Biofuels Digest Special Report on Financing Waste to Energy
SECURING FEEDSTOCK, PROVING TECHNOLOGY, AND PARTNERSHIPS KEY TO MITIGATING INVESTMENT RISK
by Biofuels Digest special correspondent Mackinnon Lawrence
With persistent uncertainty acting as an anchor on the market, renewable energy projects are facing low tolerance for risk and limited liquidity at a time when promising projects require significant capital infusions. This makes life especially difficult for project developers seeking to bridge the “Valley of Death” and take promising new solutions to market. In the waste to energy (“WTE”) space, where projects often must coordinate the interests of several stakeholders, overcome entrenched environmental interests, and win significant financial support, moving solutions forward can prove especially difficult.
Infocast’s Waste to Energy Finance & Investment Summit: Converting municipal solid waste to power, steam, and fuels offered advice for project developers seeking to blaze a path through the uncertainty. The summit featured speakers from international law firms, investment banks, and government officials as well as panelists offering project developer, municipal, and utility perspectives covering topics ranging from emerging technologies, project financing mechanisms, and policy updates.
The State of Waste
James Thompson of Waste Business Journal kicked off the summit with a keynote address that focused on the increasing commercialization of landfilling. He noted that, while the overall number of operating landfills in the US has declined in the last couple decades, the opening of “mega-landfills” has drastically reduced the cost of landfilling waste. As waste is shipped further distances, municipalities are looking to move out of the landfilling business. Meanwhile, the private sector has increasingly taken over control of transfer stations and infrastructure.
With waste increasingly shipped longer distances, one of the biggest challenges project developers face is securing a steady and consistent source of local feedstock. This is made more difficult by the fact that waste streams have shrunk in recent years (e.g. 20% in New England). While this may be a product of the economic times, there is little argument that landfill capacity is also on the decline in the US. With this, comes higher tipping fees, especially in the Northeast and Pacific regions of the country, which, as Thompson noted, can create tremendous opportunity for WTE projects. Project developers were advised to secure long-term contracts for waste (20 years ideal) and use tipping fees as a main source of revenue.
Technology and Permitting
Opinions on what constitutes a proven technology varied among speakers as different thresholds for measurements are used. In today’s cash-starved investment climate, demonstration facilities that are already up and running, positive assessments from engineering consultants, and operating a facility for several months can be instrumental in assuaging investor concern. Ken Alexander, a Partner at Chadbourne & Parke, advised developers to “keep it simple” as new (unproven) technologies are having trouble getting funded right now.
One of the difficult issues project developers face is the chicken and egg dilemma raised when securing both permits and financing. Since the EPA can take at least two years to approve permits, and it can be expensive to work through the permitting process locally, it is best to have financing secured to carry the project through. This is a tougher reality in today’s market, where institutions may be hesitant to invest in a project that may ultimately never secure permitting. To get around this, the panel advised seeking out reputable strategic partners and using political consultants that understand the lay of the land to educate policymakers and overcome NIMBY challenges.
Financing Strategies
On the subject of financing WTE projects, Ken Alexander pointed out that with the loan market currently shutdown, finding equity to back WTE projects can prove especially difficult. As a result, Alexander notes, institutional players are focusing on heavily distressed pre-crunch secondary markets rather than new deals due to the higher yields offered. And increasingly, club deals (associations of banks) have emerged as the preferred method for equity infusions. Under this scenario, Alexander advises project developers negotiate down to the lowest common denominator within the group.
Alexander also highlighted important considerations for project developers when deciding between private equity partners and strategic investors. Generally, private equity partners will often build management teams after making an investment and favor a quick liquidity event to cash out on their investment. Project developers looking at a strategic partnership, on the other hand, should approach the process as though they’re “interviewing for marriage,” and look for a good, established management structure already in place. Where private equity partners will seek out a portfolio of three to five projects, strategic investors will commit to more long-term arrangements and build value in one project. The drawback is that it can be difficult for one of the partners to cash out since there is a higher likelihood of a partner getting attached to the project.
Alternative sources of funding discussed at the summit include DOE loan guarantees, investment tax credits, and bond financing. Interestingly, a panel featuring project developers were split on whether DOE loan guarantees (details yet to be released by the agency) offer a viable financial mechanism for moving projects forward. While they may provide the lowest cost source of funds, it is unknown whether the opportunity will even be available. Referred to as gravy for WTE projects, carbon credits and RECs were discussed with measured optimism since they are not sufficient to finance projects alone. And carbon regulations lack legislative consistency so it can be difficult to rely on a price of carbon for financing purposes.
Joint Ventures
Though usually avoided due to document complexity and difficulty, Michael Moyer, a Partner in the law firm, Wilson Sonsini Goodrich & Rosati noted that joint ventures (“JV”) between feedstock providers and technology suppliers are a preferred strategy for WTE projects. But while a JV arrangement can create owner operator upside for all JV partners and mitigate risk for underperformance, they can also involve many challenges that must be worked around to preserve the benefits. On the subject of JVs, Moyer covered four specific issues: financing, management, control, and liquidity.
Financing a project can raise many challenges for the JV partnership, including maintaining ownership and control, deciding whether to raise finance from a JV partner as opposed to additional capital contributions, debt versus equity considerations, impacts on distribution waterfall, and tax issues related to unequal contributions.
Management issues include the potential for deadlock between partners with 50/50 relationships and difficulty in establishing a budget process that allows for project development predictability while also protecting against poor investment. A JV must also grant management the day-to-day authority necessary to succeed while also securing adequate oversight to ensure that projects are executed. Some of the contracting tools that should be considered in order to maintain control in the arrangement are buy-out provisions to remove unmotivated JV partners IP protections, non-compete clauses, and maintaining the ability to do business outside of the partnership.
Liquidity events also raise many issues for JV deals. Moyer advises aligning liquidity objectives of the JV partners to avoid being “captured” or the target of a “flip” by using “drag along,” “tag along,” or “ROFR” (right of first refusal) provisions as well as structuring liquidation waterfall and dissolution provisions to properly incentivize each JV partner.
Federal Perspectives and the Promise of WTE
Speaking on behalf of the EPA, Dr. Robert Wayland, Leader of the Energy Strategies Group, and Rick Brandes, Chief of the Energy Recovery Branch for the refocused Office of Resource Conservation & Recovery, offered insight into how changing regulations will affect the WTE industry.
Dr. Wayland explained that changes to Section 129 of the Clean Air Act, which covers solid waste combustion and requires the EPA to regulate nine pollutants, will seek to advance efforts to reduce chemicals at all lifecycle stages, increase energy and materials conservation, and mandate the reuse of byproducts. He also assured the audience that the EPA will propose language that will remove NIMBY issues for WTE projects in proposals coming out later this year.
Wayland emphasized the importance of WTE in meeting US’ future electricity generation needs. Citing the need to reduce the volume of landfill waste, the fact that the US is heading toward a carbon constrained regulatory environment, and mounting problems with more traditional electricity generating sources (e.g. environmental challenges to coal, peak oil, draught limiting hydro capacity, and natural gas heating demand), he argued that the window is open to replace more coal plants with MSW-fed generation facilities.
Brandes focused his talk on the increasingly polarized debate between opponents and proponents of WTE among states, the Federal government, and in NGOs.
He explained that, in the energy recovery opposition camp, “incineration” is viewed as worse than landfilling. Opponents argue that it creates a “toxic soup” that will “poison the world,” restricts composting and recycling programs, undermines zero waste efforts, impacts GHG reduction efforts by releasing SOX and NOX, has a worse carbon signature than recycling, and leads to adverse environmental justice impacts. He argues that these views are stuck in the 1970s.
Proponents, on the other hand, argue that MSW can produce clean power for an energy hungry world. It also provides better lifecycle GHG reductions and enables recovery of materials that would otherwise be lost. Brandes points out that MSW consists of 56-66% biogenic material, a fairly consistent number across the US, which means that it is mostly a renewable resource. “Mostly” is the key point — under the Waxman-Markey bill, there is a debate brewing between the House on one hand, who’s bill only allows the biogenic fraction of incinerated waste to be called “renewable,” and the Senate on the other, whose Committee on Energy and Natural Resources recently designated all MSW as renewable.
Brandes wrapped up with a pragmatic admonition, if the Waxman-Markey bill passes, financial incentives will be provided for WTE projects. If not, the future is uncertain, as no new WTE facilities have been constructed for over 15 years.
Crossing the Valley of Death
From the muni and utility perspectives, WTE features as an important strategy for supplying base load electricity, diverting waste from landfills, and meeting RPS standards.
A panel of experts from the muni camp stressed the need to get demonstration projects up and running to assuage public skepticism as well as overcome the “incinerator in disguise” moniker that WTE projects are slapped with. The panel pointed out that a major obstacle to increased uptake of WTE facilities is the false view that recycling programs and WTE are in direct conflict. In all cases, Damon Taam, Systems Contracts Manager at Spokane Regional Solid Waste System in Washington, argued that recycling and WTE have proven mutually beneficial. The panelists stressed the importance of educating the public about the sustainable, renewable, and economic benefits of locally based WTE facilities.
Representatives from Sacramento Municipal Utility District (“SMUD”), Baltimore Gas & Electric Company, and Dominion Resources, Inc. were asked how WTE plays into their respective renewable strategies. All acknowledged that waste and biomass are considered priority resources for meeting their respective RPSs and represent vitally important, locally-available base load renewable feedstock sources.
Elaine Sison-Lebrilla, Senior Project Manager for SMUD’s Advanced Renewable & Distributed Generation Program, explained that the publicly-owned utility relies heavily on locally-produced dairy, waste, forest, and agricultural waste to meet one of the country’s most aggressive RPS targets. John Rigone, Director of New Projects at Dominion, which is located in Virginia, explained that although the utility is required to meet a relatively mild RPS standard, it is looking into forest waste products to ramp up renewable base load generation capacity. Sheldon Switzer, Director of Pricing & Tariffs at Baltimore Gas & Electric, pointed out that the penalties for not meeting RPS targets does not create adequate incentives for investment in WTE projects at 1.5-4 cents per kWh versus 45 cent penalties per kWh for solar.
Conclusion
Despite recent economic troubles, a panel of project developers from WTE companies offered a favorable outlook on the current market conditions for WTE and assured the audience that, despite institutional risk being low, money is still available for good projects. Among the keys to securing financing commitments and moving projects forward: locking up a long-term feedstock supply, utilizing proven technologies, starting the permitting process early, and finding strategic partners with clout.
Mackinnon Lawrence is a principal with Biomass Advisors, a bioenergy consulting firm
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