Miami, FL, USA — The USDA tells us that more than 500 biorefineries will be need to be built between now and 2022 in the United States to meet the added requirements for advanced biofuels. With those refineries costing somewhere around $8 per gallon of capacity, or north of $300 million each, the total price tag for bioenergy expansion will be in the region of $150 billion.
Globally, the price tag could easily double that, to $300 billion, as other nations fulfill mandates and explore opportunities in energy security, job creation and climate control over the next 11 years.
The USDA and DOE have worked hard to assure that the technologies are developed and that the feedstocks are sustainable, available, reliable and affordable.
A Really, Really Big Capital Call
Just as daunting, and rarely addressed, is the innovation required to aggregate and distribute the required capital. Just to name a single concern – only a handful of firms have skills in the due diligence required in financing highly technical, capital-intensive bioenergy projects. The amounts required will shortly overwhelm the technical and financial resources of those few.
North American project finance volume for 2009, for example, was $31.2 billion for 93 projects, according to Dealogic. On the assumption that the big commercial scale-up of US advanced biofuels would begin no sooner than 2013, as companies move from demonstration to commercial scale, the capital required will be in the region of $16 billion per year, of which perhaps $13 billion will need to come from the debt market.
But it is the larger capital calls that may come, as the bio-based opportunity evolves, that make the reform of project finance an urgent topic for now, rather than some sunny future populated by smiling banks, fairies and elves. The build-out of a complete replacement of our current liquid fuels platform, based on fossil resources, would be north of $10 trillion.
A Structure for Energy Transformation
A structure for energy transformation must include not only a vision of where the feedstocks and technologies will come from and how they are brought along, but a vision of how to finance a build-out. In the Apollo moon shot, it was not simply enough to set goals and hire astronauts – at some point, someone had to write the check for the construction.
In the project finance meltdown of the past two years, where banks have simply closed their doors to bioenergy projects, of the most innovative channels of finance has been a move towards the bond market, initiated by a team from Stern Brothers, Mintz Levin and Kreig DeVault. That structure – which we highlighted in “The Name is Bond” – was very much in the spotlight in January when a number of projects went forward with USDA loan guarantees using or considering the model.
We expect that the most effective, efficient vehicle for financing bioenergy at scale will be asset-backed securities. These are securities:
“whose value and income payments are derived from and collateralized (or “backed”) by a specified pool of underlying assets…Pooling the assets into financial instruments allows them to be sold to general investors, a process called securitization, and allows the risk of investing in the underlying assets to be diversified because each security will represent a fraction of the total value of the diverse pool of underlying assets.”
The asset-backed security model has been used for years in the mortgage, credit card, auto loan, and student loan market.
How It Works
Here’s how such a model night work.
1. The Issuing Bank.
Bank A finances project A, through a traditional project finance loan.
2. The Third-party Appraiser.
A third party judges the risk on the loan depending on the risks associated with feedstock, technology and offtake.
3. The Package.
The loan is pooled with a class of other renewable energy project loans into a security with a given interest rate (commensurate with the risk), and term. These could be balanced by type of energy, geography, maturity of technology, appraised risk, to create a pooled asset to spread out the default risk.
4. The Guarantee.
The US federal government, or other sovereign authority, issues a guarantee on the debt. The government, thereby, also spreads its risk and maximizes the efficiency of its capital, while investing in the replacement of the energy infrastructure. This premium could be replaced, or augmented, by vehicles created by the insurance industry.
These premiums could be, in part or in whole, funded by the equity investors in the underlying projects.
5. The Tax-free Decision.
The federal government, or any state government, could take the position that these securities are tax-free – thereby making the investments more attractive, and more feasible at lower rates of interest.
6. The Sale.
The government-backed, asset-pooled securities are then sold into the institutional investment market, for example to insurance companies and pension funds. Mutual funds would also have an opportunity to participate and thereby bring in the retail investor.
As loans are sold into the market, capital flows back to the issuing banks, which then have their capital freed to make new loans, thereby accelerating the pace of financing.
The more projects that are built, the more operational data is accumulated that mitigates risk. Plus, economies of scale become available with larger pools of capital available to build larger projects.
7. The Result.
For the asset-backed security investor, the cash flows from the project would cover the servicing of the interest. The guarantee acts as a bulwark against default. It is not only a green investment, but has the protections and returns that investors require, while insulating them from the need to engage in project due diligence, or decide if Amyris’ latest project is less risky than, say, Coskata’s.
For the issuing bank, there is a market to sell the loan into that brings back the capital and zeroes out the risk. The bank can thereby go back into the market to make new loans.
For the government guarantor – a means of accelerating support for job creation, climate control and energy diversification without the bureaucracy and absurd risk limitations of the current loan guarantee regime.
For the project – a faster, deeper pool of capital.
For the equity investor – and more certainty of the path through the Valley of Death between successful pilots and commercialization at scale.
8. An Example.
Retail investor invests $10,000 in Mutual Fund A.
That fund, which has $10 billion under management, has invested $100 million in Rennies, renewable energy securities – in this case, 15-year, 6.5%, government-guaranteed bonds.
That particular package of Rennies represented $5 billion, in a pool of assets including parts (but not the whole loan) of 100 different renewable energy projects across the United States – wind, solar, bioenergy, geothermal – in all geographies, and representing a spectrum of technologies. Some technologies would be mature, some less so.
One of the underlying projects in that Rennie was a $300 million, 40 million gallon, advanced biofuel project in, say, Iowa. That project had $240 million in debt and $60 million in equity.
The issuing bank of the original loan, resold it to a Special Purpose Corporation that packages securities, and the $240 million was packaged into 4 separate securities, with $60 million of the project cost spread into each.
The issuing bank, having sold the loan at a discount into the pool, has recaptured its capital and is ready to make another loan to another renewable energy project.
The project itself, having paid for the due diligence required to get into the project pool, and having funded some of the insurance cost for the risk it brings to the pool, gets on with the job of creating jobs, reducing emissions and diversifying the nation’s energy supply.
Meanwhile, the retail investor receives proceeds from the mutual fund, which is earning return on the investment in the form of interest and principal payments, or from the trading of the security.
The Digest’s Challenge
There could well be a better way to finance biofuels than the asset-backed security model we have proposed. If there’s a better system, we’d like to hear about it. If not, why not get going.
This article was originally published on the Biofuels Digest and was reprinted with permission.