Arranging Debt Financing for Biomass Projects
Biomass facilities are a great source of renewable energy, but difficult to develop and finance. Despite their typically smaller size (usually 50 MW or less) their complexity is significant. Developers must secure financeable fuel supply agreements outlining appropriate term, quantity, quality and price with a creditworthy counterparty, obtain a financeable power purchase agreement, and have a thick skin and capital to get through permitting and the inevitable public relations fight.
With a financeable project, the developer can arrange permanent financing, which can be leveraged or unleveraged. Recently, most transactions have been leveraged to achieve the desired returns, with the equity component comprising 30 to 50 percent of the total capital costs. The balance of the permanent financing will be debt financed.
Debt financing for biomass projects will usually be structured as non-recourse, relying on the project’s assets as collateral and looking to the cash flow for debt service. The lenders will generally not have any recourse to the sponsor or other equity investors. Leverage at the project level will increase equity returns but also require higher tax equity returns and increase complexity. For these reasons, sponsors will sometimes seek to instead back lever projects.
Banks or institutional lenders are the primary sources of debt financing. The lenders active in the space are experienced and knowledgeable, which is critical to successfully completing the debt financing. For banks, tenors have recently lengthened to as long as 15 to 17 years for a fully amortizing loan. Institutional lenders will typically be longer term, 20 to 25 years, but with higher rates.
Perhaps the cheapest debt, but easily the most time consuming, is commercial loans backed by the USDA and the U.S. DOE. The terms of the loan will be determined by the commercial bank but the loan guaranty increases the credit support and reduces the interest rate. Significant downsides to these loan guaranty programs include the time, upfront cost and complexity of getting them completed.
Other federal financing programs include tax-exempt bonds, such as Clean Renewable Energy Bonds, bonds backed by loan guaranties under USDA Section 9003, and New Market Tax Credits. The CREBS have not been widely used for various reasons. The Section 9003 program was not overly successful because lenders did not offer terms to successfully finance projects. As recently revised, Section 9003 loan guaranties can backstop bonds issued by the company in a private placement to qualified buyers. The funds are then held by a commercial bank as a trustee.
The New Market Tax Credits program allocates tax credits to community development organizations (CDO) to create jobs and economic development in low-income areas. An investor will fund a developer’s project through the CDO in return for federal tax credits at 39 percent. A CDO typically allocates about $10 million to a single project. If a project needs $50 million of NMTCs, the sponsor will need five CDOs to participate. NMTC transactions are very complex and a developer needs to work with experienced advisors.
Equipment vendors and EPC (engineering, procurement and construction) contractors may also be a good source of permanent financing, as well as equipment or construction financing. Foreign vendors generally will have limited or no ability to use federal tax credits, so may not be a source of tax equity. Vendors who invest in the project may also have concerns about accounting treatment for various items, including consolidation of the project liabilities and the character and timing of revenue recognition.
Finally, debt financing through private placements of debt or bond offerings are gaining attention with very low rates and terms of 25 to 30 years. Securitization is difficult to combine with tax equity in a single project, so is more efficient for financing a portfolio of projects to achieve the scale needed by institutional investors.
With so much complexity, it can be nearly impossible to determine the right approach (or approaches) and to secure that particular type of financing. A sponsor would be well-served to focus on a few key items. First, make sure your project is solid and financeable. Second, understand your financial model and what cost of capital is needed to make the project successful. Finally, make sure your advisors and counterparties have experience with the development of biomass projects and the financial structures being proposed. Development and financing of a biomass project is complex. Don’t reinvent the wheel unless it is your only option, or there is a very real and significant benefit.
Author: David Benson
Partner, Stoel Rives LLP