2010 is shaping up to be an interesting year for developing and financing power projects that use biomass as feedstock. On the one hand, private capital raising for biomass projects continues to be challenging, creating further pressure on biomass developers to structure “clean” projects -- investors and lenders fund projects with the strongest combination of long-term, fixed-price fuel supply arrangements (historically, perhaps the most challenging issue for biomass projects), take-or-pay power purchase arrangements and other project contracts that favorably allocate risk to experienced and creditworthy project counterparties. On the other hand, the Obama administration has announced its support for bioenergy and has introduced or advanced a number of government funding programs and incentives that hold great promise for the financing of all kinds of bioenergy projects, including biomass power projects.
One of the most obvious factors compelling new biomass power project development this year is that, to be eligible for the cash grant program under the American Recovery and Reinvestment Act of 2009 (Stimulus Bill), biomass projects must meet a deadline currently requiring that, at a minimum, plant construction start by the end of 2010. Another very recent development of impact to both new and existing biomass power plants is the issuance in early February of proposed regulations implementing the Biomass Crop Assistance Program (BCAP). BCAP offers certain payments to eligible biomass suppliers and producers in order to stimulate the availability of biomass crops as fuel supply for bioenergy production. There are certainly a number of other government funding opportunities that may be available to certain biomass power projects, including, for example, Department of Energy (DOE) and US Department of Agriculture (USDA) loan guarantee programs, Rural Energy for America Program (REAP)1 grants and various state incentives. However, current developments or deadlines relating to the cash grant and BCAP make these two in particular worth a further look as sponsors, investors and lenders search for ways to move new projects forward or improve returns on existing projects.
Cash Grant Expiration
Much has been written regarding the US Treasury’s cash grant program for eligible generating facilities, but as 2010 progresses, the focus for many developers will turn to making sure that a plant commences construction by the end-2010 deadline in compliance with the relevant guidance, and determining what federal tax incentives remain available for projects that miss the deadline.
First, a bit of background. The Stimulus Bill provides qualifying biomass power projects (and other renewable energy generation projects) with the option to forgo production tax credits and instead receive an investment tax credit for 30 percent of eligible project cost or a cash grant from the US Treasury in an equivalent amount. For biomass projects in particular (compared to other renewable technologies like wind), this is a substantial additional subsidy. “Open-loop” biomass projects,2 which currently comprise most of the operating biomass projects in the US, qualify for only half of the value of the production tax credit for wind, but the Stimulus Bill made open-loop biomass eligible for the full investment tax credit and the equivalent cash grant that is available to other technologies (equal to 30 percent of eligible project cost).
In recent years, renewable project developers unable to efficiently use the benefits of the production tax credit have successfully monetized the tax credits by transferring them to “tax-equity investors” -- banks and other institutional investors with a large amount of taxable income to offset -- in exchange for upfront project capital. However, the credit crisis left only a handful of tax-equity investors able to use the tax credits. The cash grant program offered a solution to this problem by funneling cash directly to the project developer and eliminating the need to find tax-equity investors to gain some benefit from the tax credits. However, the cash grant was intended to be a temporary stimulus measure that would be phased out by certain deadlines as the financial markets re-gain strength. For biomass projects, the current cash grant program deadline requires that a project must either be placed in service by the end of 2010 or must commence construction by the end of 2010 and be completed by the end of 2013.
In July 2009, the US Treasury released detailed guidance on what “commence construction” means for this purpose. A cash grant applicant qualifies if it can show that “physical work of a significant nature” has begun. Physical work of a significant nature is not preliminary work such as planning, designing or clearing, but rather foundation work or other physical construction activity. However, there is some vagueness around how this standard might be applied, so developers should try to fit within a better-defined safe harbor. The guidance also includes a safe-harbor if a developer incurs at least 5 percent of the total project cost (excluding preliminary activities that precede construction, such as planning and design) and work for such payment is completed.
However, there are questions even around the safe harbor, in particular concerning the situation where a developer hires a third-party contractor to commence assembly of the plant off-site. Developers targeting the 5 percent safe-harbor should plan on leaving a margin for error (e.g., meet the test by incurring not less than 7 to 8 percent of eligible project cost in case, for example, Treasury rejects developer’s classification of certain costs as eligible costs). Treasury intends to issue, perhaps as early as this March, additional guidance that will address a number of the most common questions that have been raised. In any event, developers that hope to qualify for the cash grant, but currently anticipate the start of plant construction in the latter part of 2010 or early 2011, should carefully review their specific construction plans with their advisers to ensure the project will commence construction in compliance with the guidance and thereby meet the deadline.
Biomass power developers also need to confirm that their project meets other eligibility requirements for the cash grant program, in addition to considering whether a project can meet the construction commencement deadline. For example, among other requirements, a power plant must generally use or comprise new equipment in order to be considered qualified property. This is particularly relevant to a number of utilities and developers considering the conversion of existing coal-fired plants to biomass-fired plants as a way to comply with anticipated carbon legislation and state renewable portfolio standards. Such projects qualify for the cash grant only if the developer spends so much on upgrades that it is considered to have built a new plant under detailed standards set out by the Internal Revenue Service (IRS). Coal plants that undergo minor retrofits in order to co-fire with biomass generally won’t meet the standard.3 As a general matter, the amount spent on upgrades must be at least 80 percent of the sum of the value of the used equipment retained from the old facility plus the amount spent on upgrades.
Developers with projects that simply can’t meet the current cash grant deadline obviously are not eligible for the cash grant. These projects at least have certainty that federal tax credits will be available to qualifying projects that are placed in service during the next few years. In addition to establishing the options for eligible generating facilities to take the investment tax credit or cash grant rather than production tax credits, the Stimulus Bill extended the deadline to qualify for the tax credits. Under the relevant provisions of the Stimulus Bill, biomass projects must now be placed in service by the end of 2013 in order to qualify for production tax credits or the investment tax credit.4 This is some comfort for developers of projects that can’t meet the cash grant deadline. However, assuming (as is likely the case) that such developers cannot efficiently use tax credits themselves, they would have the risk that, when their project is ready, tax equity will not be available to them on reasonable terms and pricing. This is not a small risk.
In addition to concerns about the volume of available tax equity in general, most biomass projects seeking tax equity face the additional problem that tax equity financing (with its attendant transaction costs and potential complexity) typically makes more sense for larger utility-scale projects that are better able to bear such cost. Most biomass projects face a natural limit on size due to the prohibitive cost to source biomass fuel if it is transported from beyond a limited radius around the plant. In addition, since the cash grant is payable within 60 days of the later of the date the grant application is received or when the project is placed in service, and the investment tax credit is not realized until the project tax return is filed for the year the project was placed in service (which may be up to a year later for a project placed in service early in the year), the investment tax credit is likely worth slightly less than the cash grant due to the time value of money.
Developers that can’t meet the current deadline still may be in luck. A bill is advancing in Congress that in lieu of the cash grant would give developers of otherwise qualifying renewable energy generation projects that commence construction in 2011 or 2012 a tax refund equivalent to the cash grant amount. However, it is not certain at the date of this writing if the cash grant program will be so replaced and extended (or even permitted to expire), or what the new rules are that would attach to this “refundable grant.” Given this uncertainty and the other clear benefits of electing the cash grant over tax credits described above, biomass developers that have a realistic chance to meet the current cash grant deadline (and are otherwise eligible for the grant) should consider making an aggressive push to meet the safe harbor for commencing construction and to make the necessary filings for the grant as soon as possible.
Another recent development that may provide a boost to biomass power project financing is the advancement of BCAP. Section 9001 of the Food, Conservation and Energy Act of 2008 (2008 Farm Bill) authorized BCAP. BCAP provides funding for two main activities. First, agricultural and forest land owners and operators can receive matching payments for eligible biomass material (this includes most non-food biomass) sold to qualified biomass conversion facilities. These facilities include not just power generating plants, but also any qualifying project that converts renewable biomass into heat, power, bio-based products, advanced biodiesel or certain advanced biofuels. This is known as the Matching Payment Program. Second, producers of eligible renewable biomass crops within specified project areas can receive funding of not more than 75 percent of the cost of establishing eligible woody and non-woody perennial crops and annual payments for up to 15 years for production of such crops. This is known as the Establishment and Annual Payment Program. All of the BCAP payments are intended to induce the establishment and production of certain eligible biomass crops and the collection, harvest, storage and transportation of such materials for use in qualified biomass conversion facilities.
As noted, BCAP was originally established by the 2008 Farm Bill, but it required further implementing rules. The Obama administration has aggressively accelerated this program.
In May 2009, a presidential directive was issued to lay the groundwork for investment in and production of biofuels and specifically targeted the expeditious issuance of guidance on BCAP. Soon after the presidential directive was issued, funding and interim rules were established for the Matching Payment Program, but not the Establishment and Annual Payment Program, pursuant to a notice of funding availability (NOFA).
In early February 2010, another major step was taken as the Commodity Credit Corporation (CCC) issued a Proposed Rule to implement BCAP in its entirety. However, in connection with the issuance of the Proposed Rule, the USDA terminated funding for the Matching Payment Program under the NOFA and indicated that new applications will not be accepted until the final rule is issued. The Proposed Rule is subject to a 60-day period for public comments that ends in early April and to potential revision based on the comments. It is not yet clear based upon the Proposed Rule who the Matching Payment Program “winners” and “losers” will be under the final rule. The Proposed Rule seeks comment on three different options for payments under the Matching Payment Program, each of which creates different incentives for different types of biomass-based projects.
The first option is to provide matching payments as currently provided under the NOFA at the rate of $1 for each $1 per dry ton paid by a qualified Biomass Conversion Facility (BCF) to agricultural and forest land owners and operators for eligible material sold and delivered to such BCF. Such matching payments would be limited to a maximum of $45 per dry ton of eligible material delivered, and a time period of two (2) years from the date the first payment is made. The matching payments also would be subject to a further limit, in the case of a BCF that converts wood wastes or wood residues into heat or power for its own use. In this instance, matching payments would be payable only for such wood wastes or wood residues that are converted by the BCF to heat or power above a historical baseline of the amount of heat or power the BCF produces for self-use. This option generally treats different biomass uses the same, but with perhaps some incremental advantage to uses other than heat or power that are not subject to the self-use carveout.
The second option is a tiered approach providing that the maximum rate of $45 per ton is available only to agricultural and forest land owners and operators that deliver materials to BCFs that convert eligible material to advanced biofuels. In the case of BCFs that convert eligible material to renewable energy or biobased products rather than advanced biofuels, the biomass providers would remain eligible for the $1 for each $1 per dry ton paid by the BCF, but subject to proposed cap of $16 per dry ton. This option specifically encourages the use of biomass for advanced biofuels production over other uses.
The third approach is to vary matching payments to encourage additional biomass consumption above a historical baseline. The matching payment at the rate of $1 for each $1 per dry ton paid by the BCF would be reduced in the case of facilities that do not increase renewable biomass consumption over the historical baseline. It is not certain if this option favors one biomass usage over others, but compared to the first two options described above, it seems to favor new facilities (whether greenfield or conversion projects that change fossil fuel input to biomass feedstock) over existing biomass projects. In the case of many existing biomass facilities that had qualified for 2009 matching payments under the NOFA rules, under this last option the payments to suppliers to such facilities would likely be subject to reduction. Another important limitation in the Proposed Rule that was not in the 2008 Farm Bill is that vegetative waste materials like wood waste and wood residue are not eligible materials for matching payments to the extent they would be used as inputs for higher value-added products except for the matching payment. This change is to address complaints from certain wood product producers (such as fiberboard makers) that without this limit the payments would artificially divert waste wood to bioenergy projects and create a supply shortage for the wood product industry.
In the case of both the Matching Payment Program and the Establishment and Annual Payment Program, there are numerous additional eligibility and qualification requirements not addressed in detail here. For example, before any payment can be made, the project (or in the case of the Establishment and Annual Payment Program, a project area) must be qualified by the submission of detailed information to the local Farm Service Agency and both the project and the various biomass material producers and suppliers may need to enter into certain agreements with the CCC.
BCAP is anticipated to be most helpful to projects already in operation or that are already in development and economically viable before taking into account BCAP payments. In fact, the eligibility requirements for the Establishment and Annual Payment Program gives the CCC discretion to choose projects that can best demonstrate long-term economic viability and financing commitments without BCAP. BCAP may not make a non-economic project viable, but this program certainly has potential to create additional opportunities and options in terms of fuel-supply structuring, thus addressing a critical risk for biomass project developers trying to solidify financing arrangements.
1 Rural Energy for America Program, formerly known as the “§9006” program, was enacted in the 2008 Farm Bill and administered by the US Department of Agriculture. For more information, visit: http://www.rurdev.usda.gov/rbs/farmbill/.
2 “Open-loop” biomass is defined in the Internal Revenue Code generally as organic agricultural or cellulosic waste material, but excluding “closed-loop biomass” (which is biomass planted exclusively for use at a qualified facility to produce electricity) and excluding biomass used in conjunction with fossil fuel (co-firing).
3 There is an exception for certain facilities that use “closed-loop” biomass to co-fire if the modification is approved under the Biomass Power for Rural Development Programs or as a pilot project of the Commodity Credit Corporation.
4 It is not likely that any “open-loop” biomass projects would elect the production tax credit as opposed to the investment tax credit. As mentioned above, open-loop biomass qualifies for only half of the value of the production tax credit for wind, but the Stimulus Bill made open-loop biomass eligible for the full investment tax credit and equivalent cash grant that is available to other technologies, equal to 30 percent of eligible project cost.