“Rocks, again” for biofuels: new capital structures needed for new times?

November 1, 2012 |

Better routes to capital formation may offer routes to a better world.

(Lucy, Charlie Biofuels, and their friends go trick-or-treating on Capitol Hill.)

All: Trick or treat!
(all get their bags filled)

Coal producer: I got five pieces of candy!
Oil producer: I got a chocolate bar!
Natural gas producer: I got a quarter!
Charlie Biofuels: I got a rock.

(they go to the next office)

All: Trick or treat!
(all get their bags filled)

Afghanistan: I got a candy bar!
Egypt: Boy, I got three cookies!
Pakistan: Hey, I got a package of gum!
Charlie Taxpayer: I got a rock.

With the arrival of Hallowe’en comes the end of Advanced Biofuels Markets as companies return from San Francisco to the daily work of building transformative companies.

Inevitably – since Hallowe’en coincides with election time, there has been a lot of talk at ABM around the policy instruments by which renewable fuels might be advanced.

Tax credits, loan guarantees, mandates, subsidies, and grants have been popular with project developers. Increasingly less so with Congress and the general public — and for the renewables industries, of late the news out of Washington has been generally bad.

For the Charlie Brown of renewables, advanced biofuels, it has been a steady diet of “rocks again” from DC and other capitals.

One reason for all the bad news – a renewed emphasis on parity pricing and performance, instead of green premiums. Customer groups such as airlines and the US Navy have clearly communicated that they may pay a premium for fuels used in testing and certification, but not in the long-term for everyday operations.

Sounds pretty fair.

The waning love for green premiums

The tepid enthusiasm for green premiums has been leaking into the public sector. These days, policymakers who once dished out $7500 electric car tax credits like drunken sailors, these days focus short-term supports that help companies each economies of scale.

At the same time, interest in the sector has been increasing among strategic investors. Just this week, Bunge invested in Cobalt Technologies and Novozymes invested in Beta Renewables.

Yet, for all the signature investments in biofuels, it has been an equally great period for capital formation in the world of fossil oil & gas. For example, the Wall Street Journal reports that $34 billion was invested in the oil and gas industry in Q1 of this year alone.

How much of that oil wealth would remain untapped — were Master Limited Partnerships, accelerated depreciation and techniques such as volumetric production payment unavailable to the oil & gas industry?

Some, far from all.

Oil production rarely is financed simply via securitizing the equipment used to lift crude oil out of the ground — there’s simply not enough value in the steel. Ultimately, the wellflow is the asset that is subject to a mortgage.

Similarly, and for the same reasons, it is tough to finance, say, algae biofuels via securities on the equipment used to manufacture fuels and chemicals from CO2, sunlight and water. There’s simply not enough value in the steel.

Parity financing helps with parity price

So, while we chat about parity price and performance, we might also chat about parity financing instruments. In Congress, there has been a huge amount of chat about closing tax loopholes for the oil and gas industry. Facing headwinds, renewables supporters have lately shifted tactics. Instead of closing loopholes, broadening them to include “all of the above” energy sources?

For that reason, it’s worth spending some time looking at the techniques of capital formation in oil & gas. For one, let’s look at volumetric production payments.

What are VPPs? As Wikipedia notes:

“A volumetric production payment deal is a means of financing that has been used in the oil and gas industry for several decades. A VPP involves the owner of an oil and gas property selling a percentage of their production in exchange for an upfront cash payment.

“In the oil and gas industry Chesapeake Energy is the most visible user of VPPs, having raised around $5 billion in operating capital since 2008 without creating debt on its books or diluting shareholders by issuing more stock. Under a VPP a bank or hedge fund actually purchases and receives title to a portion of the mineral reserves in an oil and gas lease or group of leases.”

By contrast, today most biofuels producers sell equity and issue debt – the former highly dilutive to earlier-stage investors, and the latter generally unobtainable (without loan guarantees) except at ruinous interest rates.

Ruinous interest rates lead to unfinanceable projects, or unaffordable fuels — as the cost of capital itself becomes and unsustainable component of the cost of fuels.

Now, VPPs – these are just an example. There may prove to be others better suited to the task. But it illustrates the principle of porting successful financing techniques from the old world to the new.

Better capital formation, and the better world

In this way, parity leads to parity. Parity policy can drive parity price. Parity price leads to increased capacity and production, and increased energy security. Less economic exposure, for example, to instability in the Middle East.

A part of the world where, to use an example, US diplomats have been coming up with “rocks again” for decades.

Suggesting that we might take of the ingenuity that we have been expending on restructuring the Middle East, and expend it instead on restructuring the financing of energy. Better routes to capital formation may also offer routes to a better world.

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