Whatever disagreements exist about other aspects of the U.S. response to climate change, everyone seems to agree that new, carbon-reducing technologies are required. However, both utility regulators and Wall Street bankers are generally reluctant to take the risk associated with first-of-a-kind technologies for large energy installations. Thus, in the Energy Policy Act of 2005 (EPAct 2005), Congress created a federal loan guarantee program for clean energy projects that employ innovative technologies.
In 2006, Congress gave the Department of Energy (DOE) $2 billion in loan guarantee authority for the program; in 2007, that amount doubled, even though the program was stalled by the lack of implementing regulations;1 for FY 2008, DOE has sought $9 billion.2 A significantly larger program will be required in future years if loan guarantees are to bring transformational energy technologies to market.
DOE’s recently issued Final Rule on the loan guarantee program3 does not solve all the problems industry and Wall Street had identified. However, it favorably resolves some key issues concerning eligibility and loan structure so that the program can now move ahead.
In its Notice of Proposed Rulemaking (NOPR), DOE suggested that it would: 1) limit guarantees to no more than 90% of any debt instrument, 2) prohibit “stripping” the guaranteed portion of any such instrument from the non-guaranteed portion for syndication or resale, and 3) require that DOE have the first lien on all project assets pledged as collateral for the guaranteed loan. Numerous commenters had argued that the loan guarantees would be unusable with those conditions because, they said, no market exists for a hybrid instrument composed of roughly 90 percent federally guaranteed debt and roughly 10 percent debt that is non-guaranteed, subordinate, and, therefore, high risk.
In the Final Rule, DOE changed all three conditions. First, it stated that it would eliminate the 90 percent cap and would consider guarantees up to 100 percent of a debt instrument, although it did not commit itself to guaranteeing 100 percent of every debt instrument covered by the program. In cases where 100 percent of a debt instrument is guaranteed, DOE further stated that the debt will be issued and funded by the Treasury Department’s Federal Financing Bank, not by commercial lenders. Second, in cases where it guarantees 90% or less of a debt instrument, DOE eliminated the prohibition on stripping the guaranteed from the non-guaranteed portion of the debt. When DOE guarantees more than 90 percent of a debt instrument but less than 100 percent, however, the prohibition on stripping remains.4 And, finally, irrespective of the level of guarantee, DOE stated that it would no longer insist that the non-federally guaranteed portion of project debt be subordinate to the guaranteed portion. Instead, DOE maintained that it would retain control over the disposition of assets in the case of failure to repay, but that it would enter a pari passu structure with other lenders with regard to ownership of collateral assets in the event of default.
Although DOE may guarantee up to 100 percent of a given debt instrument, the EPAct 2005 limits loan guarantees under the program to 80 percent of Project Costs. Therefore, DOE also considered what, if any, constraints it might impose on the remaining 20 percent of financing. DOE did not impose a hard numerical floor on the equity contribution of project sponsors, but it stressed that it would take the type and degree of equity contributions into account when deciding which projects to select. In addition, unlike the NOPR, the Final Rule does not characterize other federal assistance as a negative factor, but merely states that it will consider whether and to what extent the applicants rely on other federal assistance in making its selections.5
Under the EPAct 2005, projects may be eligible for loan guarantees if they “(1) avoid, reduce, or sequester air pollutants or anthropogenic emissions of greenhouse gases; and (2) employ new or significantly improved technologies as compared to commercial technologies in service in the United States at the time the guarantee is issued.”6 In the Final Rule, DOE clarified ambiguities in the second of these requirements. DOE stated that it would consider applications for projects using existing technologies, so long as those technologies are not currently in general commercial use in the United States for that purpose and significantly improve upon comparable technologies that are in general commercial use.
On the question of what it means for a technology to be in “general use,” DOE created a bright line rule: a technology is in general use if it is being used in three or more commercial projects in the United States, in the same general application as the proposed project, and has been in service in each such project for at least five years.7 DOE rejected the option – left open in the NOPR – that technologies would be considered in general use merely by virtue of having been ordered by several facilities, even if they were not yet operational. Since operational risk is of paramount concern to most lenders, DOE’s final definition of general use fits well with the loan guarantee program’s underlying purpose of eliminating barriers to the financing of innovative clean energy technologies.
Use of Appropriated Funds, Credit Subsidy Costs, and Credit Ratings
The good news in the final rule on the structuring of loans and eligibility criteria is somewhat offset by some difficult issues that the rule does not resolve dealing with the availability of funding for the loans, the so-called “Credit Subsidy Cost,” and credit rating requirements.
EPAct 2005 states that loan guarantees must be either backed by appropriated funds or by payments from the borrower for the full cost of the obligation.8 Because DOE has not sought and does not intend to seek appropriated funds, the Final Rule requires all guarantee recipients to pay a fee to cover the administrative costs of the program and a Credit Subsidy payment intended to compensate DOE for the expected cost of its guarantee. DOE has stated that the Credit Subsidy Cost for a loan guarantee will reflect the “net present value of estimated payments from the government (e.g., default claim payments) and to the government (e.g., recoveries), discounted to the point of disbursement.”9 Industry asked for, but did not receive clarification as to how DOE intends to make this determination. Although it will calculate the Credit Subsidy Cost on a case-bycase basis, DOE has stated that it is working on a methodology that will allow project sponsors to estimate their subsidy costs in advance. It also stated that it will make preliminary Credit Subsidy Cost estimates available around the time projects are selected. Nevertheless, given the uncertainty about how it will be estimated, the Credit Subsidy Cost looms as an important question mark for loan guarantee applicants.
The Final Rule is clear about two details relating to Credit Subsidy Costs. First, the Final Rule makes clear that administrative fees and Credit Subsidy Costs will not constitute Project Costs for the purposes of the program’s 80 percent limit, in effect prohibiting selectees from paying these fees out of guaranteed funds. Further, the Final Rule requires that, for projects costing more than $25 million, project sponsors must acquire a credit rating from a nationally recognized agency evaluating the quality of project debt in the absence of any federal guarantee. DOE explained that it would factor in such ratings when deciding among projects and when calculating each project’s Credit Subsidy Cost. The difficulty with this aspect of the rule is that the premise of the program is that the projects are not financeable without the loan guarantee because lenders will have difficulty assessing their technology risk. Thus, it is doubtful that a rating that assumes away the loan guarantee will be meaningful.
Initial Loan Guarantee Applicants Selected
In 2006, before it issued its NOPR, DOE solicited pre-applications for its first round of loan guarantees. It received 143 pre-applications for the $2 billion in available loan guarantee authority. However, Congress directed DOE not to proceed until it issued its Final Rule. When it issued the Final Rule, DOE also invited 16 of those pre-applicants to submit full applications. Those 16 include: 4 cellulosic ethanol projects; 2 advanced diesel fuel projects; 3 integrated gasification combined cycle plants, 2 of which will be carbon capture ready and the third will gasify coal to produce both power and methanol; 2 industrial efficiency projects (a paper manufacturer and a maker of energy efficient windows); 2 solar projects, (including a photovoltaics maker and a developer of a concentrated solar power facility), an electricity delivery project, a hydrogen fuel cell project, and an alternative fuel vehicle project.
Those not selected in the initial pool of 16 or who have yet to apply must wait for the next formal solicitation from DOE. The timing for that is unclear, although the nuclear industry, which was excluded from the first round, is pressing DOE to move ahead promptly.