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Creative Finance Mechanisms Are Enabling Advanced Biofuel/Bioenergy Project Development

April 11, 2013

Ethanol & Biofuels NewsFinding funding to construct novel, first-in-kind, albeit unproven, commercial biorefining and/or bioenergy projects is a daunting task for any developer in today’s capital constrained environment but, with the help of specially-crafted taxable bonds, government-backed loan programs and a sound technology, management and business acumen, it is possible, according to Mark Riedy, partner with international law firm Mintz Levin Cohn Ferris Glovsky and Popeo PC (Mintz Levin).

There are a number of financing tools available for biorefining/bioenergy developers at their disposal that Mintz Levin facilitates, together with investment banking firm Stern Brothers and its counsel, Krieg DeVault, such as tying taxable bonds to federal loan guarantee programs, which provide long tenors, low interest rates and other attractive debt terms that reinforce the credit worthiness of a pre-commercial project seeking to reach commercial-scale.

Riedy explained to Ethanol & Biofuels News (EBN) that credit-enhanced bond financing mechanisms – accepted through the U.S. Department of Agriculture’s (USDA) (Section 9003 Program) and Rural Energy for America Program grants (Section 9007), as well as some through the U.S. Department of Energy (DOE) – essentially has replaced hard-to-find and expensive, short-term commercial debt from institutional lenders, which often perceive funding first-of-a-kind commercial biorefining and bioenergy projects as being “too risky” of a proposition.

Mark Riedy, Mintz Levin

Mark Riedy, Mintz Levin

“[The bonds] credit-enhance non-investment grade taxable bonds – bonds that are less than BBB-rated – into investment-grade bonds that are BBB-or-better where institutional investors, who Stern Brothers will place the debt with, become the lenders because they’re the bondholders, and they put their money into the project,” Riedy told EBN.

The benefit of a bank holding or reselling taxable bonds, according to Riedy, is that the bank doesn’t have to put up the lion’s share of commercial debt in the form of a traditional bank loan. “They’re the applicant; they’re the trustee on the bonds, and they hold title to the bonds and into the project security during the term of the loan guarantee. They also get paid to service principal and interest on the bonds as they would if they had their own commercial loan out there,” Riedy said.

“In essence, what [the bank] gets is a de-risked ride on the first [commercial] project, and the EPC [engineering, procurement and construction] firm who comes in to build it doesn’t have to put up a performance bond. If they do, it only helps the project, but it’s hard for an EPC firm to get their bonding authority to allow them to put a full wrap on an EPC when it’s not their technology, and it’s for technology that’s never been built before,” Riedy noted.

According to Riedy, credit-enhanced bond financing isn’t mutually exclusive to just the advanced biofuels or biobased chemical (i.e. biorefining) industries. He and his firm are already helping finance other renewable-energy projects – such as solar, wind and geothermal – domestically and abroad, other energy-related projects such as in the oil and gas sectors, and other infrastructure projects, such as marine terminals, airports and other commercial industrial facilities.

Progress Already Being Made

In all, Mintz Levin, together with Stern Brothers, Krieg DeVault and Westar Trade, have helped draft the legal documents to qualify 12 U.S.-based commercial scale advanced biofuels and bio-based chemical projects for funding.

Three of the 12 have closed financing their respective projects, according to Riedy, and the remaining nine are “in the queue” headed toward closing. “All 12 projects supporting different renewable energy and chemical technologies tell us they want to build 20- plus or more [commercial] projects,” Riedy said. On the guaranteed portion of the senior loan, Riedy said he and his team is able to get coupon rates of between 150 and 200 basis points on the bonds over U.S. Treasury yields.

On the unguaranteed portion, it could be coupon rates between 9% and 17% because they’re considered “junk” bonds, according to Riedy. “Depending on how much of the senior debt is covered with the loan guarantee, it’s going to be a blended coupon rate of somewhere between 6% and 9.5% on the bonds for 20 years. That’s better than what you would get from a commercial bank, even if a bank would lend for a first commercial project,” Riedy said.

Riedy further noted that credit-enhanced bond financing could be as much as 30%-40% of total domestic and international project finance in the foreseeable future because of Basel III requirements that are projected to be effective in 2015. Under Basel III, global banks will be required to hold 4.5% of common equity (up from 2% in Basel II) and 6% of Tier I capital (up from 4% in Basel II) of risk-weighted assets.

“This means interest rates will go up, tenors will become shorter and risky projects will become perceived riskier than today,” Riedy said.

Importance of ‘Insurance Wraps’

While the U.S. Congress extended the 2008 Farm Bill for nine months (until the end of fiscal-year 2013) as part of the American Taxpayer Relief Act signed into law on January 2, the legislation, however, excluded mandatory funding for energy-title programs through the USDA, such as the Biorefinery Assistance Program (BAP) and Rural Energy for America Program (REAP).

Until these programs get reauthorized in a new Farm Bill, Riedy said he and his team have had to rely heavily on “insurance wraps” of first commercial project technology risks in order to cover the absence of financial assistance from the government to finance these new first-commercial renewable-energy projects.

“In the U.S., if you wrap the technology risk, you won’t get as good a coupon rate – probably between 10% and 12% – but you still get the project done because you still can’t get a bank to do the first one with its commercial debt,” Riedy said.

“As soon as you’ve been able to show continuous operation for a year or so then you can refinance it,” according to Riedy. “Then, a bank would come in and you’d get better terms because the construction risk and operational risks are mitigated. We don’t have a closing there yet, but we fully expect to have one in the foreseeable future.”

Leveraging International Financial Institutions

Some foreign banking institutions – such as Denmark’s EKF export credit agency – can provide loans and loan guarantees to new U.S.-based companies that are seeking to build out subsequent commercial renewable-energy projects in the U.S., according to Riedy.

Additional funds could become available from the U.S. Export-Import Bank if President Barrack Obama remains committed – as he has hinted in several speeches during his re-election campaign – to rechartering the bank to permit lending to domestic companies for U.S. projects, he noted.

Riedy, who has worked with the U.S. Export-Import Bank since the 1970s, said a federal loan guarantee could cover the entire senior portion of the debt for a commercial renewable-energy project (outside of U.S.).

“We also can do that with any type of energy or infrastructure project, but you have to be commercial scale,” Riedy said. “Project companies won’t do a first commercial project in an international finance from a bilateral or a multi-lateral finance agency. These projects must use proven commercial technologies.”

U.S. Congress has appropriated a historically high level of funding – US$140 billion – to the U.S. Export-Import Bank for fiscal year 2013 and 2014, Riedy noted, compared to just $32 billion a year earlier.

“At the U.S. Export-Import Bank, I currently can get a 10-year loan at a fixed rate of 2.08% right now, and I can get an 18-year loan at a fixed rate of 2.95%,” Riedy said, adding that the bank typically covers 85% of the U.S. contents of the project.

“In other words, if your project costs $100 million; they can do $85 million. Then, they’ll do 30% more of the local-country content, which would be your EPC costs in that country, generally,” according to Riedy.

“You have to pay the remaining 15%, but you can pay for it out of the financing. So, the amount of equity you have to put up is minimal. This rate can beat what we’re doing with the bond financing, but you have to be commercial. However, if the foreign project relies heavily on non-U.S. content, then our use of multi-lateral or bi-lateral agency loans guarantees cover project bonds as credit enhancement is the clear winner on low-cost and long-tenor financings,” Riedy further noted.

Possible Inclusion of Renewable Energy in MLPs/REITs

According to Riedy, opening up the U.S. tax code to include renewable-energy projects – to include advanced biofuels and bio-based chemicals – under master limited partnerships (MLPs) would provide additional sources of domestic capital.

MLPs are a unique tax structure that is taxed as a partnership, but whose ownership interests are traded like corporate stock on a public market. By statute, MLPs have only been available to investors in energy portfolios for oil, natural gas, coal extraction and pipeline projects.

Riedy estimated there were more than $350 billion in MLPs at year-end 2011, and that figure likely crossed the $500 billion-mark by year-end 2012, adding that MLPs typically provide returns in excess of 6% annually. Thus, these projects get access to capital at a lower cost and are more liquid than traditional financing approaches to energy projects, making them highly effective at attracting private investment.

To give equal treatment to renewable-energy projects for gaining similar access to capital, Riedy said Mintz Levin helped craft The Master Limited Partnerships Parity Act introduced in June 2012 by U.S. Sens. Chris Coons (DDel.) and Jerry Moran (R-Kan.), and subsequently supported by 11 bipartisan Senators.

Ted Poe (R-Texas) and Mike Thompson (D-Calif.) introduced companion legislation in the U.S. House of Representatives in September 2012. The proposed legislation, which aims at “leveling the playing field” by giving investors in renewable-energy projects access to much-needed capital, gained “excellent traction” during the fall lame-duck session as the first time ever introduced, according to Riedy. However, these legislative measures are expected to be reintroduced in the 113th Congress for consideration into law and have a good chance of passage as many members of Congress have expressed their support, Riedy noted.

In addition to helping restructure MLPs to include renewable-energy projects, Riedy and his firm plan crafting similar language in order to introduce legislation that would enable renewable-power and biorefining projects to qualify for real-estate investment trusts (REITs).

REITs are securities that sell like a stock on major exchanges and invest in real estate directly, either through properties or mortgages. They can also be funded through private placements, unlike MLPs, which require IPOs (initial public offerings) to capitalize them. REITs also receive special tax considerations and typically offer investors high yields in excess of 10% annually, as well as a highly liquid method of investing in real estate. “There were about $440 billion worth of REITs at the end of 2011. That figure is likely close to about $600 billion now,” Riedy said.

“For REITs, you have to distribute 90% of your annual income, so you just use that distribution and build more plants. That’s the intent. We have to get each – MLPs and REITs – to where renewable power, fuels and chemicals are qualified.

“With an MLP, you have to go to a capital market to file an IPO [initial public offering],” Riedy added. “With a REIT, you can either do an IPO or a private placement.” According to Riedy, the average annual rate of return for an MLP is typically about 6%, and the average annual rate of return for a REIT is over 10%. “A REIT is a little harder to play with because you have to fit within the definition of real-estate, which inherently means ‘no moving parts’ and most renewable-energy projects have moving parts. Therefore, the trick will be to make each of these new capital-creation mechanisms usable by the renewable-energy and bio-based chemical industries,” Riedy noted.

Riedy firmly believes that the respective industries “can pull this off if they jump in with both feet to help out,” he said. – Bryan Sims, Ethanol & Biofuels News, Copyright 2013. Hart Energy

– Bryan Sims, Ethanol & Biofuels News, Copyright 2013. Hart Energy

Posted with permission by Hart Energy as seen in the January 16, 2013 issue of Ethanol & Biofuels News, see http://tinyurl.com/BarryOnEnergy020

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