Federal Loan Guarantees –Part Two–

Will they give the U.S. climate response a needed boost in 2008?

by Mary Anne Sullivan and Sam Walsh

Almost three years ago in the Energy Policy Act of 2005, Congress gave the U.S. Department of Energy authority to provide loan guarantees for innovative energy technologies. This authority was seen by its supporters and Congress as a tool to jump-start commercialization of climate-friendly energy technologies that have been demonstrated at the pilot scale or in other countries, but not yet commercialized in the U.S.

The loan guarantee program was stalled, but as we enter 2008 it appears that the program is about to begin delivering on the promise of helping to bring important new greenhouse gas-reducing technologies to the marketplace. Particularly for the most costly technologies, most notably new nuclear power plants, some questions about the structure and affordability of the program remain. Those questions will be front and center as the program unfolds in the coming months, but hopes are high that the program is about to kick into high gear.

(Editor’s Note: In Part I, published in the January/February 2008 issue, funding and loan structure were addressed. Archived copies of the issue are available online at www.elp.com.)

Full faith and credit

In their rulemaking comments, Wall Street firms emphasized that a loan guarantee must represent the unconditional commitment of the full faith and credit of the United States if the program is to succeed in attracting affordable private investment to innovative technologies. The final rule seems to have calmed concerns that the guarantees might be conditioned in a way that would preclude the “AAA” rating for the federally guaranteed debt that the program was designed to assure. The guarantees will be absolute, absent fraud or material misrepresentation by the holder of a guaranteed obligation.

Eligible technologies

Congress said that DOE could issue loan guarantees for projects that “(1) avoid, reduce or sequester air pollutants or anthropogenic emissions of greenhouse gases; and (2) employ new or significantly improved technologies as compared to commercial technologies in service in the United States at the time the guarantee is issued.”

Although other projects can qualify under this test, carbon-reducing technologies are likely to receive the bulk of loan guarantees.

On the question of what it means for a technology to be in “general use,” DOE created a generous bright line rule: A technology is in general use only if it is being used in three or more commercial projects in the United States, in the same general application as the proposed project, and has been in service in each such project for at least five years. DOE abandoned its original proposal, that technologies might be considered in general use merely by virtue of having been ordered for use in multiple facilities, even if they were not yet operational. Since operational risk associated with new technology is of paramount concern to most lenders, DOE’s final definition of general use fits well with the loan guarantee program’s underlying purpose of eliminating barriers to the financing of innovative clean energy technologies.

Credit Subsidy Cost

The good news about funding levels and DOE’s more flexible approach to the structuring of loan guarantees is somewhat offset by a couple of difficult issues that the rule does not resolve dealing with the so-called “Credit Subsidy Cost,” and the related credit rating requirements.

EPAct 2005 states that loan guarantees must be either backed by appropriated funds or by payments from the borrower for the full cost of the obligation. Because DOE has not sought and does not intend to seek appropriated funds to cover the costs of administering the loan guarantees, the final rule requires all guarantee recipients to pay a fee to cover the administrative costs of the program and a Credit Subsidy payment intended to reflect the risk to the government of default on the guaranteed loan. These are upfront, non-refundable payments that must be made by a project sponsor.

DOE has stated that the Credit Subsidy Cost for a loan guarantee will be calculated on a case-by-case basis, and reflect the “net present value of estimated payments from the government (e.g., default claim payments) and to the government (e.g., recoveries), discounted to the point of disbursement.” Because the Credit Subsidy Cost is intended to reflect project risk and this program is designed specifically for projects that present technology risk, industry asked for, but did not receive, clarification as to how DOE intends to calculate the subsidy cost. DOE has committed to provide guidance soon that will allow project sponsors to estimate their subsidy costs in advance. It has also stated that it will make preliminary Credit Subsidy Cost estimates available around the time projects are selected, before the non-refundable payment must be made. Nevertheless, given the uncertainty about how it will be estimated, the affordability of the Credit Subsidy Cost looms as a critical open question for prospective loan guarantee applicants.

The final rule is clear about two details relating to Credit Subsidy Costs. First, the final rule makes clear that administrative fees and Credit Subsidy Costs cannot be financed out of guaranteed funds. Further, the final rule requires that, for projects costing more than $25 million, project sponsors must obtain a credit rating from a nationally recognized agency evaluating the quality of project debt assuming no federal guarantee. DOE has explained that such ratings will be important both when deciding among projects and when calculating each project’s Credit Subsidy Cost.

The difficulty with this aspect of the rule is that the premise of the program is that the projects are not readily financeable without the loan guarantee because lenders will have difficulty assessing their technology risk. Thus, it is unclear how a rating that assumes away the loan guarantee will be meaningful. Moreover, if the rating agencies are technology-risk averse, the Credit Subsidy Cost may prove to be too high to make the program useful, particularly given that project developers have to fund it up front. Those seeking loan guarantees are busy developing strategies that will give the rating agencies and DOE comfort that the risk to the federal Treasury associated with their projects is low.

Selection criteria

DOE has established a wide-ranging list of criteria upon which DOE will evaluate loan guarantee applications. These criteria, along with the explanations resolving several contested aspects of the final rule, signal that DOE is looking for projects that are as close as possible to commercial and only need the extra push to overcome the risk associated with financing first-of-a-kind technologies. (See sidebar.)

A critic might say DOE has chosen to support projects that need its support the least. More accurately, however, the selection criteria reflect a judgment that the program’s purpose–and perhaps the most that can be expected of it given its self-financing structure–will be to bring across the finish line projects that are already on the cusp of commercial viability. Moreover, the special attention DOE is paying to commercial viability in this program is quite likely a result of historical lessons learned the hard way. DOE loan guarantee programs in the past, including the synfuels program of the 1970s and the alcohol loan guarantee program of the 1980s, suffered punishingly high rates of default. Reviewing this history, one author has observed that in the past, DOE “based its financing decisions on whether technology was innovative and could solve current technological shortcomings in the industry, and failed to follow standard due diligence practices that emphasize financial viability.” Clearly, DOE intends to focus on financial viability this time around.

The solicitation process

Despite the request of many in industry that DOE make loan guarantees available on a rolling basis, DOE intends to proceed by solicitations. Particularly in light of the directions in the 2008 Omnibus Appropriations Act about how DOE should allocate the authorized funding, it seems likely that DOE will issue solicitations focused on particular project types, such as renewables, advanced coal, and nuclear projects. This will set up the kind of competition DOE quite clearly wants in order to enable it to select “the best in class” among similar proposals. The difficulty for developers, however, will be that not all projects are likely to be at an equal stage of readiness on DOE’s appointed schedule. A project that may be more promising in the long run could find itself at a disadvantage if project planning is not as advanced as other, potentially less meritorious but more fully developed projects at the time DOE solicits proposals for that project type.

Initial loan guarantee applicants selected

Before it issued its NOPR in 2006, DOE solicited pre-applications for its first round of loan guarantees. It received 143 pre-applications for the $2 billion in available loan guarantee authority. However, Congress directed DOE not to proceed until it issued its final rule. When it issued the final rule, DOE also invited 16 of those pre-applicants to submit full applications. Those 16 include:

  • four cellulosic ethanol projects
  • two advanced diesel fuel projects
  • three integrated gasification combined cycle plants, two of which will be carbon-capture ready and one which will gasify coal to produce both power and methanol
  • two industrial efficiency projects (a paper manufacturer and a maker of energy efficient windows)
  • two solar projects, (a photovoltaics maker and a developer of a concentrated solar power facility)
  • an electricity delivery project
  • a hydrogen fuel cell project
  • an alternative fuel vehicle project

DOE is moving forward to the formal application phase with this group of projects. Its actions with respect to that first group of 16 should teach us all more about how–and how expeditiously–DOE intends to implement the loan guarantee program.


DOE has established a wide-ranging list of criteria upon which DOE will evaluate loan guarantee applications. Among the selection criteria are:

  • the financial viability of the project
  • the extent to which the technology is widely replicable
  • the importance of the technological improvements and the quantity of emissions reduced
  • the likelihood the project will be ready for full commercial operations within the time frame proposed
  • the equity contribution of the project sponsors
  • the probability the project will produce revenues sufficient to service its debts
  • the capacity and expertise of the sponsors to successfully operate the project
  • a generalized assessment of the market, regulatory, legal, financial, and technological risks associated with the project.

Author

Mary Anne Sullivan, partner in Hogan & Hartson’s energy practice, has more than 25 years of experience as an energy lawyer. She previously served as general counsel of the U.S. Department of Energy and as deputy general counsel for environment and nuclear programs. Currently, her practice focuses on electricity and advanced energy technologies and she has assisted several clients with loan guarantee applications and comments. One client was recently accepted to proceed to the next stage based on its loan guarantee application. Contact Sullivan at masullivan@hhlaw.com. Sam Walsh is an associate at Hogan & Hartson.

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