A Potential Structure for Biomass Energy Production Incentives
The existing programs for biomass energy production incentives for alternative energy production are complex, cross agencies, are continued and then discontinued, have varying deadline dates, and require approvals through a variety of unrelated Government agencies. Instead of incenting the production of jobs, the on-again, off again nature of the incentives leads to huge project development inefficiencies and slows job development. What is needed is a new program that is offered as an alternative option to the current programs so that new applications can be completed in less than 90 days with all approvals. It should be designed to speed up the production of jobs, and to meet national energy production replacement priorities. This paper is dedicated to the biomass portion of the incentives and streamlining the incentives and approvals.
In the document that follows, the key elements of future USDA/Treasury financing programs are proposed:
(1) Put incentives on EFFICIENT use of biomass
The current programs promote the inefficient development of biomass based alternative energy. While the CHP Partnership of the EPA recommends the efficient use of biomass through Combined Heat and Power Technology (CHP), the legislation allows for only the largest tax credit to be applied to electric only plants (30% ITC). This causes more than 2 times as much biomass to be needed to produce the same about of total power, while penalizing the CHP provider (who also could also sell off steam and hot water) by providing 1/3 as much for the tax credit ( 10% ITC). It rewards the inefficient plant provider through the BCAP program by providing incentives based on tonnage, not based on tonnage effectively used. Current programs essentially reinforce existing waste of scarce biomass. In the new programs, it is proposed that efficiency be the driver of incentives, not purely volume. These programs should be tied to ONLY new jobs, and only new plants that create (directly or indirectly) energy. At the very least, equalize the incentives for CHP and pure electric plants.
(2) Put incentives on FRONT END financing
The market for financing clean energy is a very difficult market right now. The problem is that there are too many Government programs for permanent financing, and essentially none for project finance. While it costs about $1.5-$2.0 million to put together a package to present for financing one of these projects, the timelines on the incentives are very short, span multiple agencies, and lack cohesiveness. Apart from the investment, it may take 4-9 months to put together a biomass energy production facility investment package. With the programs being announced, then rescinded, then modified, or the rules on implementation coming out 8 months later, a great deal of the work needs to be done over. This slows down everything, and can lead to a deal falling apart since the commitments were for a specific time window from the participants. Since project finance is the gating factor to putting together a successful financing package, there needs to be greater emphasis on the front end financing, with the front end financing rolling into the backend financing.
(3) Put in an ALTERNATIVE program to the current program that has the same economic consequences, but with single-stop approval across agencies
The rules for existing programs are too complex, overlap, contradict, or offset the rules of other programs. The rules also require involvement with the DOE, the Treasury, The USDA at both the field and the national level, and others to get approved. An alternative to this should be a single biomass investment program that is approved by one entity. Many of the problems in the programs are due to people applying for funds (as was the case with BCAP) for unintended purposes. If the programs were restructured, to where one entity could provide all approvals, it would speed up job creation. This could be achieved by setting up an interdisciplinary team that was dedicated to this one goal of creating jobs, and applying the incentives only where they are needed. By requiring a summary business plan for getting the incentive, rather than a reimbursement request, this goal could be achieved. It would require fraud in the business plan for the plan to be used in a way that was unintended, or to subsidize existing operations.
(4) Establish an Office of Energy Oversight for BIOMASS within USDA
The objective of this office, which could be interdisciplinary, would be to work on creating a national program to create both the steam and electric to meet the requirements of RPS, and RFS2 and steam and hot water users by utilizing more fully rural communities and creating more structured programs. If we are to become energy independent, we need the BCAP, REAP, ITC (with it expanded to include CHP at 30% at a bare minimum), and other programs with a focus on figuring out how the programs can be consolidated to achieve a desired result.
(5) Focus the Alternative Program on OUTPUT, not inputs
Part of this objective can be obtained through modifications to some of the USDA rules for accounting for equity and debt. Each project should have a minimum of 10% cash equity, with up to 5% of this amount being in the cost of putting together the investment package. The balance should be in the form of loans (50% is available and can meet covenants) and the balance should be issued to the recipients as preferred stock. By using preferred stock, the entity can have the debt forgiven at the rate of 20% of the balance outstanding per year (which is the same as the ITC claw-back under the cash ITC program) and USDA can be assured that the wood is used as intended, and as represented or the preferred stock is not forgiven. The capital structure would be 10% cash or in kind from the plant owner, 40% in preferred stock forgiven over a 5 year period AFTER the plant is in operation and 50% debt (probably RUSA or Build America). The COMPLETE cost of the plant including pre-construction, the wood yard, and the operating plant should be rolled up into one entity. This would take out all issues related to conflict of interest.
To meet this criteria for biomass financing, an entity should be certified by DOE (with 90 days to react) as a plant that is either technically feasible, or one where there are at least 10 successful biomass plants in operation that they can visit and see that they are utility grade and have demonstrated results to qualify for the program. The reduction in the preferred stock should not be taxable, but should impact the basis in the project by 15% of the amount forgiven. (the way the ITC works today).
(6) Integrate PROJECT FINANCE and permanent finance
There is insufficient project finance money available today. The USDA should be allowed to issue construction loan guarantees on the projects where it is providing preferred stock and debt equal in amount to the normal 80% debt limit. This means that the “risk money” in the project is 20% until the plant is commissioned, and 10% thereafter plus earnings, and preferred stock forgiveness.
(7) BioMass2 (BCAP 15 year energy crop program)
Leave the 15 year program in effect for owners of land that are providing the raw materials to meet the requirements of either RPS, or RPF2. Establish approved plants, and establish a direct link between the plant and the fuel source provider. Tie the agreement with the land owner to the plant that would be the user.
(8) Establish one company for the business plan, and for project execution
The company should spend no more than 5% on project development, it would borrow its money under USDA agreements to pay for construction interest, it would include the wood yard for the facility, and it would include the project costs for building out the project. It would put down 20% during construction, with a 10% rebate (10% down) once the plant is operational. Under this alternative, there is no BCAP going to the harvester, and the 15 year energy land bank program would have its own separate rules for funding per acre, or per ton of material produced.
It these eight core actions are taken, and USDA can take the lead with providing one stop-shopping for the project finance and the permanent loans with the preferred stock (which would have the present value equivalent of the harvester BCAP and the plant ITC) the project would be greatly simplified and jobs could be produced faster.
If these programs are approved as recommended, the program becomes predictable and the issues relating to conflict of interest, intent, and production are fixed. In addition, the emphasis is shifted from input to output so that the Government is assured that there is annual production of energy as a result of the incentive program.
The dividends on the preferred stock would be accrued, and paid as warrants on the completed plant. If the plant in the company was eventually sold at a gain, the proceeds from exercising the warrants could be sold by the Government and used to refresh the funding for future projects, or to recover costs.
Integrated USDA Project finance and Permanent Finance Program
(1) Establish interdisciplinary team (Treasury and USDA) to review business plans for adherence to new energy production guidelines for a biomass energy production (CHP or electric) plant
(2) Review project for risk, and co-investment by outside investors
(3) Provide for three things if a project finance loan is approved:
a. A project finance loan where 20% equity is required, and an 80% loan with a USDA guarantee
i. Allow up to 5% of total project development cost to be included as equity
ii. Require 15% in cash for balance of project finance period
iii. Require backend permanent loan takeouts (terms below)
iv. Do not look to source of equity, as long as the equity cannot be taken back during the project finance phase
b. The project basis would be the TOTAL plant investment in the business plan including the preconstruction costs (the investment package), the wood yard to provide the wood, and the actual plant construction costs as well as construction period interest (approximately 2 years)
(4) Provide for a 40% preferred Stock investment in the project upon completion
a. The preferred stock would apply to both CHP and electric only plants
b. The preferred stock would be issued when the permanent financing closed
c. The preferred stock would replace the existing BCAP program, and the ITC program
d. The preferred stock would be forgiven at the rate of 20% per annum AS THE FACILITY produced energy (the ITC is actually handled in a similar way today)
e. The preferred stock would pay a dividend in warrants that could be exercised at the total cost value of the plant at the time the plant was sold. If there was a gain, the gain could go back into the program. The warrants would equal up to 10% of the plant value above original cost.
f. The depreciable value of the plant would be set at 85% of total cost (just like under the ITC provisions), and the preferred stock forgiveness would be excluded from income (just like the ITC)
(5) REAP Grants
a. Reap grants should be available ONCE a completed investment package is done. The REAP grant should be for up to $500,000 or 25% of the investment package project cost. The REAP grant should not be considered when computing the equity requirements for loans
(6) Permanent Finance
a. Permanent financing should be granted on a project with the same USDA 20% equity requirement, but this requirements should be:
i. The project development cost (up to 5% of project development cost)
ii. Cash equal to another 5% of project development cost
iii. The balance should be the preferred stock that is issued at closing
iv. All other covenants, such as adequate debt coverage and appraisal should be included in any loan documentation and approvals
v. Establish PLP’s for this sector, just like SBA has with banks or independent lenders
vi. Focus initially on approvals of projects where the technology is mature (10 or more plants in operation, demonstrated financial feasibility)
(7) Apply this program to the first 300 plants, or through 2014, which even occurs faster, and, allow two years thereafter for build-out of the plants
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