Lost Generation: ICCT’s financing scheme to jump start advanced biofuels at scale

One thing that is clear in hindsight from the flow of energy project investment between 2010 and 2014 is that investors believed in three predictions that didn’t come true:

1. The spread between natgas and oil would continue at historically high levels — a belief that touched off a spate of announced gas-to-ethylene projects, that otherwise would not have been competitive with naphtha-to-ethylene.

2. Oil prices would continue at $70+ per barrel levels — a belief that touched off a spate of announced tight oil fracking projects, that otherwise would not have been cost-feasible.

3. That the Renewable Fuel Standard supports and other tax credits for advanced biofuels would collapse — a belief that shut down almost all investment in commercial-scale advanced biofuels projects during this period.

All of this turned out to be nonsense. Yet, we are left with underutilized fracking capacity, a spate of cancelled gas-cracker projects and a lost generation of investment for advanced biofuels that BIO estimated last year exceeded $10 billion.

In so many reports on the state of advanced biofuels, analysts refer to the “policy and market uncertainty” regarding advanced renewable fuels. But really, it’s not a case of uncertainty at all. It is a case of a wrong-headed certainty — a passionate belief in assumptions that failed to pan out, and a general desire to leap on the “drill, baby, drill” bandwagon.

Now that the market has been cured, we hope, of a belief that fossil projects competitive with $70 oil are immediate winners — and there’s now a sea on unemployed in Houston who can attest to it — there remains the challenge of attacking the “certainty” that renewable fuels tax and mandate policies.

How much support do credits really, truly provide?

On stage at ABLC, in this period, The Digest routinely warned project developers that potential debt financiers would “zero out” the value of RINs and tax credits — regarding them “as gravy” that would provide an elevated return to equity, rather than helping to justify affordable project finance.

Lot of gravy, kemosabee. Consider this slide from our March Madness series earlier this year.

Here, industry consultant Michele Rubino identified $3.74 in hard value per cellulosic ethanol gallon sold in California, of which $1.54 represented the marlet value of the fuel. That’s a tremendous amount of real-world support — yet, where are the gallons?

Contracts for Difference

This week, a new study released by the International Council on Clean Transportation argues that a Contracts-for-Difference (CfD) policy, similar to a policy already implemented in the United Kingdom to support renewable electricity, could provide the necessary confidence to spur investors to support larger projects. The new policy would be funded by California’s Greenhouse Gas Reduction Fund and provide price-certainty to ultralow-carbon fuel producers.

A CfD works by contractually setting a price floor on a unit of qualifying, ultralow-carbon fuel with a specific producer. Whenever the market value of that finished fuel (i.e., the sum of its sale price and any applicable credits and subsidies) is lower than that price floor, the guarantor of that contract (in this case, California) would pay the difference between those two values. As in the U.K., the price floors would be set via a reverse auction, wherein interested producers compete for contracts by bidding down the strike price to the lowest price their project could support.

The study finds that a CfD can be a cost-effective method to support new fuel production by leveraging the spending of other, existing policies. So long as the strike price is relatively close to the sum of a fuel’s sale price and existing incentives, this policy’s spending can be minimized. The CfD only kicks in whenever the policy or market conditions drop the value of fuels and incentives—whenever conditions are good, the program can actually accrue funding to prepare for future downturns.

“We found that the perceived value of many existing financial incentives is much lower than their face value,” says Nikita Pavlenko, a fuels researcher with the ICCT and a co-author of the study. “What this means is that investors discount the present day values of policies to account for future uncertainty. A CfD acts as a type of insurance or hedge against that kind of risk.”

The cost model developed in the study suggests that in a business-as-usual baseline policy scenario, assuming the Renewable Fuel Standard (RFS) and Low-Carbon Fuel Standard (LCFS) exist through 2030, a CfD policy could accrue revenue and support additional and larger projects over time. While the CfD fund would underspend annually in order to accrue funding to protect against liabilities during down years, the volume of fuel supported would grow from 4 million gasoline gallon-equivalents (GGE) of cellulosic ethanol in the first auction to nearly 50 million GGE of annual production by 2028.

Other ideas

In 2011, we proposed an asset-backed security structure. You can read all about it here. 

The Bottom Line

Regardless of whether you support the ICCT’s mechanism, it represents a new approach to solving a real problem — they call it “uncertainty”, we call it “wrong-headed, adverse market sentiment that looketh not to the hard data.” By any name, the phenomenon inhibits investment in renewable fuels, and the ICCT’s proposal may well be the one to get behind.

You can download the ICCT white paper here.