The Valley of Fog: As Sundrop moves on from Louisiana, what’s up and what’s wrong with Loan Guarantee programs?

August 15, 2017 |

In Louisiana, reports surfaced in Alexandria’s TownTalk online paper that Sundrop Fuels has struck an agreement to sell the 1200-acre site where it once planned to build its $450 million, 50 million gallon capacity first commercial plant to produce green gasoline from woody biomass.

The company selected the site, the former location of the Cowboy Town entertainment complex, in November 2011 and completed the purchase in January 2012.

The CEO of Central Louisiana Economic Development Alliance, Jim Clinton, told TownTalk that “The company tried extremely hard to make this work. Sundrop management did everything within their power. By the time they got to the point where they could build the plant, the economics had changed and the politics had changed.”

Sundrop has now confirmed that “It has become clear given the new politics in Washington that our application through the DOE Loan Guarantee program is not going to progress further.  As such we are not going to be able to finance and build the facility in Louisiana so there is no point in tying up money there.”

So, an unfortunate step backwards for the manufacturing sector — and an interesting proof point that the DOE Loan Guarantee program success is closely tied to the revival of domestic manufacturing. We hope a temporary one — Sundrop’s technology and team march on, with we hope another project emerging soon. Perhaps offshore, perhaps one with financing not tied back to Washington’s shifting sands. Asia has long been in the long-term focus of the company.

Sundrop’s vision

Sundrop said that its Louisiana site could support, when fully built out, more than  225 million gallons of capacity for 87-octane biogasoline. The company also said that “Future full-scale biorefineries will also annually produce more than 200 million gallons of fuel that is fully compatible with fuel industry quality standards and available at an unsubsidized cost of about $2 per gallon (~$0.53 per liter).”

The emissions picture was striking. The company said that it would reach the 60% greenhouse gas emission reduction necessary to qualify for cellulosic RIBs.

The Sundrop Technology

Sundrop has developed three step process which it described thus:

1. Grinding of biomass. A unique, non-grinding biomass preparation process that converts any type of wet biomass, whether wood, wood residues, energy grasses, rice hulls or other types of agricultural wastes, into a homogenous powder form. This creates a consistent, highly reactive feedstock, regardless of its initial form, for processing in the Sundrop Fuels conversion technology.

2. Gasification. This pre-processed feedstock advances into the Sundrop Fuels proprietary BioReforming system where the biomass is converted into ultra-clean synthesis gas.

3. Conversion to end products. The resulting synthesis gas then moves into the downstream portion of the Sundrop Fuels plant where it is efficiently converted into finished gasoline, diesel, aviation fuel or other chemicals ready for direct sale to the market. This step is accomplished using well-established, commercially proven, licensed technologies.

Adding Hydrogen via natural gas

As Sundrop noted, “Advanced biofuels production has historically been limited because plant material feedstock has generally about a one-to-one ratio of hydrogen-to-carbon, while gasoline used in today’s combustion engines must have twice as much hydrogen as carbon.  To correct this imbalance, many other biofuels processes simply do not utilize one-third of these renewable carbons, rejecting them as carbon dioxide into the air.

“Sundrop Fuels, however, resolves the imbalance not by throwing away renewable carbon, but by adding hydrogen to the production process.  The supplemental hydrogen feedstock is obtained from abundant, clean-burning natural gas using a traditional steam methane reforming process.

“Because the company adds hydrogen to the renewable biomass being converted in its ultra-high temperature BioReforming reactor, virtually one hundred percent of all the carbon in the plant material is converted into biogasoline.  The process generates extremely low amounts of CO2 or tar.

Sundrop’s Wonder Years

The high point in the company’s fortunes to date was reached in July 2011 when Sundrop received $175 million in investment, $155 million of that from Chesapeake Energy accounting for a 50% stake in the company.

It is one of the first investments to come from Chesapeake’s new $1 billion investment facility it will undertake with its new company Chesapeake NG Ventures Corp during the next 10 years. The remaining investment came from Sundrop’s existing investor Oak Investment Partners.

We reported in October 2012 that Sundrop Fuels said it expected to begin construction early next year on its first commercial plant. The company had begun to hire plant managers and plans to begin training entry-level and other staff positions in late 2013, with construction then expected to be complete in 2014.

In July 2013, we reported that Sundrop Fuels had selected IHI E&C International Corp as their contractor for the project, and had begun preparing their site for the plant, which will occupy about 100 of the 1,213 acres that the company purchased in February. Construction was reported then scheduled to begin late in 2013, with operations expected to begin at the end of 2015.

LED’s Lead Development Group identified and began actively cultivating Sundrop Fuels in early 2011, and the Alexandria area emerged as a promising location because of its access to major electrical and natural gas supplies and because of the abundance of wood byproducts the region boasts. The state’s targeted incentives for workforce training and research and development helped Louisiana win the project over several other states in the South and Southwest.

Because of the refinery’s broad use of suppliers and support industries, Louisiana Economic Development estimates nearly eight indirect jobs will be created by the project for every direct Sundrop Fuels job. To secure the project, LED offered Sundrop Fuels performance-based grants for building and financing costs ($14 million over 10 years), as well as $4.5 million to reimburse relocation costs of research and development operations and key employees.

Sundrop Fuels also expected to apply for a private activity bond allocation of $330 million or greater, which will help the State utilize capacity that otherwise would have gone unused; the private activity bond allocation will enable the company to reduce its project financing costs.

The Sundrop origin story

Late in 2010, Sundrop Fuels, emerged from stealth mode as a solar gasification-based renewable energy company.

“As you know, Sundrop Fuels did indeed begin as a “solar fuels” company, but over the last year or so that model has changed,” the project’s Steve Silvers told the Digest in July 2011. “The biomass to advanced drop-in biofuels process uses natural gas to power the RP Reactor. The economics of the business made considerably more sense if we could run the thermochemical plant 24 hours a day – hence natural gas, rather than solar.

According to Silvers, “We already had to have natural gas coming into the facility because we’re stealing the hydrogen from natural gas to add to the biomass being gasified as to create the fuel-ready 2-to-1 hydrogen to carbon ratio. Additionally, like other biofuels companies, we are benefiting from the strategic partnership of a large energy company.”

The plant expected to salvage wood waste from renewable forests in Central Louisiana and adjacent regions and use that biomass as a feedstock. Sundrop Fuels also will extract hydrogen from abundant supplies of Louisiana natural gas, combining the hydrogen in a proprietary reactor with carbon extracted from wood waste. The result — up to 50 million gallons of fuel a year — will represent the world’s first renewable green gasoline that’s immediately adaptable to existing pumps, pipelines, engines and transportation infrastructure.

By 2020, Sundrop Fuels expects to produce more than 1 billion gallons of renewable fuel annually through its process (including but not limited to its Louisiana facility), meeting nearly 10 percent of the federal government’s stated goal for renewable fuels refined from cellulosic material and other alternatives to crude oil.

Bullish through 2015

Though construction did not materialize in Louisiana in 2013, the company said in 2014 that it had expanded plans to build biofuels plants globally, with focus on Asia and North America.

And in January 2015, the company began expansion of its advanced R&D laboratory and simulation facility at its Longmont, Colorado headquarters, including a new fully integrated pilot plant system. The facility was capable of testing a wide variety of feedstocks from around the world. Previously, the company had been testing its high-temperature BioReforming Reactor at since summer 2014 at the Energy and Environmental Resource Center (EERC) in North Dakota.

In March 2015, good news arrived from Washington when Sundrop Fuels received approval for Part 1 of its application for a US Department of Energy loan guarantee, and in December the company said that it had begun commissioning and operation of its Integrated BioReforming Demonstration Facility (IBDF) at the company’s headquarters in Longmont, Colorado.

Are Loan Guarantee programs effective?

It’s this loan guarantee application that has been at the center of the company’s fortunes of late — and this is the one that ultimately was abandoned this summer.

Veronique de Rugy, Senior Research Fellow at George Mason University, testified in a devastating fashion before the House Committee on Oversight and Government Reform, Subcommittee on Regulatory Affairs. Here’s an excerpt that gives you the flavor.

The failure of Solyndra has attracted much attention, but the problems with loan guarantees are much more fundamental than the cost of one or more failed projects. In fact, the economic literature shows that every loan guarantee program (a) transfers the risk from lenders to taxpayers, (b) is likely to inhibit innovation, and (c) increases the overall cost of borrowing. At a minimum, such guarantees distort crucial market signals that determine where capital should be invested, resulting in lower interest rates that are unmerited and a reduction of capital for more worthy projects. At their worst, these guarantees introduce political incentives into business decisions, creating the conditions for businesses to seek financial rewards by pleasing political interests rather than customers. This is called cronyism, and it entails real economic costs.1 

So what can we make of these figures? First, it should be noted that very few permanent green jobs were created under the 1705 loan program, or any of the other loan programs…o the extent that green jobs were created, the $6.7 million taxpayer exposure per job is quite spectacular. 

Second, our data demonstrates that under the 1705 program most of the money has gone to large, established companies rather than to startups. Companies that benefited included established utility firms, large multinational manufacturers, and a global real estate investment fund. In addition, the data shows that nearly 90 percent of the loans guaranteed by the federal government since 2009 went to subsidize lower-risk power plants, which in many cases were backed by big companies with vast resources. 

Quoted in the New York Times recently,  David W. Crane, NRG’s chief executive, explained, “I have never seen anything that I have had to do in my 20 years in the power industry that involved less risk than these projects,” he said. “It is just filling the desert with panels.”

De Rugy offered this slide on who got the money:

The 2014 Loan Program Office report

The last comprehensive public performance report we have on DOE Loan Guarantee Program dates to late 2014. At the time, the program’s executive director, Peter Davison, painted a starkly different picture to de Rugy’s perspective. He wrote:

In the five years since it issued its first conditional commitment, LPO has helped launch the utility-scale photovoltaic (PV) solar industry, deploy the next generation of concentrating solar power, revitalize the U.S. nuclear industry, commercialize cellulosic biofuels, and accelerate the growth of advanced and electric vehicle manufacturing.

As of September 2014, 20 projects supported by LPO are operational and generating revenue. Already, $3.5 billion in loan principal has been repaid on these long-term loans, which have an average tenor of 22 years. In addition, more than $810 million in interest payments have already been earned. For loans that have been disbursed to date, we expect to earn more than $5 billion in total interest payments over the full term of the loans — all of which goes back to the benefit of taxpayers.

Today, actual and estimated loan losses to the portfolio are only approximately $780 million, or only a little over 2 percent of the program’s loans, loan guarantees and commitments.

The Loan Programs Office in late 2014 offered up this slide on how the money was managed:

Looking at the Market Failure to back advanced industrial biotechnology

One thing that all parties agree on, loan guarantees have been developed to address the market’s failure to back certain projects. Meanwhile, the data demonstrates is that almost all the money went to solar, and precious little to bioenergy, or other advanced technologies.

Are loan guarantees workable and effective and do they address the real problems? As de Rugy noted:

In a 2003 speech to the National Economists Club in Washington, D.C., then–Federal Reserve Governor Edward M. Gramlich argued that loan guarantee programs are unable to save failing industries or to create millions of jobs, because—he explained—the original lack of access to credit markets is caused by serious industrial problems, not vice versa. If an applicant’s business plan cannot show a profit under reasonable economic assumptions, private lenders are unlikely to issue a loan, and rightly so. 

If the original access to credit market is caused by serious industrial problems — what are those problems, aside from late-stage industry failure? They generally refer to four failures:

1. Late-stage company failure. Loan guarantees and bailouts have been criticized for tying up capital in support of failing companies at the end-of-life stage.

2. Trade and currency imbalance. Public intervention has sometimes been caused by currency valuation problems. A currency that is overvalued relative to industrial output (because, for example, of the financial appeal of a fungible, low-risk, basket currency) can lead to excessive costs for domestic production relative to imports.

3. The lack of interest in debt markets for projects that have perceived technology risk, because of the low rates of return on these projects discourage appetite for risk. It’s the Valley of Death problem — projects can’t get financing until they are demonstrated at scale to work, but they can’t be demonstrated at scale to work until they get financing.

4. The most unique benefit of green technology — reducing carbon emissions — goes to society and not the project itself. Or the financial benefit to the project is considered unreliable (e.g. RIN credits under the Renewable Fuel Standard).

Loan guarantees in the modern sense of the DOE program generally address #3 and #4. In a loan guarantee program, the public steps forward through government entity to invest in the project to realize the social benefit — though the public role is limited to issuing debt or guaranteeing debt issued by commercial financiers.

Problems, perceived or real?

Cronyism, backing projects that would have financed anyway and simply offering them a lower-cost loan, the problem of the government “picking winners” between competing companies and technologies and sectors, the moral hazard of removing the incentive for deep project due diligence — these are objections that are typically raised by critics of Loan Programs.

In general, programs get caught between two problematic outcomes. If the default rate is too high, there is criticism of the public cost and accusations of lax oversight. If the default rate is too low, it can indicate a healthy program, or one that is simply competing with the private sector in backing commercially-feasible projects, rather than focusing on higher-risk, higher-reward projects.

Consider the multiple failures that the DOE experienced in backing the development of fracking technology. Seen from a DOE project portfolio point of view, the program was a colossal waste of public money — many failures, just one real success. Yet, DOE galvanized an industry that changed the world.

The Digest’s Take: Fix the bigger problem first, and you may find it’s less expensive, too

In our view, the market failure lies in the due diligence problem — advanced projects struggle to get a fair “day in court” because banks don’t have the technical resources for the underwriting that complex projects require, and projects themselves rarely have the financial resources.

The Valley of Death is actually a Valley of Fog that people avoid because, who knows, maybe it’s filled with coyotes and rattlesnakes. Markets have long dealt with commodity price risk for both raw materials and refined product: after all, petroleum has that risk, too, as does agriculture. But technology risk is more about the uncertainty of whether something works as designed, rather than the problem of peering into the future of prices. The most attractive solution is intelligence — as opposed to hedging, insurance or transfer of risk to the broader public.

If there is a social benefit to be realized, a co-operative public-private effort to develop better, faster and cheaper due diligence is a far less costly adventure than guaranteeing loans that can’t get financing because of insufficient risk profiling.  Rather than founding new programs to take elevated risks, why not minimize risks?

Something worth noting about entrepreneurs — they are celebrated as risk takers, but this is a complete misunderstanding of what entrepreneurs do. They are risk minimizers — and that skill is what permits them to operate successfully in high-reward sectors and utilize new technologies in new ways. Reducing risk is something that society, projects and investors all benefit from.

It’s something that the DOE itself is beginning to look more deeply at — whether the traditional concepts of component readiness (technical readiness levels) correspond to system readiness. We might add, project readiness.

Something for the public and the private sectors to work on, soon and with serious intent: to better understand and score the nature of forward risk. If the financial sector is actively and supportively in the mix from the outset, it can help unlock financing through the market itself. Markets don’t mind returns commensurate with the risks: but they shy away from the unknown, and advanced technology too often stalls in the Valley of Fog.

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