The BB Gun – the DOE’s “BB” rating requirement blasts diversity in clean energy development

In Washington, the US Department of Energy is requiring that to receive DOE loan guarantees renewable energy projects meet a debt rating standard higher than 63 percent of all US corporate first-time debt issuers since 2007 in order to qualify for renewable energy loan guarantees. Affected is the Section 1705 loan guarantee program. The section 1703 program, which does not require a specific credit rating but projects must go through a preliminary rating process. The Section 1703 program was described by investment bankers as “of not great interest to the banking community due to the risk.”

Congressional legislation for DOE loan guarantees typically require “reasonable prospect of repayment of the principal and interest on the obligation by the borrower.” The Department of Energy is generally left with the responsibility of interpreting “reasonable”. In this case, the DOE, as advised by investment banks, has developed minimum threshold for loan guarantees of a “BB” or higher rating (prior to the guarantee).

According to Standard & Poor’s, 333 of all US corporate first-time issuers since 2007 – out of a total of 528, failed to meet that standard. In many cases, these issuers would not have been attempting to bring transformative technologies to the market in support of a national energy policy based on what EPA Administrator Lisa Jackson said was designed to produce “green jobs, innovation and technology, and action on global climate change.”

According to David Jacob, Executive Managing Director and Head of Structures Finance Ratings for Standard & Poor, ratings for renewable energy projects range from BBB- to CCC, with a preponderance of ratings weighted towards CCC, or two ratings below the threshold set by the DOE. Jacob was speaking at a recent meeting on energy finance in New Jersey.

Is there a disconnect between Congress, DOE, and renewable energy developers?

Based on the current requirements of the DOE, Van Ness Feldman partner Curt Rich told the Algal Biomass Summit, “no biofuels projects as currently structured will meet the requirements for a loan guarantee.”

Greg Burkart, managing director of financial advisory and investment bank Duff & Phelps, agrees. “When you slap a preliminary credit rating of BB – you are going to rule out cxertain projects that are using technologies with risk.”

Burkart explains that the DOE has made attempts to improve the chances that transformative technologies — for example, cellulosic ethanol — can get financed. For example, the DOE structured two loan guarantee solicitations — a first, aimed at projects with newer or significantly improved technology. A second, released this month, focused on projects with technologies already in general use.

This year, the DOE changed the definition of “in general use” to shorten the required period from five years to two years. Burkart said that “there were a lot of questions as to why that period was shortened. It’s possible that the DOE is trying to move more rapidly from successful demonstrations to qualifying projects as “commercial technology”.

But, according to Burkart, “The lending community is not actively pursuing” financing opportunities in the first solicitation, for transformative technologies. “They think the first has too much risk. DOE has to provide more at-risk capital for the riskier endeavors. Those need equity. Look at the successful efforts in the build up of lithium-ion battery technologies. None of them got debt – they were not viable in the debt market.

“For example, one lithium ion battery project got $290 million from the DOE, and $120 million in refundable tax credits from the state of Michigan, out of a $440-$450 million project. Other states have good financing programs, also. Missouri has a transferrable credit.  New Mexico had a cash grant program with $1 billion in the fund. Texas had $350 million in an Enterprise fund.”

In addition, investment bankers point to a perception vs. reality problem in financing bioenergy projects.

“Some of the projects are thought to be sensitive to feedstock supply – like the old ethanol projects competing with food for feedstock,” said Burkart. “It’s more appearance than a practical matter. Perception is something the industry needs to do something about.”

According to Arnold Klann at Bluefire Ethanol, “A project like ours, ironically, is very close to qualifying under the non-recourse project financing model. In that case, the lender is trying to limit risk by contracting it out – off-take risk, feedstock risk, and so on. We have off-take contracts with credit worthy buyers and credit worthy feedstock contracts, plus we have guarantees from engineering, procurement and construction (EPC) contractors in terms of the performance of their work. What we don’t have is the performance guarantee on the technology – because it is first-of-its-kind. If the government could help with a guarantee of performance – then we would be able to qualify for a different financing instrument.

“Now the DOE wants this rating,” Klann added, “and developers have to go to Fitch or something — because that’s the advice which the guys in the trenches at DOE are receiving from the Morgan Stanley guys.”

The troubles cited by project developers, attorneys and investment bankers familiar with the structures and challenges raises a conundrum: why are transformative renewable energy technologies, at this time in history, being held to a higher standard for a DOE loan guarantee than the average US corporate first-time debt issuer?

Does this not, by its nature, narrow the range of viable energy projects, and force the US to put, by definition, more eggs in fewer baskets?

In a feisty response to previous reporting in the Digest on DOE finance policy, Dan Leistikow, Director of Public Affairs, U.S. Department of Energy, wrote: “Anyone who has spent five minutes listening to Secretary Chu also knows he is one of the country’s staunchest advocates for pursuing a broad portfolio of clean energy research, and has warned against investing all our resources in a single technology to the exclusion of all others.”

But according to industry professionals familiar with the outcomes of DOE policy, the loan guarantee program as currently designed is creating a narrower portfolio, and is causing resources to be invested in a smaller group of technologies.

According to Burkart, even with the positive movement in solar and wind projects, the promising solar thermal technologies are not receiving as much support from the lending community, because the technology is less proven, and solar PV technology is receiving stronger support because the technology is older, and is seen now as more conventional.

For projects that do not have conventional technologies, the large funds necessary for commercial deployment in bioenergy — as much as $400 million for a commercial-scale refinery or $80 million for a demonstration— make all-equity structures nearly impossible to structure. So a Catch-22 emerges. Demonstration projects cannot attract debt because they are not proven at commercial scale, and commercial projects cannot attract debt because they have not been proven at a demonstration scale.

According to investment banker Robert Oei, the only available solution is to partner with a corporate strategic investor who can either provide the equity or use its own credit rating to finance the project. In these cases, he muses, who needs a loan guarantee program?

Oei suggests that the problem was successfully faced by the mobile telcoms market years ago. “There,” he said, “you had operators with a license to operate in a new country, needing massive capital requirements to build out their networks, and no guarantee that a market would develop. You could take out all the risks with good partners, but you could never take out the country risk, so OPIC and other export-import guarantors were launched to address the country risk. In energy, the technology is like the country risk — the government has to focus on building a bridge to take that risk off the table.”

Without such an approach, say insiders, growth will be incremental. Only narrow bands of conventional technologies will find large pools of capital, and by their nature they will transform the energy economy less rapidly. By their nature, they will put more bets on fewer horses.

The rifle approach or the shotgun approach, goes the age-old choice in development strategies. Now, we have another possibility: the BB approach.

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