would suspect, one of the highest rated projects DOE had," BlueFire CEO Arnie Klann said shortly after Fulcrum's term sheet announcement in November. "My feeling is if [the DOE] got that one out, I would hope that they could get the rest out by the end of the year. We're hopeful that we'll be next." In mid-November, BlueFire was working through the initial due diligence phase and had acquired all of the environmental permits necessary for its proposed 19 MMgy wood waste-to-ethanol plant in Fulton, Miss. BlueFire is seeking $215 million from the DOE to fund its $296 million construction contract.

The Process Slog

The initial DOE loan guarantee program, Section 1703, was created in 2005 in order to support technologies that reduce greenhouse gas emissions. In 2008, the American Recovery and Reinvestment Act included funding for a new loan guarantee section, Section 1705, with the goal of financing clean energy projects that would otherwise have a difficult time acquiring funding due to the collapsing credit market situation. Very few applications have been filed for Section 1703, most likely because the applicant would be required to pay for any credit subsidy costs associated with approved loan guarantees. The 1705 program, however, does not require the applicant to pay for credit subsidy costs. During testimony given to the Senate energy committee at a September hearing, Jonathan Silver, executive director of the DOE's loan program, said the agency had issued four conditional commitments under the 1703 program and 10 under the 1705 program since 2008. Combined, the commitments represent $13 billion in loan guarantees. None of the commitments were made to biofuels projects.

Before a loan guarantee can be granted, applicants must pass an extensive six-step process which includes project summary reviews, due diligence and term sheet negotiations, credit analysis and review, deal approval, post-conditional commitment due diligence and financing negotiation and, finally, closing. "By better leveraging our existing resources and re-engineering our processes, we have been able to significantly reduce the amount of time it takes to review applications, to expedite the transaction approval process and to provide greater transparency in our work," Silver told the senators. "Over the last few months, we have significantly improved the pace at which we are processing transactions, and aim to do even better."

Tim Newell, senior advisor at U.S. Renewables Group, a private equity firm that has invested in Fulcrum and other renewable projects, testified at the September Senate energy committee hearing and commended Silver and the loan guarantee office for its progress. "Our firm has experienced its own share of frustrations, especially early on when the program was critically hampered by a lack of personnel generally, and a lack of seasoned project finance professionals," he told the senators. "Over the past year, my firm has seen a major transition in the operation of the DOE loan guarantee program under Jonathan Silver, including the much-needed attention of seasoned project finance professionals with extensive energy financing experience. The proof of that change is striking." Newell said it previously would not be uncommon for his firm to wait at least three months for the DOE to approve a simple project summary. In August, however, the DOE approved a Part 1 application in just six days. "That is progress you can measure," he added.

Federal Favoritism

According to the RFA, these slight improvements are a positive step, but major modifications still must be made in order for the loan guarantee program to provide the assistance for which it was designed. Of particular concern is the required long-term off-take agreements and feedstock supply contracts. This step unfairly favors power generation projects over fuel projects, according to Dinneen. "Anyone even tangentially aware of fuel markets knows this is simply not how fuel markets operate," he says. "The markets for electricity and fuels function differently. As such, the loan guarantee program must reflect these differing real-world circumstances in determining the qualifications of various applicants. We can't bury costs in a rate base and we don't have long-term supply agreements. As long as the DOE loan guarantee program is going to ignore the realities of fuel marketing, and hold to a risk assessment equivalent to that of any private sector bank, it will not be the tool Congress intended to assist emerging technologies over the investment valley of death."

Fulcrum and BlueFire have managed to sign offtake and supply contracts, but not without struggle. Klann says creating and finalizing such agreements without an estimated financing approval date has been the most difficult aspect of the application process thus far for BlueFire. "That's been the hardest hurdle in the essence of getting everything to work together time-wise when one of the biggest pieces, which is the loan guarantee program, is not nailed down."

RFA points out that the program, which was designed to help commercialize risky, innovative technologies, includes a requirement for some applicants to provide data from a commercial-scale facility. This requirement is nearly impossible for applicants who are applying for funding specifically so that they can scale-up their projects from demonstration to commercial scale.

Another irony of the program is that it was created to provide financing to projects that would otherwise have difficult accessing capital, yet the program itself is running short on capital. In 2009, approximately $2 billion was redirected from the loan guarantee program to pay for the Cash for Clunkers program. In 2010, Congress approved the transfer of another $1.5 billion from the loan program to state budget accounts. "That $3.5 billion, assuming the DOE had this program operating appropriately, which it does not, would have financed up to a dozen commercial-scale cellulosic and other next-generation ethanol projects," Dinneen says.

In Newell's testimony to the Senate committee, he said it appears the Office of Management and Budget initiated the transfer of funds away from the loan guarantee program and that the agency is overstepping its administrative role in the loan guarantee process. U.S. Renewables Group has determined that if all projects that were in the due diligence phase in August were approved, the loan guarantee program's entire budget would be used by February, seven months before the program is scheduled to end. "Renewable energy trade associations and members of Congress are still seeking to fully understand OMB's role in evaluating these applications and why OMB appears to be a major cause of delay in issuing these guarantees," Newell said in his testimony. "OMB's level of involvement and review times appears to exceed that of other federal loan guarantee programs."

Other Options

The USDA's loan guarantee program appears to be increasingly viewed as the best alternative for federal financing of cellulosic projects. BlueFire filed an application with the USDA in August as a direct result of the DOE's program delays, according to Klann. "We have two bites at the apple, so to speak," he says. "We're hoping for either a USDA or a DOE guarantee." Klann says the USDA already has a proven track record funding biofuels projects, (it approved loan guarantees previously for Range Fuels Inc. and Sapphire Energy Inc.) whereas the DOE has yet to complete a biofuels application. "The USDA knows how to manage risk," he says. "I believe they may be more adept at managing risk than the DOE. But from a financial standpoint, the DOE appears to be better." The DOE's loan guarantees offer a lower interest rate and direct lending, which means less negotiating with private banks, he says.

During comments made to attendees at the Cellulosic Biofuels Summit held Nov. 15-17 in Washington, D.C., Dinneen also praised the USDA for its role in providing assistance to cellulosic producers. "There is clearly more hope for the USDA's loan guarantee program," he said. "Secretary [Tom] Vilsack and Under Secretary [Dallas] Tonsager are committed to seeding investment and appear willing to accept a few inevitable failures in order to assure the desired successes. But even with that program, the influence of bean counters at OMB could ultimately undermine the program's intent."

Legislative reform may be the only way the DOE loan guarantee program can achieve widespread success. An Oct. 25 memo sent to President Obama from Carol Browner, the assistant to the president for energy and climate change, Ron Klain, chief of staff to vice president Joe Biden, and Larry Summers, White House economic advisor, stated their belief that the program is valuable enough to be extended past its scheduled expiration date of Sept. 30, 2011, but extensive reform is also necessary.

Silver has also reportedly admitted that a necessary overhaul of the loan guarantee program will only be possible through legislation. But while loan guarantees can certainly play a vital role in advancing risky technologies such as cellulosic biofuels, Silver pointed out in his Senate testimony that they shouldn't be considered the only option for advancing these technologies. "It is important to recognize that the loan programs represent only one of a variety of potential approaches to providing federal support for clean energy," he said. "We must think about enabling private sector clean energy financing in a comprehensive manner, ensuring that our limited resources are deployed in the most effective and coordinated manner. Only then will we be able to create an environment where the private sector will invest in clean energy technologies at a scale needed to reach our national clean energy goals."

Author: Kris Bevill Associate Editor, Ethanol Producer Magazine (701) 540-6846