Part II of II
Cellulosic ethanol arrives at scale “The five years away forever” put to rest but are there troubling waters still ahead? For whom, and why?
There’s a gigantic disconnect between two sections in the country as to whether the United States should be celebrating the success or the failure of cellulosic biofuels. Supporters and detractors alike saying that the wave of commercial-scale cellulosic ethanol refineries is a new wave in technology or the latest round in a wave of unimportant hype.
We looked at the supporters, the detractors, the problems of targets, the Projection Problem, optimistic timelines and the question of whether targets were “juiced” – in part I, here.
Which brings us to the problem of financing. As we’ll continue in PART II of this special report.
The smoking gun: the failed loan guarantee program for cellulosics
No one ever, ever thought that cellulosic fuels would get off the ground without a loan guarantee program. First-of-kind technologies are simply too risky for conventional project finance lenders and costs and credit-card interest rates made the projects not economically viable.
So, DOE-backed projects into which DOE would have extraordinary oversight and insight weresupposed to have access to DOE-backed loan guarantees for their first commercial projects which theoretically would allow them to zero out the project risk to the lender and allow them to tap conventional project finance at conventional interest rates something like 4-7 percent. After the first commercial, the technology risk would be eliminated, and the companies could tap conventional project finance on their own so went the theory.
Did DOE get a start on the program? Sure, In fact, it was not authorized under the 2007 EISA Act, one was originally established under the 2005 Energy Policy Act. By 2007, Ethanol Producer was reporting, “The DOE is also developing a loan guarantee program for cellulosic projects as authorized in the Energy Policy Act of 2005.”
As of today, the DOE has only two loan guarantees in its portfolio for this 1703 program both for nuclear energy.
Bottom line, of the 11 projects we outlined, only one received one of those DOE loan guarantees, and that one was not finalized until September 2011 $132.4M for the Abengoa Bioenergy project. The INEOS New Planet Energy project and Range Fuels (ironically) received USDA loan guarantees. BlueFire has a conditional USDA loan guarantee commitment, but no lender of record yet. The rest of them had to find wealthy corporate backers.
Numerous projects attempted to attract DOE loan guarantees, and no dice.
A house oversight committee found that:
“DOE invested a disproportionate amount of its funds into solar technology leaving taxpayers vulnerable by overemphasizing a single technology. 16 of the 27 1705-backed projects employed solar technology – that represented 80 percent of DOE’s funds.”
And noted that:
“DOE has engaged in a disturbing pattern of suspending the approval of a credible project that adheres to all stated standards, only to later approve massive funding for a project proven to be nowhere nearly as far along in the process as DOE purported. DOE’s favoritism significantly harmed numerous companies that had relied on the promise of 1705 financing. The perception is that DOE actively misleads applicants about the status of their loan application, thereby encouraging these firms to misallocate capital, which has led to financial harm.”
Bottom line, financing woes have been the biggest cause of delay primarily, the government’s inability to construct the loan guarantee program it knew would be needed for first commercials.
The Abengoa project that received funding was, in fact, the lowest-rated project in the DOE’s entire technology loan portfolio receiving a CCC rating, which is rated as a “highly-speculative investment”. In fact., Abengoa was exposed to criticism in the House Oversight Report because of the Abengoa Bioenergy loan:
A single Spanish firm, Abengoa, received an aggregate $2.45 billion in loans and loan guarantees plus $818 million in Treasury cash grants.54 This reveals excessive risk and subsidies provided to a single firm via multiple subsidiaries. Abengoa has a credit rating of BB, which is considered Junk, thus making this concentration of investment in one company speculative and highly questionable. Exemplifying the risk DOE took in the case of Abengoa, the company managed to obtain a DOE loan commitment for the lowest rated project across the entire DOE Junk portfolio; Abengoa Bioenergy Biomass of Kansas received an extraordinarily low CCC rating and yet the DOE approved a direct loan to the project.
In a 2011 independent review of loan guarantees ordered by the White House, former Assistant Secretary of the Treasury, Herbert Allison, found:
” A lack of clarity in the lines of authority within the loan program office; A lack of clear guidance regarding DOE’s standard of “reasonable prospect of repayment;” and “A lack of clarity with regard to DOE’s goals and tradeoffs with respect to financial goals versus policy goals”
The crisis of innovative technology financing
The problem of the Loan Guarantee program is that it simultaneously required a “reasonable prospect of repayment” while at the same time focusing, in the language of the Energy Policy Act:
The Secretary may only make loan guarantees under §1703 for projects that employ “new or significantly improved technologies.” DOE’s implementing regulation defines this as an energy technology “that is not a Commercial Technology, and that has either (1) Only recently been developed, discovered, or learned; or (2) Involves or constitutes one or more meaningful and important improvements in productivity and value, in comparison to Commercial Technologies in use in the United States. . . .”
Common-sense tells us that energy technology “that is not a Commercial Technology” and has “Only recently been developed, discovered, or learned” or “Involves or constitutes one or more meaningful and important improvements in productivity and value, in comparison to Commercial Technologies” is by definition a first-of-kind project.
Common-sense also tells us that first-of-kind projects are not going to have “investment-grade” project ratings.
Fitch, the project finance rating agency, in commenting on the DOE’s newest round of loan guarantee funds, noted:
“The DOE will favor projects that may be unable to obtain full commercial financing due to perceived risks accompanying newer technologies. Eligible projects offering a catalytic effect on subsequent projects, which replicate or extend the innovative features of eligible projects, may also be favored. In determining which applicants advance, the DOE will assess whether a project provides a reasonable prospect of repaying all project debt, and whether available capital from all sourc
es will be sufficient to carry out a project. No minimum credit rating is specified for this solicitation.”
‘Projects seeking funding must use new or significantly improved technology,” said Gregory Remec, Senior Director with Fitch’s Global Infrastructure Group.
The repayment problem in the face of feedstock and product price risk
What we are left with is this, that borrowers must provide:
“An analysis demonstrating that, at the time of the Application, there is a reasonable prospect that Borrower will be able to repay the Guaranteed Obligations (including interest) according to their terms, and a complete description of the operational and financial assumptions and methodologies on which this demonstration is based.”
Which isn’t much. The definition of “reasonability” is critical in the case of first-of-kind technologies, and was left so entirely vague that a DOE Loan Programs officer could rightly determine that repayment prospects could and should be entirely based on a Fitch rating where feedstock and commodity market risk would be heaped on biofuels vs, say wind or solar that have free feedstock and fixed power contracts with utilities and that left the financing of cellulosic biofuels in the lurch.
The First Lien Problem
Another critical failure in the Loan Guarantee program. Despite no specific language requiring this in the Energy Policy Act of 2005, the DOE Loan Program rules specified that:
‘‘[t]he [guaranteed] obligation shall be subject to the condition that the obligation is not subordinate to other financing.’ and that ‘‘[t]he rights of the Secretary, with respect to any property acquired pursuant to a guarantee or related agreements, shall be superior to the rights of any other person with respect to the property.’’
What does that mean, exactly? Comes down to interpretation. In this case, in 2007 DOE issued a final rule implementing Title XVII, and issued regulations which requiring a first lien security interest in all project assets as an incident to making a guarantee.
Now, if you’ve tried to get a home loan, and had a parent or relative guarantee the loan, you know that the guarantor is not going to wrest the first lien away from the bank. The bank remains first in line with a right to foreclose. It was a non-starter for many projects, all across the energy spectrum.
It was bad news for energy projects. As DOE itself reflected in late 2009, “nowhere does section 1702 itself require that the Secretary receive a first lien on all project assets as a condition of his ability to make a loan guarantee. Instead the statute requires only that the Secretary’s guaranteed obligation ‘‘not be subordinate to other financing.’’ In fact, section 1702 does not require that the lender or the Secretary receive any collateral as a statutory requirement for making a loan guarantee.
DOE reexamined the statute, particularly its text and structure, and now concludes that “A first lien on all project assets is better understood as one element that the Secretary may require for a particular project, but is not compelled by the statute to require,” and amended its rules. Pushing back the start date for many projects by almost four years.
Now, keep in mind that cellulosic targets were set to commence in 2011, just 13 months after the clarifications on the 1703 loan guarantee program. And the rules for the cellulosic provisions of RFS2 itself the critical rules that would underpin any efforts commercially to build capacity to meet of those targets were finalized by EPA in early 2010.
The impact of the rule problems
All this unsophisticated hoo-hah about “missed targets”. And, also, companies put the extra time to good use in developing more cost-effective technology and logistic operations. So, in the long-term the delay produced better technologies and more of them.
So that’s the technology but what about market access?
One thing that supporters and detractors can agree on is that, in the United States, E10 (10 percent ethanol blends) have reached a saturation point, with around 13.5 billion gallons of ethanol blended into roughly 135 billion gallons of gasoline. The overwhelming majority of that fuel is corn ethanol which has advantages in cost and availability over cellulosic fuels.
Ethanol vs gasoline, which costs less?
Today, in fact, on an energy basis, ethanol is so cheap that what was once a subsidized fuel and criticized as such in some quarters is right at parity with gasoline on an energy basis. As GasBuddy.com pointed out here, ethanol-free gasoline costs 10-15 cents more per gallon than E10 unleaded.
And there’s good reason for that. November ethanol futures were trading at $1.59 on the Chicago Board of trade, while the November RBOB gasoline contract was trading at $2.30. RBOB is blended with 10% ethanol content to make 87-octane regular unleaded fuel with ethanol supplying an extra boost of octane.
What’s the market access debate over now?
Most of the debate focuses on where fuels go, past the E10 saturation point. That’s not the base for biodiesel or drop-in fuels but for first-generation and cellulosic ethanol, and for obligated blenders, it’s the big issue on the table.
One option is E15 blending, which is now EPA-approved for vehicles made in 2001 or later. But adoption rates have been cruelly slow a handful of outlets offer E15. Opinions differ on whether that reflects petroleum industry influence or retailer resistance.
Another option is E85, which is very cost effective for consumers, but it is only available at fewer than 3,000 fuel stations (out of 150,000 nationally), mostly in the Midwest. Retailers balk at the cost of retrofitting for E85 without government help and in general E85 is marked up way higher at retail than the market will bear. We reported on that here.
Bottom line, there’s no clear path for added ethanol capacity to reach a market at the moment. And corn ethanol is going to be more cost competitive right now. With corn trading at $3.41 per bushel for the December contract, there’s a notional cost of $0.78 per gallon for the corn feedstock right now (even without considering renewable fuel credit values – RINs) and that’s impossible for cellulosic fuel to compete with right now.
Which puts a brake on financing until the market access picture clears up.
E85 vs gasoline, which costs less?
On a wholesale basis, E85 wins. It’s priced as low as $1.39, wholesale, if you avoid buying it from petroleum companies. That’s a savings of 32 cents per gallon, vs RBOB gasoline, after allowing for differences in energy density.
The Bottom Line
The technologies were hamstrung by a combination of:
1. Overly optimistic views of construction and development timelines from pilot to demonstration, to first commercial, to steady-state operations at scale, to the multiple facility scale. The project developers point out that they are creating several new industries, from scratch (e.g. in many cases, biomass harvesting, pre-treatment, cellulosic hydrolysis, and fermentation) and there is much to be considered in the fact that they did what they said they’d do, in greater numbers, only later.
2. Unlucky timing in terms of the 2008-09 financing crisis and the shutdown of project finance markets.
3. No emergence of consensus on how to deal with the E10 saturation point which accelerated in the face of falling gasoline demand.
4. Poor structure of loan guarantee program, in a way that virtually shut out liquid transportation fuels, even though they were the primary foc
us of “ending the oil addiction” and the 2005 and 2007 energy policy legislation.
In the short-term, much of the excitement of their arrival, in the general public view has been dampened by the exhaustive timeline of the journey. Many in the public have moved on, to electrics, cheap natural gas, or to taking more selfies.
In the long-term, the market access problem looms large. Unless that is solved perhaps through confrontation, perhaps through confrontation this wave of cellulosic ethanol technologies will not be joined by a second wave, at least in the United States. Asia and Latin America have become the most likely candidates for deployment now.