Financing a Biomass Project When Commercializing New Technology

November 22, 2018 |

By Glenn Farris, Member of Lee Enterprises Consulting, Inc.
Special to The Digest

If you are planning to develop, or are already developing, a biomass to energy project involving the commercialization of new technology, you have a tough job in front of you. Financing a biomass-to-energy project is never easy, especially when commercialization of new technology is involved. Unless your company has a large and healthy balance sheet or enough cash to self-finance the project, in which case a lot of this article will not apply, you will be looking for financing. This can take many forms and may involve a search for both equity and debt. Depending on the project’s Technology Readiness Level, see CJ Evan’s series of articles on government funding.

This article explores through the eyes of your potential lenders or investors what they will be looking for in the due diligence process. If you are properly prepared, and understand your tasks, it can at least be made a little easier. We are making one obvious assumption: that the projections of profitability in your proforma are solid and fact-based, i.e., there is enough engineering for a qualified EPC contractor to estimate a price for construction. You also will have solid contracts and facts behind the estimated feedstock pricing and there are contracts for the offtake of whatever product you are producing. See Lawrence Bauer’s article in this series on technical due diligence for related guidelines and also Jess Hewitt’s article on off-take agreements.

Both equity investors and lenders will want to see the same thing; therefore, we will use the term investor for both. Additionally, investors seek a return commensurate with the risk they perceive. If you can prepare for and mitigate the risks of the project in the development stages, you will move much more quickly through the process towards a financial close.

The financing for which you are aiming can take many forms. You might be looking for a US Department of Energy or Department of Agriculture loan guarantee. I have seen biomass energy projects be a part of a municipal bond financing or a corporate bond offering. You might sell limited partnerships. This is all incidental because the underwriting processes, no matter what the financial avenue, will be pretty much identical. It is always about verifiable documentation for every part and phase of the project.

There are essentially four key components of a biomass project; the feedstock supply chain, the new technology you are commercializing, balance of plant and the off-take plans. The investor will have no problems with balance of plant. The balance of plant is well understood and involves off-the-shelf equipment. It could be power generating equipment like steam or gas turbines, bag houses for particulate matter control or fermenting columns. This equipment will have a low threshold of technical understanding and the off-take structure is straightforward. However, it is not so with the biomass supply chain and the new technology.

For each component of the project, you must be able to address the following:

  • Define the risks in each part of the project and make sure your team has the expertise to define not only what could happen but the likelihood that it will happen;
  • Specifically identify how you plan to mitigate the risks;
  • Identify the consequences associated with the risk;
  • Identify any monetary damage that could be associated with the risk.

You should be specific with your risk mitigation plans.

It is always advisable to get out front when addressing these risks because it shows you are on top of the project and understand what is at stake. If you have not addressed the risk associated with each part of your project, the investor will read this as real weakness with your development team. Figure 1 is a rendering of a project planned in Florida and Table 1 is the risk matrix for just the environmental permits necessary for this development.

Almost all major projects using biomass in an energy conversion scenario will require one or more federal permits. This will trigger a National Environmental Policy Act (NEPA) study. The most significant risk associated with a NEPA is if a FONSI (finding of no significant impact) is not issued and a full EIS (environmental impact statement) is required, there will be a significant negative effect on the timeline and budget.

Additionally, for this type of project, an investor will expect to see a similar table for the PPA (purchase power agreement), LGIA (large generator interconnection agreement), feedstock supply agreements, the site itself and other site agreements (easements and right-of-ways), other contracts (partnership agreements, fuel supply agreements, tax agreements, etc.), O&M and Commissioning, engineering and EPC, insurance, and financing. On the positive side, this evaluation can be performed while the project is being developed and can be a very positive experience. It will show that you are firmly in control of the project and truly appreciate what an investor needs to know. This effort will help develop stronger team members, especially those that are newer to project development and financing.

Two project areas require further discussion; feedstock supply and technology commercialization risk. This is where most projects using biomass and new technology get sidetracked, bogged down, and cause them to never get funded or built.

New technology risk can be the easier to successfully underwrite, depending on several factors. Several issues must be addressed. The most significant concerns the novelty of the technology – the more “black box”, the more carefully the technology must be explained: is it based upon similar methods used with other products? For example, when the concept of cellulosic ethanol first appeared, fermenting to produce alcohol was well understood and therefore represented low technical risk. The part that was new involved the new enzymes and microbes that had to be developed to release the sugars from these novel materials for fermenting. However, verifiable and repeatable data can be studied, and the case made for the successful use of these materials to produce ethanol. This technical underwriting was not easy but easier than other technology scale-up such as gasification.

Early in its life, gasification of biomass required multiple engineering studies. It had to be shown to operate for significant hours at demonstration scale. If you were trying to scale up greater than few times to one this was also seen as an exorbitant risk. From time to time, insurance companies were willing to underwrite a technology performance guarantee for this type of technology. However, this is not always a dependable avenue for risk mitigation.

The last major part of the puzzle is your feedstock and the supporting supply chain. For the most part there is no existing commodities market or logistics system that supports the biomass to energy sector.

The exception to this is the corn grain market, which was able to provide for the very rapid growth in the starch or grain ethanol business. When this business grew from 1 billion gallons in 2001 to just over 10 billion in 2010 there was a complete support system for the raw material, corn. We knew how to grow it, store it, dry it and if you needed to buy a million bushels there was a market where you could go to buy it. You could argue that there is a better general understanding for projects that use woody biomass due to the long history of the forest products industry and this is true. Unfortunately, this is not the case with ag residues and purpose-grown crops like miscanthus or switchgrass. Yet this is many times the largest expense and risk to the project; the feedstock cost may be a greater proforma cost line item than debt service or labor.

Historically, the supply chain and handling system for feedstock is where biomass projects fail. The lack of a large-scale logistics system for the supply chain has been a drag on the growth of this industry.

Most of these materials are in the hands of individual farm or timber owners. There are very few bankers or financing underwriters with experience or expertise to underwrite this risk. The plan for this part of the project must be air tight.

You very possibly will have hundreds of individual contracts to manage; there must be a collection system with a packaging plan in place with dozens of seasonal employees; potentially dozens of storage sites; a trucking operation that will involve thousands of trips; and very few companies or individuals with any experience to call upon for help that have actually successfully performed or managed such a logistics system at commercial scale.

Your plan must address oversupply as well as undersupply. On a positive note, there is work being done and information available about current best practices to let you know how to achieve a high quality and sustainable feedstock supply for your project. The consultants at Lee Enterprises Consulting can provide that expertise.

The problems associated with the handling of the feedstock materials once they get inside the project fence are also not yet well understood. The good news is that there are many R&D projects by USDOE, USDA and private industry groups that are making strides in identifying and closing these gaps.

Finally, you need a contingency plan to address the unforeseen circumstances that happen in every project that aren’t in the plan. Financing a biomass to energy project is difficult but doable for those of you that pay attention to the details, think like an investor and are creative, innovative problem solvers.

About the author

Glenn Farris, Principal of Farris Advisory Services, is a member of Lee Enterprises Consulting, the world’s premier bioeconomy consulting group, with more than 100 consultants and experts worldwide who collaborate on interdisciplinary projects, including the types discussed in this article. The opinions expressed herein are those of the author, and do not necessarily express the views of Lee Enterprises Consulting.

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