The Biofuels Debt Offensive: New Perspectives, and 5-Minute Guide to the Players in financing at scale

In Part 3 of 3 in our series on commercial-scale financing, we look at the real problems, the new paradigm, the nature of de-risking, the role of strategics.

Plus, a 5-Minute Guide to the Major Players in biobased financing at scale.

In Part I of our series, we looked at the slowdown in bioenergy financing, the Administration’s policies, and the gaps between what’s needed and what’s available. And the certainty that vision and technology means nothing without financing.

In Part II of our series, we looked at the biggest misunderstanding in the industry – “that lenders will not lend unless perfect de-risking is achieved” — and how to educate the lenders as to the nature and scope of the residual risks left in the deal — and how insurance, credit wraps and offtake structures can be used in effective de-risking.

So, what’s the problem?

“We must move away from projects being planned by technology companies which cannot make the economics work for those particular projects,” said Stern Brothers managing director John May. “It is not that the technology does not work; empirically, it does. What has been stalling projects in terms of financing commercialization is that after all the pre-development planning, they do not generate sufficient revenue.

“This is primarily due to miscalculation of scale,” May added, “building projects too big with capital costs that cannot be amortized quickly enough, and to a misunderstanding of the myriad project site-specific supply chain issues, any one of which can have a dramatic impact on project margins. Most entrepreneurial developers focus on their technology ‘working’ first, and only then go looking for a project location in which they can solve a problem.”

Westar’s Cindy Thyfault has a slightly different perspective, singling out the nature of capital restraints on all lower EBITDA, high volume, cyclic businesses.

“The financing problem that existed 20 years ago and still exists today is that the value-added product that is being created is a commodity product also (biofuel and chemicals) that has only a certain marginal demand in the marketplace.  Most businesses in these types of industries across the board have a much lower EBITDA, they are high volume, lower net profit industries.

“For this reason,” Thyfault added, “any business with this type of finance profile has a hard time competing for funding because of the risk of negative profits due to cyclic nature of their business cycles (for example, beef processing has a historical 5 year cycle of boom and bust). This also narrows the playing field for large project equity infusions and mezzanine debt, and requires that these type of projects carry a large amount of low-interest debt.

It’s not just biofuels and chemicals, she warns.

“To believe that the biofuels industry is the only one currently with this unique problem takes attention away from the reality of the financing situation for all value-added commodity businesses, and doesn’t help the industry find creative solutions for this problem.  We have been focusing all of our attention on federal loan guarantees and grants that can assist in creating an initial industry foundation by funding a few first-of-a-kind businesses, but what we need is a large platform with billions of dollars to create a worldwide sustainable industry.

What’s the new paradigm?

One way to look at it is in terms of an extended joint venture of strategics across the supply chain.

“The new bio business and finance model,” says May, “must necessarily involve a true joint venture of strategics (feedstock, offtake, EPC, etc.), each of which will (i) not only integrate forward or backward toward the project developer, in supply chain terms, to de-risking these commercial arrangements which affect the credibility of cash flows — and thus the credit quality of the project financing; and ( ii ) put their balance sheets to work in providing much needed equity to complement non – recourse debt from the bond market.”

If it sounds like the kind of integrated structures that DuPont, Beta Renewables and POET-DSM have been developing — that is probably not a coincidence.

How does de-risking work with the new technologies?

Not a surprise, most of the advanced celluloisic technologies keep the details of specific performance commitments given to customers very much on the Q.T.

But Doug Rivers at ICM, in commenting on the company’s Generation 1.5 cellulosic ethanol technology, noted that a lot of de-risking lies not in process guarantees, but in the scale-up steps undertaken previously to prove out the technology, and in the support that is offered by the licensor.

“The de-risking has been pretty well done in our 10TPD integrated pilot plant,” Rivers explained. ” This has included commercial scale fermentations.  The scale up to a full commercial operations leaves about a 10X scaling of the pretreatment operation.  For first adopters (first 3 or so plants), we are not providing a guarantee, but we are providing a discounted cost package along with extensive commissioning support.  Once we have 2-3 up and running, we will begin offering process guarantees.”

Additional support? “Our plan is to not use our standard start up team on the first adopters,” said Rivers, “but to have our full development team available on site to handle any unforeseen issues and to assure that the plant operations team is fully up to speed in this new part of the operation before turning them loose on their own.

What about the strategics?

The strategics need to contribute equity to the project, for two reasons:

“First, they have the greatest interest,” said May, “in the long-term benefits of the commercialization of bio technologies over the time horizon and at the return levels. Second, because their contributions greatly increase the credibility of the cash flows arising from the resulting supply chain.”

What about feedstock?

“We have seen the development,” May added, “of such structures as credit wraps from insurers, and counter-party credit enhancement from significant feedstock suppliers with balance sheets, as well as from intermediary aggregators.

What about technology? Offtake?

May noted: “In addition to the traditional use of EPC wraps, which are still rare, and loan guarantees, which are time consuming and expensive, we have seen the emergence of technology performance risk insurance. It is a a more ‘surgical’ approach to de-risking technology scale up, and has the possibility of being less expensive and time-consuming than loan guarantees.

“The issue of the lack of off-takes for biofuels and chemicals has been one of the most vexing problems. Even partial off-takes, which deliver some price and margin definition over the medium-term, is a good starting point. This is especially true where the energy or non-energy products being produced by the biorefinery are not volatile from a price standpoint. It is up to the developer and its financiers to convince the debt markets that the probabilistic outcomes from modeling the cash flows do not suggest the need for long-term off-take.”

It all comes down to finding lower-interest financing, said Thyfault.

“What I believe is the need and the solution,” she said, “is to create and utilize new sustainable financing structures that allow for lower interest financing that a value-added commodity business can afford to pay, and overcoming the risk of the business cycle as well as the technology risk.  That is why I have been working with Broadway Capital over the last few years to develop the Risk Transfer Guaranty Bond structure.

The new players

“Important players in the new financing structures will be firms that are strategically related to the projects,” said May, “and third party ‘specialists’ who have the ability and the balance sheet to de-risk various project elements in a customized way, which has the effect of de-risking cash flows.”

Here are profiles of firms that have been notable thought-leaders in the new financing paradigm.

Insurance players

AIG.

American International Group Inc.’s new energy warranty product provides technology risk transfer coverage worldwide to renewable, alternative and conventional energy facility owners/developers and contractors who need to provide systems performance assurance to their investment and lending partners.

Zurich.

Zurich’s Supply Chain Insurance provides “all risks” coverage “which is not restricted to property damage, because physical damage is historically not one of the most frequent causes of interruption,” the company explains.

“The supply chain insurance can cover all supplier Tiers, and can finance extra recovery expenses. It also offers the option of a pre-agreed claims methodology to increase transparency, certainty and speed of claims. It can complement and fill gaps in other coverages (business interruption, contingent BI, political risk, marine and trade credit), helping to fortify risk management programs.

Investment banking, financial services and and risk management players

Stern Brothers

Stern Brothers & Co., headquartered in St. Louis, is an investment bank and registered broker-dealer. Stern’s Alternative Energy Finance Group, lead by co-heads Les Krone and John May, focuses on the structuring and placement of debt, as well as corporate and project equity, for companies and projects across all sectors of the renewables industry. Stern pioneered the use of non-recourse tax-exempt bonds as an alternative to bank debt in the biofuels and landfill gas areas, and has expanded its practice to include tax-exempt and taxable bonds for second generation biofuels, biomass, hydro, solar and waste-to-energy projects. In a non-financing role, Stern acts as a financial advisor to companies seeking joint venture partners and merger advice.

Rutherfoord

Rutherfoord, a Marsh & McLennan Agency LLC company, is a full service insurance and risk management broker to a broad portfolio of clients including the energy sector — developing business solutions designed to proactively manage risk, and meet emerging needs of increasing complex enterprises.

Broadway Capital

Broadway Capital, in partnership with Westar, developed the Risk Transfer Guaranty Bond structure.  It allows a minimum amount of equity to be invested into the project, and also provides lower interest rates, flexible payments, and the opportunity of deferred interest during the construction period to allow the project to be built, commissioned, and operate for several years to stabilize the project.

Westar Trade Resources

Westar is a 20 year old international boutique consulting firm that has assisted over $2 billion worth of projects to obtain over $1 billion government guaranteed funding from the USDA, DOE, and Export-Import Bank.

Westar assists clients in lowering obstacles to finance and can assist in producing positive financing outcomes for both large and small businesses across multiple industries. We work to identify the proper funding venue(s,) prepare a independent feasibility study and other documents, develop risk mitigation strategies, and assist the client through the application process, which can include government programs, traditional financing, and proprietary bond finance structures. We also provide on-going monitoring services for bond transactions and can assist in developing and executing re-financing options. Westar’s domestic and international client portfolio currently includes companies that have engaged in renewable fuels and feedstocks, renewable electricity and battery storage, energy efficiency, biochemicals, other environmentally sustainable technologies, oil and gas service companies, food and fiber manufacturing and infrastructure.

Counselors

Kilpatrick Townsend

Kilpatrick Townsend & Stockton currently has nearly 700 attorneys and expects to add 150 transactional lawyers in energy and health care as part of an approximate 300 attorney build out over the same near term period of time, and building a major energy and infrastructure transactional department focusing on project finance and private placements, headed by legendary sector attorney Mark Riedy, with the intention of growing it to 75+ attorneys in the next 2-3 years. The firm has 19 offices worldwide with headquarters in Atlanta (regional offices in Augusta, Charlotte, Raleigh and Winston-Salem and other offices currently in Washington, DC, NYC, SF, LA, San Diego, Menlo Park, Denver, Seattle (with new Texas offices in the near term) and international offices currently in Shanghai, Stockholm, Tokyo, Jeddah, Riyadh, Al-Khobar).

Kreig DeVault

Krieg DeVault’s Alternative Energy and Clean Tech Group is a multidisciplinary group of attorneys covering all aspects of the energy business, including debt financing, equity capital, real estate, environmental, project contracts (feedstock and off-take), intellectual property, federal and state regulatory matters and related services in all aspect of an energy business’s lifecycle.  The group is led by John Kirkwood and consists of approximately 15 attorneys who have teamed on projects starting with the first generation ethanol revolution to present day projects in wind, solar, waste to energy, biofuels and biochemicals.  The team has represented developers, commercial banks, investment banks and institutional investors and has worked with the USDA and the DOE to adapt their programs to modern day project finance standards.  In recent years, they’ve become a national leader in project finance for the biofuels and biochemical industries, using our innovative skills to bring products such as supply chain and technology risk insurance products to project finance — and are advisors to many of the Biofuels Digest Top 100 companies.

Wilson Sonsini

With more than 400 energy and clean technology clients, Wilson Sonsini Goodrich & Rosati is actively advancing the interests of hundreds of emerging companies, mature energy technology and project development enterprises, and major public corporations in energy and resources. The team provides strategic counsel to clients across a broad range of industry sectors, including advanced energy generation (such as solar, wind, geothermal, biomass, waste-to-energy, natural gas, cleaner coal, and hydrokinetic); battery and other energy storage technologies; energy efficiency; transmission, distribution, and smart grid; green building; bio-based chemicals; and electric vehicle, biofuels, and other transportation technologies. They also represent many of the leading venture capital firms, private equity firms, and energy project investors.

DLA Piper

DLA Piper are advising companies and financiers across the renewable energy spectrum, including hydro, energy-from-waste, solar, on and off-shore wind, biomass and biofuels. They also advise project sponsors, corporations, financial institutions, governments and regulatory bodies. We also assist in fundraising, supplier obligations, permitting, regulations and in the political sphere. They cover all stages of a project, including project finance, M&A, advice on the commercial gains that renewable projects generate, such as ROCs, LECs and CfDs in the UK, as well as statutory feed-in tariffs, direct marketing activities and power purchase agreements, for both suppliers and end-users.