Development Capital – the Lifeblood of Every New Initiative Is Much Too Hard to Obtain

By CJ Evans, Managing Director, American Diversified Enterprises, Co-Founder, Alternative Fuels & Chemicals coalition
Special to The Daily Digest

There’s good news and bad news about the climate crisis.

The good news is that virtually every technology that can mitigate the climate crisis and avert its worst impacts already is under development or being commercialized. 

The bad news is that major obstacles are standing in the way of advancing these projects:

First, every project being developed – every one that is needed to mitigate the climate crisis – only can advance with infusions, sometimes large infusions, of development capital.

For example, a typical $1 billion biomass-to-Sustainable-Aviation-Fuel (SAF) project may require $50 million or more in development capital to move the project through permitting and Front-End Engineering and Design (FEED) to a final investment decision (FID).

Without this development capital, it can’t move forward … and delays in securing development capital result in day-for-day, month-for-month, and year-for-year delays in a project’s timeline.

Second, this is the hardest money to raise, which recently has been made even harder because of increasingly tightened credit.

Even under the best economic conditions, it is hard to raise this money because new, first-of-their-kind innovations, no matter how promising they seem, and even existing technologies used in new applications, are viewed by the credit markets as untried and unproven and, therefore, carry considerable risk. They may not work. Money may run out before they can be completed. The payoff which, with high risk, may generate a high return – that is, if ever there is a return – typically is years away.

There are many other investments – certificates of deposit, mutual funds, bonds, even artwork – which are much more secure and reliable in providing returns and do so without years of waiting.

This is why it typically takes 8-10 years, or more, for an innovation to progress through each technology readiness level (TRL) to where it can be commercialized and deployed.

Third, some projects will never reach the point where they can address the climate crisis – or provide their other benefits to society, which we will never know about or be able to enjoy – because they end up being unrealized dreams due to the lack of the money that was necessary for them to continue.

There is hope, as outlined in an eBook I wrote,  YOU, ME, life on the planet, and the climate crisis, that was published in May by the Innovation News Network.

Hope also is being provided by The Inflation Reduction Act, enacted in August 2022, which has tripled the amount of funding that is available for federal bioeconomy grant programs and increased the Department of Energy’s Title 17 Clean Technology Financing program’s loan authority by tenfold, from $40 billion to $400 billion.

This is encouraging news. But it does not provide even $1 of development capital.

Current economic conditions have greatly exacerbated the difficulty in securing development capital: Inflation, climate change, the war in Ukraine, supply chain disruptions, and the COVID-19 pandemic, to name a few, have coalesced into what experts have called a “polycrisis.”

This has resulted in tightened credit, which makes it harder and takes much longer to raise the development capital that is the lifeblood of every new initiative that is being advanced, every solution that can reduce the impacts of the climate crisis.

The innovators and project finance specialists who are engaged in raising this capital have found that it is harder to do so than at any time since the 2008 financial crisis.

With the climate crisis upon us, we do not have time to wait

The typical delay in being able to advance the projects that will address the climate crisis needs to be cut down from 8-10 years to 3 to 4 years.

That is the reason for this article.

The current economic climate and tight credit, along with recent U.S. bank failures, and fears of inflation, have placed a lot of money on the sidelines, what one could call “scared money,“ which is watching and waiting for market trends to improve.

This money needs to be brought off the sidelines and unleashed — quickly — so projects that will address the climate crisis can move forward.

But how?

Federal government grants offer one approach. They are available for every technology readiness level (TRL), except for the gap between a pilot plant or prototype and the final TRL, first-time commercialization.

But government grants only lend a hand, provide a leg up. They usually require a 50 percent match, which often only can come from development capital.

Even when a technology is ready to move to its final step – its development is complete, it has been tested, retested, validated, and pronounced ready for commercialization and deployment, there is one last obstacle – a valley of death for many innovations – that must be spanned.

To qualify for a commercial loan or government loan guarantee to build a project, the project must be ready for construction, meaning that it has completed its FEED along with each pre-construction step (which include site acquisition, permitting, feedstock and offtake contracts, and the like) so that a FID can be made, which is where a project either is approved – or not – to secure the financing necessary to proceed to construction.

To reach FID, after everything that has gone before, requires additional money to fill the gap, a bridge to cross over the final valley of death. There are no grants and no loans available to do this. It only can come from development capital.

To find out how this might be done, to learn what obstacles need to be overcome and what actions need to be put in place to unleash the amounts of money that are necessary for you, me, and life on the planet to survive the climate crisis, I turned to two seasoned project financing experts as well as several members of the Finance Committee of the Alternative Fuels & Chemicals Coalition (AFCC), which I co-founded in 2019 with the second expert, Mark Riedy, and AFCC’s Executive Vice President for Policy, Rina Singh, Ph.D.

AFCC’s Development Capital Advocacy

AFCC is a Washington-DC based advocacy group with 150+ member companies that employ more than 600,000 people and generate in excess for $350 billion per year in revenues. As part of its fiscal year (FY) 2024 appropriations requests, AFCC drafted legislative language that was incorporated into its FY2024 appropriation request for the Department of Energy’s (DOE’s) Title 17 loan guarantee program (see link, pages 4-9).

AFCC’s language would have established a $500 million grant program – the first of its kind – financed by the annual interest payments made to the U.S. Treasury from the Title 17 loan guarantee obligation payments, which now exceed $500 million per year, to establish a grant program to provide development capital.

Despite AFCC’s advocacy, the grant program is not included in either the Energy and Water Appropriations bill passed by the U.S. House of Representatives on June 22 nor the corresponding appropriations bill that was voted out of the Senate Committee on Appropriations on July 20, 2023.

AFCC, therefore, will attempt again next year – when the annual appropriations process begins in mid- to late-February – to convince the members of the House and Senate Energy and Water Appropriations Subcommittees and House and Senate Appropriations Committees of the critical need for this grant program and to push for its enactment.

Although the appropriations process will not begin until next February, there are several steps that can be taken now to lay the groundwork for the next session of Congress. Please see the sidebar –  What Can You Do to Expand Access to Development Capital? – that accompanies this article. The steps outlined in the sidebar build on the following suggestions.

Development Capital Suggestions from Two Project Financing Experts

The first expert to whom I turned for suggestions on overcoming current development capital challenges is a senior executive at a top five U.S. bank. The second expert is Mark J. Riedy, a partner of the Kilpatrick, Townsend & Stockton (KTS) law firm, who co-founded and leads the KTS project finance and energy team of 80+ attorneys. Mark Riedy’s focus during his 45+ year career has been on U.S. and international project development, as well as on finance and private placement representation of renewable and conventional energy, clean technology, environmental, and infrastructure clients. He has been deeply involved in all government grant and loan guarantee programs that contribute to advancing projects that can address the climate crisis.

There are five key obstacles.

Current Development Capital Obstacles

• Development capital is the hardest money to raise, particularly for first commercial projects.
• Project financing generally requires government guarantees, bond financing, and risk insurance packages to mitigate the many risks posed by first commercial and early-stage projects.
• Long term tax incentives are needed to provide more business certainty and, thus, reduce the risk of new projects so they can attract development capital … at least, until recently in the US. The passage of the Inflation Reduction Act (IRA) by the U.S. Congress in August 2022 has reduced this need through the new project financing it provides. But it has not eliminated this need, nor has the IRA been able to alleviate the business uncertainties that come with first-of-their-kind projects. Long-term tax incentives, therefore, are still needed since they play an important role in attracting development capital .
• Obtaining secure construction arrangements is proving difficult in today’s high inflation and challenging supply chain environment. Project finance lenders want a creditworthy contractor to engineer and build a project on a fixed price and fixed schedule basis. Few contractors are willing to take that risk today.
• Regulatory incentives advance the development and deployment of renewable fuels through U.S. Renewable Identification Numbers (RINs) and state Low Carbon Fuel Standard (LCFS) credits. These incentives, however, face several current obstacles:
  1. They were thought to be subject to government challenges only
  2. But, instead, state incentives have been hurt by commercial issues
  3. This is due to too many U.S. refineries converting to renewable fuels and excessive amounts of renewable natural gas (RNG) being produced in or sent to California (to obtain the LCFS), which is the strongest U.S. market for renewable fuels,
  4. The result of this has been to drastically reduce the values of LCFS credits and the California Air Resources Board (CARB) has been slow to respond.

Also:

5. Federal incentives have been hurt by excessive grants of small refinery waivers by the U.S. Environmental Protection Agency (EPA) and stalled updates to Renewable Volume Obligations (RVOs) for 2023-2025, the SET rule, and the new eRINs regulations which, along with the spot market prices of RINs, govern how the U.S. Renewable Fuel Standards are to operate each year, all four of which are determined and governed by the EPA. Only recently have all but the eRINs regulations been addressed and resolved.

Here are Some Solutions

• Development capital: many new funds are bringing money to the U.S. from the United Kingdom and European Union for renewable fuels projects, which will place early-stage, pre-FID money in these projects for engineering and working capital.
• Project Financing: the U.S. Infrastructure and Jobs Act (IIJA) and IRA, passed by the U.S. Congress and enacted in 2021 and 2022, are providing substantial funds for grant, loan, and loan guarantee programs through the U.S. Departments of Agriculture (USDA), Energy (DOE), Transportation (DOT), and EPA.
• The amount of funding being made available for U.S. federal grant programs has been tripled over prior year funding levels.
• The loan authority for the DOE’s Title 17 loan guarantee program has been increased ten-fold, from $40 billion to $400 billion.
• Technology risk programs, such the DOE’s Title 17 and USDA’s Section 9003 loan guarantee programs, are now flush with funds to finance first-of-a-kind commercial projects.
• US tax exempt bond and private capital markets provide additional avenues for funding first commercial projects. While these investors are more flexible than traditional commercial bank project finance lenders, they still expect a high likelihood of repayment.
• Technology risk insurance protects first commercial projects by paying debt service to avoid loan covenant It also offers interest-free loans to fix technology glitches expeditiously.
• Other insurance products protect regulatory, tax incentive, feedstock, and other commercial risks to enhance project
• Tax Incentives: The IRA has provided the most comprehensive renewable energy tax incentives in U.S. history, on a long-term basis, with many incentives running for 10-12 years.
• Regulatory incentives are becoming clearer:
• The new SET rule has been issued by the EPA with significant improvements in the transferability of tax incentives, at a better price, above prices accorded to tax equity (and with less costly and more efficient documentation), and without a dilution in project owners’ equity ownership.
• US incentives that will deepen product markets are being expanded, such as the expected issuance by the EPA of new eRINs to qualify electric vehicles and charging infrastructure for federal RINs
• New state sustainable aviation fuel (SAF) production tax credits (PTCs) have been enacted in the States of Illinois and Washington that can be added to the sales price of SAF.
• Further, the U.S. Supreme Court has resolved the majority of issues surrounding the small refiners waivers granted by the EPA in favor of the biofuels producers.
• Also, more U.S. states are expected to provide LCFS credits in addition to California, Oregon and Washington, such as the States of New York, Minnesota, Michigan, Wisconsin, New Mexico, Nebraska, Iowa, and South Dakota, among others.
• Canada has just started a nationwide LCSF program, in July 2023.
• The upshot of these expanding and proposed new LCFS markets is that much of the biofuels that historically have ended up in California will move to other venues, increasing the value of the California LCFS as the volumes targeting that state decrease.
• Finally, changes in the CARB LCFS program with an increased carbon intensity (CI) floor and better scoping rules will further increase the value of California’s LCFS.

What’s Next?

There is a growing recognition of the need to both expedite and increase the resources and means in which development capital can be made available to first-of-a-kind, game-changing, climate-crisis-mitigating projects.

There is a current, concerted action to step up efforts on the part of commercial lenders; U.S. state and federal grant, loan, loan guarantee, technical assistance, and incentive program leaders; project finance specialists; and providers of risk and other insurance products to accelerate the transition to a low-carbon economy and facilitate climate solutions.

For the first time, several U.S. investment firms are providing development capital by contributing a portion of their funds and bringing together groups of individual investors through coordinated investment programs, so project developers no longer have to rely solely on wooing “angel” and individual investors to obtain their initial seed funding (with the hope of securing infusions of additional cash afterwards) followed by Series A, B, and C funding rounds.

By providing development capital to multiple projects that fit the firm’s criteria, and creating programs in which scores of investors can participate, these firms are spreading their risk across multiple projects and, in a very real sense, creating development capital “mutual funds” for their investors.

Each one of these efforts is encouraging.

Each adds to what is needed for projects to secure their much-needed development capital.

Each will help projects advance much more quickly.

There is just one more thing that is needed: They have to be expanded many times over. Not just in the U.S., but globally.

You can help do this: See the accompanying sidebar: What Can You Do to Expand Access to Development Capital?

The American Diversified Enterprises holding company encompasses several companies that are “enablers,” helping innovators and project developers advance, as well as several “innovations” in agriculture, transportation, carbon sequestering, and ecosystem stewardship projects that ADE is advancing. In all cases, it is committed to contributing, through its clients and its own projects, to mitigating the climate crisis.