Federal Loan Guarantees—Part One

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

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 by intramural battles within Congress and between DOE and Congress, the need to conduct a rulemaking to guide the exercise of this authority, and general caution by DOE. (DOE’s past experience with loan guarantees has not been good. The caution is understandable.)

However, 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. The battles with Congress have abated; the rulemaking is finished, and the 2008 Omnibus Appropriations Act gives DOE greatly increased loan guarantee funding. 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.

Good news on funding

Even though the loan guarantee program is designed to be self-funding, DOE takes the position that it must have appropriations authority each year for the total amount of the loan guarantees it issues. In 2006, Congress gave DOE $2 billion in loan guarantee authority for the program; in 2007, that amount doubled to $4 billion, even though the program was stalled by the lack of implementing regulations; for 2008, DOE sought $9 billion. Recognizing that a significantly larger program will be required if loan guarantees are to bring transformational energy technologies to market, Congress has been more generous. The report accompanying the Omnibus Appropriations Act for 2008 authorizes $38.5 billion in loan guarantees. Report language further directs that $18.5 billion of that go to loan guarantees for new nuclear plants, $10 billion for renewable energy, $6 billion for carbon capture, $2 billion for advanced coal gasification, and $2 billion for uranium enrichment. This should enable DOE to proceed with multiple solicitations, each focused on a designated class of technology.

Loan structure issues resolved

In its Notice of Proposed Rulemaking, DOE suggested that it would: (1) limit guarantees to no more than 90 percent of any debt instrument; (2) prohibit “stripping” the guaranteed portion of any such instrument from the non-guaranteed portion for syndication or resale; and (3) require that DOE have the first lien on all project assets pledged as collateral for the guaranteed loan. Numerous parties argued that the loan guarantees would be unusable with those conditions because no market exists for a hybrid instrument composed of roughly 90 percent federally guaranteed debt and roughly 10 percent debt that is non-guaranteed, subordinate and, therefore, much riskier. In addition, many argued that private lenders would never agree to be entirely subordinate to DOE in the event of default.

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DOE took those concerns seriously and in the final rule DOE changed all three conditions.

First, DOE eliminated the firm 90 percent cap, indicating it would consider guarantees up to 100 percent of a debt instrument, although it did not commit itself to guaranteeing 100 percent of every debt instrument covered by the program. In an unexpected turn of events, DOE said that where 100 percent of a debt instrument is guaranteed, the debt must be issued by the Treasury Department’s Federal Financing Bank, not by commercial lenders. While this means less of a role for Wall Street, it may reduce the cost of the debt, a plus for project developers.

Second, in cases where it guarantees 90 percent or less of a debt instrument, DOE eliminated the prohibition on stripping the guaranteed portion of the debt from the non-guaranteed portion. Thus, debt can be resold in parts based on the differing risk profiles attached to the guaranteed and non-guaranteed portion of a loan. When DOE guarantees more than 90 percent of a debt instrument but less than 100 percent, the prohibition on stripping remains.

Finally, irrespective of the level of guarantee, DOE stated that it would no longer insist that the non-federally guaranteed portion of project debt be subordinate to the guaranteed portion. Instead, DOE will retain control over the disposition of assets, but it will agree to a pari passu structure with other lenders, giving them a proportional recovery from collateral in the event of default.

Although DOE may guarantee up to 100 percent of a given debt instrument, the law limits loan guarantees under the program to 80 percent of project costs. Therefore, DOE also considered what, if any, constraints it might impose on the remaining 20 percent of financing. DOE did not impose a hard numerical floor on the equity contribution of project sponsors, but it stressed that it would take the type and amount of equity contributions into account when deciding which projects to select. DOE is clearly looking for project sponsors to be at risk, alongside the government, if a project is to receive a guarantee.

[Part Two of this article will be published in the March/April issue.]

Authors

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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