Real Promise or False Hope: DOE's Title XVII Loan Guarantee

Jennifer F. Massouh is a Partner in the Finance Department of the New York and London offices of Latham and Watkins. Massouh’s practice focuses on energy acquisition, finance, and project finance, and includes the representation of developers, private equity funds, lenders, and underwriters in financing the development, construction, and acquisition of energy and other infrastructure projects. George D. Cannon, Jr. is a Partner in the Energy Regulatory and Markets Group in the Washington office of Latham and Watkins LLP. Cannon focuses on regulatory and transactional issues associated with competitive wholesale power markets, transmission access, and the development of renewable resources. He concentrates primarily on energy regulatory and market matters, with a focus on the production and delivery of electric energy and related products from wind, solar and other renewable resources. Suzanne M. Logan is an Associate in the Finance Department in the Washington office of Latham and Watkins. Her practice focuses on project development and project finance for clients developing solar, wind and other renewable resources. David L. Schwartz is a Partner and Chair of the Energy Regulatory and Markets Group in the Washington office of Latham and Watkins. Schwartz represents entities involved in electric generation and transmission, electric and gas marketing and investor-owned electric and gas utilities on matters involving regulation, the energy markets, and mergers and acquisitions.

Real Promise or False Hope: DOE’s Title XVII Loan Guarantee While the American Recovery and Reinvestment Act of 2009 expanded the DOE loan guarantee program to include certain ‘‘shovel-ready’’ projects, and appropriated $6 billion to cover the credit subsidy cost associated with these projects, it failed to resolve some of the most pressing problems facing the program. Here are some recommendations that may finally get some shovels in the ground. Jennifer F. Massouh, George D. Cannon, Suzanne M. Logan and David L. Schwartz

I. Introduction The threat of global climate change is forcing the U.S. to face an unprecedented challenge: reconciling the critical imperative of reducing the nation’s greenhouse gas emissions and dependence on fossil fuel with the need to continue to foster economic growth by meeting the nation’s growing energy demands. The Electric Power

Research Institute recently estimated that to reduce greenhouse gas emissions to 1990 levels, the nation must, inter alia, install an additional 100,000 MW of new renewable energy capacity and 64,000 MW of new nuclear capacity, and implement demand-side management to reduce demand growth from 1.05 percent to 0.75 percent per year.1 James Asselstine, managing director of Barclays Capital,

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recently testified before the Senate Committee on Energy and Natural Resources that ‘‘approximately $1.5–2.0 trillion in new investment will be required by 2030 for new generating capacity, new transmission and distribution, efficiency programs, and environmental controls on operating plants. To place this estimate in perspective, the current book value of the entire U.S. electricity supply system, built up over approximately the last 60 years, is only $750 billion.’’2 n Title XVII of the Energy Policy Act of 2005 (‘‘EPAct 2005’’), Congress established a loan guarantee program (the ‘‘Loan Guarantee Program’’) administered by the U.S. Department of Energy (DOE, or the ‘‘Department’’) to catalyze the much-needed investment in certain ‘‘clean’’ energy projects that utilize new or significantly improved technologies (i.e., technologies not yet applied on a commercial basis). Through the end of fiscal year 2008, Congress had granted the Department a total of $42.5 billion in loan guarantee authority to implement the Loan Guarantee Program, and for FY 2009 authorized DOE to issue an additional $47 billion in loan guarantees, of which $18.5 billion is reserved specifically for nuclear power facilities and which is available until committed.3 Although the Department entered into its first conditional commitment to issue a guarantee on March 20,

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2009, DOE has yet to finalize a single guarantee out of its nearly $90 billion in authority to do so. In the American Recovery and Reinvestment Act of 2009 (ARRA 2009), Congress authorized the Department to establish, on a temporary basis, an expanded loan guarantee program (the ‘‘Temporary Program’’) to cover certain new categories of projects – certain ‘‘shovel-ready’’ renewable and transmission

Will the provisions of the ARRA 2009 simply be more of the false hopes that we have seen in the past?

projects and leading-edge biofuels projects – and appropriated $6 billion to cover the cost of loan guarantees for these new projects. ill the provisions of the ARRA 2009 simply be more of the false hopes that we have seen in the past or will there be any real chance of having these allocated funds jumpstart the kind of development that is intended? This article first describes the Loan Guarantee Program as it is currently being implemented, and highlights its fundamental, systemic weaknesses that have led to criticism and cynicism about

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whether the Loan Guarantee Program can have any chance of success. This article then suggests what measures are needed to make both programs effective financial tools to foster the investment needed to enable the U.S. electric power sector to overcome the significant challenges it faces today. While it is likely that DOE will issue new regulations in the near future to implement the Temporary Program as well as to revise the original Loan Guarantee Program, the authors anticipate that many of the concerns that currently plague the Loan Guarantee Program may continue to impede both programs.

II. Overview of the Loan Guarantee Program4 Title XVII of the EPAct 2005 authorized DOE to issue loan guarantees for projects that: (1) avoid, reduce, or sequester air pollutants or anthropogenic emissions of greenhouse gases; (2) will be constructed and operated in the U.S.; (3) employ technologies, defined as ‘‘new or significantly improved technologies,’’ that: a. are concerned with the production, consumption, or transportation of energy; b. are not ‘‘commercial technologies’’—defined as a technology that has been in use in at least three commercial projects in the U.S. for at least five years in each such project, measured from the in-service date;

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c. either (i) have only recently been developed, discovered, or learned or (ii) involve or constitute one or more meaningful improvements in productivity or value as compared to commercial technologies in the U.S.; d. have the potential to be replicated in other commercial projects in the U.S.; and e. are or are likely to be available in the U.S. for further commercial application; and (4) are not research, development, or demonstration projects. The principal objectives of the Loan Guarantee Program are to (1) facilitate the introduction of new or significantly improved energy technologies with a high probability of commercial success into the marketplace, and (2) achieve significant environmental benefits. DOE currently implements the Loan Guarantee Program by issuing solicitations focusing on specific categories of projects. To date, five such solicitations have been issued. The initial solicitation was issued in August 2006 and invited pre-applications for eligible projects, while the final rules and regulations were in the process of being promulgated. Other past solicitations have invited applications for advanced nuclear power facilities; advanced ‘‘frontend’’ nuclear facilities; and innovative clean coal facilities. The most recent solicitation, which closed on Feb. 26, 2009, invited applications for a wide variety of energy efficiency, renewable energy, and advanced

transmission and distribution projects.

III. Current Program Rules and Requirements A. Basic structure Loan guarantees under the Loan Guarantee Program are available to support loans to pay ‘‘project costs’’ (as defined below)

To date, five solicitations focusing on specific categories of projects have been issued.

for eligible projects (i.e., projects that meet the requirements listed above). ‘‘Project costs’’ are costs, including escalations and contingencies, incurred by a borrower that ‘‘are necessary, reasonable, customary and directly related to’’ the construction, commissioning and startup of eligible projects.5 Expenses that are not considered ‘‘project costs’’ (the financing for which, therefore, will not be guaranteed) include: (1) costs the DOE determines are ‘‘excessive’’ (including the cost of hedging instruments), (2) the borrowerpaid fees and expenses, including the credit subsidy cost (which is

discussed below), of obtaining the loan guarantee, (3) fees and commissions related to obtaining federal or other funding, (4) parent corporation or affiliated entity general and administrative expenses, (5) dividend payments, (6) research, development, and demonstration costs of readying the technology for commercial deployment, and (7) expenses incurred after startup and commissioning of the project but prior to the project’s in-service date.6 OE has several specific requirements with respect to financial structuring of projects for which guarantees are sought. These requirements include the following:  Guarantees may only support loans in amounts up to 80 percent of an eligible project’s total project costs, and the project sponsor is required to make a ‘‘significant’’ equity contribution to the project.  The loans must be made by the Federal Financing Bank or other ‘‘eligible lenders’’ under the DOE’s implementing regulations. If the applicant seeks a guarantee for 100 percent of its total guaranteed debt obligation, then the applicant must obtain the underlying loan from the Federal Financing Bank.  The loans must mature on the earlier of 30 years or 90 percent of the project’s useful life.  DOE must have a first-priority security interest in all project assets.  Other than for projects under the Temporary Program, the borrower must pay the credit

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subsidy cost (i.e., the net present value of estimated (a) payments by the government to cover defaults, delinquencies, and other payments; and (b) payments to the government including origination and other fees, penalties and recoveries (all as discounted to the point of disbursement)) and all administrative fees related to issuing the guarantee.

their respective applications (a) to be complete and (b) to employ a new or significantly improved technology. DOE then performs a technical and financial review of the projects which passed its completeness review. Independent consultants and outside counsel may assist the Department to perform the due diligence required, and applicants are required to pay all of the attendant fees and expenses. The

B. Application process A project sponsor, whether foreign-owned or domesticowned, may submit an application for a loan guarantee, so long as the project is physically located in the U.S. or its territories, and the application meets all DOE requirements. As set forth in the current implementing regulations, applications are accepted solely through the solicitation process; in each solicitation, the Department specifies the types of eligible projects for that specific round.7 Applicants may submit only one application for one project using a particular technology. Twenty-five percent of the non-refundable application fee must be submitted with each application.8 fter receiving applications for a particular solicitation round, DOE first performs a ‘‘completeness’’ review. Within the timeframe set forth in the particular solicitation,9 the Department notifies applicants in writing as to whether it deems

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An applicant must submit a significant amount of information in order to apply for a loan guarantee.

remaining 75 percent of the application fee is payable to DOE upon notification that a project sponsor’s application has been selected for technical and financial review. Through the technical and financial review process, DOE selects the projects it believes may be suitable for a loan guarantee. In such a case, DOE and the applicant enter into negotiations to produce a term sheet for final approval by the DOE Credit Review Board. After this final approval, the term sheet becomes a conditional commitment to pursue the execution of a loan guarantee agreement. DOE,

however, can terminate the commitment at any time prior to execution of the loan guarantee agreement. Prior to the financial closing of the loan guarantee agreement, other than for projects under the Temporary Program, an applicant must pay the credit subsidy cost in full.10 Once the credit subsidy cost is paid and all other conditions precedent to closing are satisfied, the loan guarantee agreement is executed and the transaction is closed. o firm timeline from application submission to closing is established in the implementing regulations and none can be gleaned from past experience, as no loan guarantees have yet been finalized. Secretary Chu, however, recently stated that DOE plans to begin issuing guarantees to applicants from past solicitations (likely starting with applicants from the 2006 solicitation) by ‘‘late April or early May’’ 2009.11 DOE’s conditional commitment to issue a $535 million loan guarantee to Solyndra, Inc., an applicant from the 2006 pre-solicitation, may be an indication that DOE is moving forward to try to meet Secretary Chu’s stated goals. The Department also has indicated that it may begin to accept applications on a rolling basis, rather than through solicitations, to speed the review and issuing processes. However, further delays may occur, because as of the date of publication of this article, DOE has not yet issued any streamlined or programmatic process for issuing guarantees.

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C. Application requirements An applicant must submit a significant amount of information in order to apply for a loan guarantee. The various informational requirements can be broken into four general categories: project description; potential bankability; prospects for repayment of the debt obligation; and creditworthiness of the applicant. First, an applicant is required to provide a detailed description of the project, including descriptions of the following: (a) how and to what extent the project will avoid, reduce or sequester air pollutants or anthropogenic emissions of greenhouse gases; (b) how the project employs a new or significantly improved technology; (c) all potential project costs; (d) all parties contracted to provide engineering, procurement, construction, operations, and/or maintenance for the project, including component suppliers; and (e) all material permits required to proceed with the project, including a timeline for obtaining such permits. An applicant also is required to submit copies of an independent engineer’s report, an environmental report, an appraisal for any real property assets, all material contracts in place for the project (in draft or execution form), and all legal opinions and other material reports, analyses, and reviews related to the project.

Second, an applicant is required to submit information that will allow DOE to assess the project’s bankability, including a market analysis for any product to be produced by the project, together with copies of any offtake agreements; a detailed business plan; and a financial model, including pro forma balance sheets and

income and cash flow statements for the proposed term of the guarantee. hird, an applicant must submit information regarding the financial structure of the project, to allow DOE to evaluate the applicant’s ability to repay the debt obligation for which the guarantee is sought. This information includes a description of the sources and uses of debt and equity, a list of assets to be used as collateral for the debt obligation, and a preliminary credit assessment for the project if the estimated project costs exceed $25 million. If the applicant plans to obtain the guaranteed loan from a

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financial institution other than the Federal Financing Bank, the applicant also must include information regarding such financial institution and why it qualifies as an ‘‘eligible lender’’ under the implementing regulations. Finally, DOE requires an applicant to submit financial statements for as many of the past three years as are available, to evaluate the applicant’s creditworthiness. A credit history is also required for the applicant and any party who owns or controls a 5 percent or greater interest in the project or the applicant. In general, the application requirements are voluminous and detailed and many applicants have found them to be overly burdensome, at least relative to the likely benefit DOE obtains from the required information.12 DOE has also included additional requirements in the various solicitations. D. Selection criteria DOE evaluates the technical and programmatic aspects of each project as well as the creditworthiness of the project and applicant in order to choose likely awardees. Under the current implementing regulations, DOE evaluates projects on a ‘‘competitive’’ basis; i.e. it evaluates the strengths and weaknesses of each application as compared to other applications it has received.13

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With respect to technical selection criteria, DOE evaluates the following:  Technical Relevance and Merit. DOE considers the extent to which the project will employ new or significantly improved technologies as compared to commercial technologies. Based on the type of information requested in past solicitations, it appears that DOE values more highly those projects that employ technologies that have not been commercially applied in the U.S. at all, as opposed to projects that have been commercially applied one to three times in the past five years.  Applicant Capabilities, Technical Approach, and Work Plan. DOE evaluates (a) the potential for replicability of commercial use of the technology in the U.S.; (b) the potential for long-term commercial success of the technology; (c) the technical readiness for near-term commercial use; (d) the risk and mitigation plans associated with commercially applying the technology; and (e) the timeframe required to achieve the projected results.  Environmental and Energy Security Benefits. DOE evaluates to what measurable extent the project avoids, reduces, or sequesters air pollutants and/or anthropogenic emissions of greenhouse gases. These emissions-reduction benefits will be compared to existing technologies or systems. 58

With respect to programmatic selection criteria, DOE evaluates the following:  Construction Factors. DOE evaluates the project’s construction cost, the financial integrity of the chosen contractor and any cost overrun reserve facilities. DOE also evaluates the technology’s component

manufacturer using the same criteria.  Legal and Regulatory Factors. DOE considers the project’s capacity to mitigate potential legal and/or regulatory risks; areas of focus include permitting and public acceptance risks. inally, with respect to creditworthiness, DOE will consider the experience and financial capability of the project sponsor, the scope, timing, and amount of equity commitments, the project sponsor’s ability to pay transaction costs in a timely fashion, and the credibility of the business and financial plans. In several past solicitations, DOE has based as much as 50 percent (30 percent in its most recent

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solicitation) of its decision on the project sponsor’s or applicant’s creditworthiness. Greater weight also is given to projects which are applying for a guarantee that is a smaller percentage of debt and of total project costs, all else being equal.

IV. ARRA 2009 Establishes a Temporary Program for Shovel-Ready Commercial Projects ARRA 2009 establishes a Temporary Program for Rapid Deployment of Renewable Energy and Electric Power Transmission Projects and appropriates $6 billion to cover the costs of guarantees for loans to eligible projects under the Temporary Program. Of this $6 billion, $35 million is targeted for administrative expenses (more than doubling the administrative funding for DOE), and the remaining funds will be used to defray the credit subsidy costs of the guarantees. While Congress did not limit the amount of loan guarantee authority granted to DOE for eligible projects under the Temporary Program, the Joint Explanatory Statement of the Committee of Conference estimates that the $6 billion appropriation will support more than $60 billion in loans for qualifying projects. nder the Temporary Program, a project is eligible for a guarantee if it will commence construction no later

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than Sept. 30, 2011, and if it falls within one of the following three categories: (1) renewable energy systems, including incremental hydropower, that generate electricity; (2) electric power transmission systems, including upgrading and reconductoring projects; and (3) leading-edge biofuel projects14 that will use technologies performing at the pilot or demonstration scale that DOE determines are likely to become commercial technologies and will produce transportation fuels that substantially reduce life-cycle greenhouse gas emissions compared to other transportation fuels.15 Consistent with the broader goals of ARRA 2009, the Temporary Program is designed to facilitate financing for ‘‘shovelready’’ eligible projects employing commercially demonstrated technologies (as opposed to ‘‘new or significantly improved’’ technologies that are eligible under the original Loan Guarantee Program). DOE’s loan guarantee authority under the Temporary Program expires on Sept. 30, 2011. Shortly after ARRA 2009 was enacted, DOE announced what it called a ‘‘sweeping reorganization’’ in order to facilitate and expedite the issuing of guarantees under both the original Loan Guarantee Program and the Temporary Program.16 Specifically, Secretary Steven Chu announced that:  New applications will be reviewed on a rolling basis rather than by solicitation;

 Application forms will be streamlined and simplified;  Certain applicants may have the opportunity to pay application fees at closing rather than prior to technical and financial review;  The credit subsidy cost will be restructured to be payable incrementally over the life of the loan rather than at closing

(presumably where such costs are not paid with the $6 billion appropriation as described above);  Additional staff will be hired to assist with application processing; and  A Web site will be created to increase transparency and help applicants through the process.17 n addition, Secretary Chu recently announced that DOE plans to begin offering guarantees under the Temporary Program in early summer of 2009 and to utilize fully 70 percent of its $6 billion appropriation from the ARRA 2009 by the end of 2010.18 At this time, it is unclear whether DOE will implement the Temporary Program under the

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existing regulations or develop new regulations specific to the Temporary Program. DOE could seek to implement the Temporary Program under the existing regulations, with revisions to accommodate certain aspects of the new program. Recent public comments by the Secretary of Energy also suggest that DOE may revise the existing regulations to expedite the application process and ensure that funds are expended more quickly under both programs. The next two sections describe the deficiencies in the current regulations and offer recommendations that, if implemented, could help DOE to realize the goals of both the original Loan Guarantee Program and the Temporary Program. While DOE may have issued new regulations for the implementation of the Loan Guarantee Program and the Temporary Program, or may soon issue such regulations, it is likely that such new regulations would not satisfactorily address many of the authors’ concerns set forth in this article, and will likely require supplements or interpretive guidance in order to address these concerns.

V. Critiques of and Recommendations for the Loan Guarantee Program The Loan Guarantee Program has generated enormous interest from project sponsors, lenders

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and equity investors alike. For instance, DOE received 143 preapplications in response to its initial solicitation in August 2006, requesting more than $27 billion in loan guarantees.19 DOE received requests pursuant to the June 2008 nuclear solicitation for a total of $122 billion in loan guarantees, more than six times the $18.5 billion made available in that solicitation.20 No statistics are available yet for the most recent solicitation, but DOE has indicated that this solicitation was as oversubscribed as earlier solicitations. To date, however, not a single loan guarantee has been granted.21 The Honorable Alexander ‘‘Andy’’ Karsner, former Assistant Secretary of Energy Efficiency and Renewable Energy, summarized the state of the Loan Guarantee Program well, when he testified in February 2009 before Congress: ‘‘Despite the need for a bridge between private capital and public priorities, despite the importance of accelerating market penetration for clean energy technologies, despite the clear emphasis that Congress has placed on loan guarantees, very little progress has been made since the Energy Policy Act was signed into law almost four years ago. Not a penny of the more than $42 billion in authority has been used.’’22 DOE Secretary Chu also has acknowledged the failure of the Loan Guarantee Program to fulfill its mission when he said, ‘‘Appropriated in 2006, and still no money is out the door. And 60

here we are at the beginning of 2009.’’23 he Loan Guarantee Program suffers from several critical flaws that have drastically impeded the issuance of loan guarantees and hampered the effectiveness of the program. Each of these flaws, described below, should be addressed in order for the Loan Guarantee Program to

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serve its intended purpose of catalyzing investment in the U.S. clean energy and energy efficiency sectors. A. ‘‘New’’ versus ‘‘bankable’’ Putting aside the Temporary Program, a fundamental tension exists between the statutory goals of the Loan Guarantee Program and the selection criteria employed in granting loan guarantees. Title XVII originally granted DOE authority to make loan guarantees for projects employing new or significantly improved technologies (i.e., noncommercial technologies), yet DOE, in selecting applicants to whom to grant loan guarantees,

focuses heavily on the bankability of the applicants’ projects and the creditworthiness of the applicants themselves. Many applicants, e.g., startup technology companies, may have no commercially proven revenue streams and thus likely cannot obtain an investment grade credit rating. In many ways, DOE fails to take this into account. For instance, in recent solicitations, up to 50 percent of DOE’s decision to grant a loan guarantee was based not on the likely impact the technology might have but on the creditworthiness of the applicant. Moreover, credit subsidy costs— which, other than with respect to projects that qualify under the Temporary Program, are required to be paid by the applicant and are not considered to be project costs for purposes of calculating the amount of the guarantee—are determined based heavily on bankability and creditworthiness. y focusing so heavily on these factors, DOE may be denying loan guarantees to many of the very projects Title XVII was intended to support. At the very least, the program is skewed toward granting guarantees to more established project sponsors, to the detriment of smaller ones. This is especially troubling because the less established project sponsors are often those that are seeking guarantees for innovative projects in the renewable energy sector. Effecitvely excluding these smaller, less established sponsors would counteract what is arguably the most important goal

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of the Loan Guarantee Program, creating viable sources of renewable energy in the United States. B. Certain application requirements are overly burdensome The existing application process is generally overly costly and burdensome. The application fee itself, 100 percent of which must currently be paid before DOE even begins the technical and financial review of an application, imposes an unnecessary burden. The Honorable Andy Karsner explains, ‘‘[t]he present method of asking applicants to pay exorbitant sums for the privilege of filing applications that empirically linger for years with no predictable pathway or timetable to closing is unacceptable at best and attracts the wrong applicants at worst.’’24 oreover, in addition to voluminous information requirements, DOE requires applicants to submit a number of supplemental items that impose a significant burden without necessarily creating a corresponding benefit. First, for projects with estimated costs in excess of $25 million, the DOE requires the submission of a ‘‘preliminary credit assessment’’ from a nationally recognized rating agency that assigns a rating to the project without the loan guarantee. Acquiring this rating is costly and time consuming for the applicant and does not always

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provide information to DOE because ratings for projects in need of a loan guarantee (i.e., not tested in the financial markets) will be highly dependent on the existence or non-existence of the guarantee. Perhaps a more flexible ratings analysis or a less formal analysis by an investment bank or similar entity would be more useful. The existing

application requirements also include other documents that are not generally available at the stage an application is submitted, including commitment letters from potential debt and equity providers, closing checklists, and certified appraisals for real property. Attempting to obtain these items, or more frequently craft reasons why they are not available, costs an applicant time which could be better spent preparing detailed and comprehensive descriptions of the project, its proposed financing structure and its risks and mitigants, which are the better sources for DOE to assess whether a project should receive a loan guarantee. Many of these

supplemental items serve a better purpose as conditions to closing the loan guarantee, not documents to be submitted with an initial application. All of this is complicated by the fact that DOE currently administers the program by issuing solicitations, rather than reviewing applications on a rolling basis. Solicitations have only allowed project sponsors to submit applications in relatively short windows of time. For instance, applicants in the most recent solicitation originally had just two months to compile and submit their applications. While the deadline subsequently was extended by two months, giving applicants a total of four months, the sheer volume of information required to be submitted and the significant costs required to be paid in such a short time nonetheless made it difficult for some applicants to participate in the program. DOE recently announced plans to allow at least some applicants to submit applications on a rolling basis, rather than by solicitation. Some sources have indicated, however, that this reform might only apply to applications for loan guarantees below a certain dollar threshold.25 In order to ameliorate the problems discussed above, DOE should (1) allow all applications to be submitted on a rolling basis; (2) allow application fees to be remitted later in the application process when applicants have more certainty regarding their potential for success; and (3)

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eliminate the preliminary credit assessment and other supplemental items described above from the application process and, if needed, revise these requirements to be closing conditions. C. Credit subsidy cost: an uncertain, potentially significant cost DOE is statutorily obligated to receive the credit subsidy cost either from congressional appropriation or from the applicant. Other than with respect to the Temporary Program as described above, no such appropriations have materialized with respect to the Loan Guarantee Program. In addition, in its recently enacted appropriations bill for FY 2009, Congress specifically states that ‘‘no appropriations are available to pay the subsidy cost’’ of any guarantees issued by DOE under the proposed $47 billion in additional loan guarantee authority.26 Applicants outside of the Temporary Program, therefore, must pay the credit subsidy cost, separate and apart from the application fee, prior to financial close. Note that the credit subsidy cost is not an eligible project cost and thus cannot simply be rolled back into the amount for which applicants seek a guarantee. he Office of Management and Budget (OMB) calculates the credit subsidy cost using a proprietary financial model that takes into account the

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project’s financial and business plan, the creditworthiness of the applicant, and the terms and conditions of the guarantee under negotiation. Neither OMB nor DOE has made its model public. Moreover, DOE first provides an applicant with an estimated credit subsidy cost amount only when it provides the term sheet – many months after the applicant

submitted its application and after the applicant has paid the full application fee and incurred potentially significant administrative costs inherent in DOE’s technical and financial review, in addition to the applicant’s own legal and administrative costs. These two factors have combined to create a great deal of uncertainty and speculation with respect to the credit subsidy cost. n addition to being a virtually unknown cost, there is much speculation that the dollar amount of the credit subsidy cost will be significant. For instance, Standard & Poor’s estimated the possible range of credit subsidy costs for projects in the recent

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nuclear solicitation. They determined that if (1) a proposed 1,000 MW nuclear facility has total project costs of $6 billion; (2) a developer seeks a Title XVII guarantee for 100 percent of the debt financing ($4.8 billion); and (3) the project is rated ‘‘BB-’’, the credit subsidy cost would be approximately $288 million, while the credit subsidy cost for a similarly situated project with a rating of ‘‘BB’’ would be roughly $192 million.27 With respect to the most recent solicitation for energy efficiency, renewable energy, and advanced transmission and distribution projects, applicants project that credit subsidy cost could be as high as 30 percent of the amount of the guarantee being sought, and very well could be much more.28 ARRA 2009 appropriated $6 billion to cover the credit subsidy cost for projects eligible to receive loan guarantees under the Temporary Program, but fails to ameliorate the heavy burden the credit subsidy cost poses for existing loan guarantee applicants under the original program. DOE also recently announced plans to restructure the credit subsidy cost for some applicants under the original program, such that the credit subsidy cost would be payable over the life of the loan rather than in a lump sum at closing. It is unclear, however, whether this reform will be implemented on a case-by-case basis, apply to all applicants seeking guarantees below a certain threshold, or apply to all applicants generally. Without

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D. Certain structuring aspects create problems

decide against the liquidation of project assets and instead to complete construction of the project, subject to appropriations, or to sell an incomplete project to an entity that will complete the project.’’29 Therefore, if a project applicant seeks a guarantee for, e.g., 75 percent of the total debt obligation, the lender providing the remaining 25 percent of the

1. Intercreditor and collateral issues During the rulemaking process, many public commenters stressed the need to be able to separate, or ‘‘strip,’’ the non-guaranteed portion of the loan from the guaranteed portion and allow the non-guaranteed portion to benefit from a first priority security interest in the project assets. In other words, commenters argued for the ability to finance a project with multiple tranches of pari passu debt as is customary in project financing structures. This ability is especially important for projects with significant construction costs that will exceed the likely capacity of the Loan Guarantee Program—e.g., nuclear power facilities. hile the existing regulations allow for sharing of collateral proceeds on a pari passu basis with other lenders, at this point DOE statutorily must retain superior control with respect to decisions regarding dispositions of project assets. The preamble to the regulations states that ‘‘DOE retains – as a superior right – the ability, even over the objections of other parties, to

debt financing must agree to subordinate at least some of its collateral rights to the U.S. government. This structure is not consistent with customary project financings, including those involving government agency lenders like the Overseas Private Investment Corporation (OPIC) and U.S. Export-Import Bank (USEXIM), and will certainly drive away many lenders that would otherwise be interested in financing projects side by side with DOE. Ironically, the intercreditor tensions caused by this aspect of the Loan Guarantee Program may encourage or leave applicants with no choice but to try to seek DOE guarantees for 100 percent of the debt obligation

fixing this problem for all applicants, the uncertainty and potential amount of the credit subsidy cost likely will deter many applicants that would otherwise be good candidates for the existing loan guarantee program.

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(when DOE views more favorably those applicants who seek guarantees for lower percentages of the total debt) and thus have to borrow from the Federal Financing Bank, rather than seeking diversification with other lenders. The existing regulations also require that the non-guaranteed portion of the loan cannot be repaid on a shorter amortization schedule than the guaranteed portion.30 The statute and regulations allow the guaranteed portion to be amortized over a period of up to the shorter of 30 years or 90 percent of the projected useful life of the project’s major physical assets. Being able to amortize the guaranteed portion of the loan over 30 years is very beneficial to the economics of many projects. However, these projects may require a non-guaranteed tranche in order to fund all project costs, either because of the size of the project or the fact that certain costs may not be eligible project costs under the Loan Guarantee Program or may have to be funded prior to the issuance of a loan guarantee. Many funding sources either cannot lend on a 30-year basis because of internal policies (e.g., certain export credit agencies) or will not lend on such basis on commercially reasonable terms. Thus, the applicant is forced either to obtain the guaranteed portion of the loan with a shorter maturity, potentially impairing the project’s economics, or be limited in the sources it can tap to fund project

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costs not covered by the guaranteed portion. he statute requires that DOE have a first priority security interest in all project assets, which is consistent with typical project financing structures. However, the regulations also require that the collateral package include other collateral or surety, including non-project-related assets, determined by DOE to be necessary to ensure repayment. In addition, applicants to date have experienced requests from DOE for undertakings akin to sponsor guarantees. Expanding the collateral and other support requirements beyond the project assets removes the non-recourse benefit of project financing to the sponsors and creates uncertainty for the sponsors as to how much of their ‘‘balance sheet’’ they will need to put on the line in order to obtain a loan guarantee. In order to improve the effectiveness of the Loan Guarantee Program, DOE must address the structural problems described above and must be more clear and consistent in what structures will and will not work within the program. To date, applicants have spent valuable time and expended significant amounts for legal fees trying to decipher the structural limitations of the Loan Guarantee Program and how to shoehorn their projects into the requirements. Customary project finance structures have been used time and time again to provide adequate protection to lenders while allowing sponsors to

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finance projects economically and efficiently; there is no reason these structures cannot be used for the Loan Guarantee Program. 2. ‘‘Significant’’ cash equity contributions required Title XVII of EPAct 2005 states that the face value of the debt guaranteed by DOE may not exceed 80 percent of the total

project costs. Though the Department declined in the final regulations to set a fixed, numerical minimum equity contribution (the draft regulations originally required a 20 percent equity contribution), DOE nonetheless does require a ‘‘significant equity investment’’ and provides that such equity must be in cash. DOE also states in the most recent solicitation that projects with comparatively higher levels of equity commitments will be viewed more favorably than projects with lower levels of equity commitments. Several portions of the application require demonstration of the project sponsor’s current ability to

provide the needed cash equity (e.g., equity commitment letter, credit history, audited financial statements). any applicants, particularly under the original Loan Guarantee Program, are relatively small companies without significant cash on hand. These applicants, especially those submitting applications for much-needed renewable energy projects, often intend to fund the required equity through tax credits (e.g., the investment tax credit for solar projects), equity sales to taxincentivized investors, contribution of existing tangible assets or intellectual property, and other structures generally accepted in the relevant industry. Instead of mandating one type of equity investment (e.g., cash), DOE should assess proposed equity contributions on a case-by-case basis to avoid driving away applicants with otherwise worthy projects.

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E. Certain financing structures not supported Under the Loan Guarantee Program’s implementing regulations, guarantees are available solely to support loans and other debt obligations. Financing structures in the renewable energy sector in recent years largely have been equity-driven, with passive investors taking advantage of the renewable energy tax credits available to such projects. Three examples of such structures are

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the sale-leaseback, lease pass-through, and partnership flip financing structures. In the current financial climate, equity investors’ tax appetites are significantly lower; thus, there is a lower incentive for such equity investors to enter into these transactions and provide much-needed funding to the sector. Under the current regulations, the equity portion of such financing structures is not eligiible for support under the Loan Guarantee Program, and the complexity of these structures makes it challenging to incorporate even the debt portion into the Loan Guarantee Program. DOE staff has suggested that issuing guarantees for these types of transactions will be difficult to implement.

VI. Conclusion The Loan Guarantee Program in theory has been hailed as ‘‘the greatest energy policy achievement in modern American history since the creation of the Strategic Petroleum Reserve within the Energy Policy and Conservation Act of 1975.’’31 The program in practice, however, has been described in less glowing terms: ‘‘painfully slow,’’ with an ‘‘unacceptable rate of progress,’’ stemming from ‘‘institutional barriers, organizational intransigence, and bureaucratic dysfunction.’’32 While ARRA 2009 established the Temporary Program to include certain

‘‘shovel-ready’’ projects, and appropriated $6 billion to cover the credit subsidy cost associated with such projects, it failed to resolve most of the pressing problems facing the existing program. n April 17, 2009, a joint discussion draft of a bill entitled the ‘‘21st Century Energy Deployment Act’’ was introduced

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into the Senate, inter alia, to improve the Loan Guarantee Program.33 The bill would transfer authority (within 18 months of enactment) for the Loan Guarantee Program to an independent administration within DOE with the authority to issue a variety of financial support instruments to spur innovative clean technology development. While discussing the bill in its entirety is beyond the scope of this article, the bill does propose to address a few of the problems facing the Loan Guarantee Program, including the following:  It would allow the Credit Subsidy Cost to be paid (at the administration’s

discretion) in part by both the borrower and the federal government;  It would eliminate the requirement that the federal government retain superior rights in any collateral;  It would require that fees be levied ‘‘in accordance with commercial rates’’ and that the minimum practicable fees be levied for projects employing breakthrough technologies; and  It would require the administration to try to expedite the review process so that conditional commitments may be issued within 180 days of the submission of a completed application. Whether this bill will become law is uncertain, and even if it were to pass, the Loan Guarantee Program would be administered in its current state by DOE for up to 18 months after such time. In the meantime, then, DOE (and/or Congress, if necessary) should consider implementing the following reforms to address the systemic weaknesses of the loan guarantee program:  Allow all applications to be submitted on a rolling basis;  Allow all application fees to be remitted later in the application process when applicants have more certainty regarding their potential for success;  Eliminate the preliminary credit assessment or replace it with a more useful analysis and certain other supplemental

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application requirements or adjust such requirements to be closing conditions;  Where the credit subsidy cost is not paid with federal funds (e.g., for projects that are not eligible under the Temporary Program), provide more transparency with respect to the level of the credit subsidy cost and consider allowing the cost to be payable over the life of the guaranteed loan;  Model intercreditor provisions after those used by OPIC and USEXIM;

 Allow the non-guaranteed portion of a project’s debt obligation to be repaid on a shorter amortization schedule than the guaranteed portion;  Limit collateral and other support requirements to project assets as is customary in project financing structures; and  Evaluate proposed equity contributions on a case-by-case basis rather than simply requiring ‘‘significant’’ cash equity contributions.

Based on its latest statements, it appears that DOE already may be in the process of implementing some of these reforms. If it can implement some or all of these reforms, the Loan Guarantee Program could succeed. With these reforms, the program could help to achieve the Obama administration’s stated goals of tackling climate change and creating ‘‘green’’ jobs while at the same time positioning the U.S. as the world’s leader in the clean energy and clean technologies industries.&

Based on its latest statements, it appears that DOE already may be in the process of implementing some of these reforms. 66

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Endnotes: 1. Full Committee Hearing: To Receive Testimony on the Current State of the Department of Energy Loan Guarantee Program, 111th Cong. (Feb. 12, 2009) (statement of James K. Asselstine, Managing Director, Barclays Capital); see also Electric Power Research Institute, The Power to Reduce CO2 Emissions: The Full Portfolio – 2008 Economic Sensitivity Studies (2008), available at http://mydocs.epri.com/ docs/public/ 000000000001018431.pdf. 2. Id. (citing The Brattle Group, Transforming America’s Power Industry: The Investment Challenge, 2010-2030, Nov. 2008). 3. Omnibus Appropriations Act, 2009, Pub. L. 111–8 (March 11, 2009). 4. The Web site maintained by DOE for the Loan Guarantee Program is at www.lgprogram.energy.gov and contains, among other publications, the implementing regulations for the program and solicitation materials for past solicitations. 5. Loan Guarantees for Projects that Employ Innovative Technologies; Final Rule, 10 C.F.R. § 609.2 (2007). 6. 10 C.F.R. § 609.12(c). 7. 10 C.F.R. § 609.

therefore, in all solicitations to date, applicants must pay the credit subsidy cost, which is separate from any application fee, to obtain the loan guarantee. 11. Department of Energy, DOE Secretary Chu Announces Changes to Expedite Economic Recovery Funding, Feb. 19, 2009, at http://www. energy.gov/news2009/6934.htm. 12. The full list of requirements is contained in Section 609.6 of the implementing regulations. 13. 10 C.F.R. § 609.7(a). 14. Note that funding for guarantees for leading edge biofuels projects is capped at $500 million. 15. American Recovery and Reinvestment Act of 2009, Public L. 111–5 (Feb. 17, 2009). 16. DOE supra note 10. 17. Id. 18. Id. 19. See Department of Energy, DOE Releases Information on Loan Guarantee Pre-Applications, Mar. 6, 2007, at http://www.lgprogram. energy.gov/press/030607.html. 20. S&P on Nuclear Power Subsidy Estimates, Reuters UK, Oct. 7, 2008, at http://uk.reuters.com/article/ oilRpt/idUKWNA597920081007.

9. In the most recent solicitation, DOE has approximately 60 days to perform the initial application review.

21. The Department of Energy reports that 16 of the original 143 pre-applicants in the 2006 solicitation were invited to submit applications and that 11 applicants did so. Seven of these 11 projects have been identified by the Department as early-movers, and Dennis Frantz, head of DOE’s loan guarantee program, states that DOE plans to make its ‘‘ultimate recommendation to the Secretary on these applications this year.’’ Full Committee Hearing: To Receive Testimony on the Current State of the Department of Energy Loan Guarantee Program, 111th Cong. (Feb. 12, 2009) (statement of Dennis G. Frantz, U.S. Department of Energy).

10. DOE is statutorily obligated to receive the credit subsidy cost either from congressional appropriation or from the applicant. No such appropriations have materialized;

22. Full Committee Hearing, supra note 18 (statement of The Honorable Alexander ‘‘Andy’’ Karsner, Distinguished Fellow, Council on Competitiveness).

8. Application fees for individual solicitations differ greatly. For example, in the solicitation for advanced nuclear facilities, the non-refundable application fee was $800,000. The application fee under the most recent solicitation ranges from $75,000 to $125,000, with the highest fee reserved for projects seeking loan guarantees for energy efficiency, renewable energy, and advanced transmission and distribution technology projects in excess of $500,000,000.

23. We’ve Got to Do This: Energy Secretary Chu Plans Rapid, Careful Spending, WALL ST. J., Feb. 6, 2009, at http:// online.wsj.com/article/ SB123393841471357455.html. 24. Full Committee Hearing, supra note 18 (Karsner statement). 25. See, e.g., Chu: DOE Hopes to Approve Loan Guarantees by April or May, PLATTS ELEC. POWER DAILY, Feb. 19, 2009. 26. Omnibus Appropriations Act, supra note 3. 27. S&P on Nuclear Power Subsidy Estimates, supra note 17. Note that S&P used its own model to make these projections, rather than the OMB’s proprietary model. 28. By way of example, consider the case of an applicant whose total project costs equaled $20 million. If such applicant has a debt/equity ratio of 80/20 – the highest level of debt statutorily allowed by applicants seeking Title XVII loan guarantees – then such applicant has a $16 million debt obligation. If such applicant seeks a loan guarantee for the full $16 million, and the credit subsidy cost is 30 percent of the total guarantee being sought, then the credit subsidy cost for this project would be $4.8 million, or 24 percent of such applicant’s total project costs. 29. Loan Guarantees for Projects That Employ Innovative Technologies; Final Rule, 10 C.F.R. § 609 (2007). 30. 10 C.F.R. § 609.10(d)(6). 31. Full Committee Hearing, supra note 18 (statement of Kevin Book, Senior Vice President, Energy Policy, Oil & Alternative Energy, Friedman, Billings, Ramsey & Co., Inc.). 32. Full Committee Hearing, supra note 18 (Karsner statement). 33. A summary and full text of this draft are available at http:// energy.senate.gov/public/ index.cfm?FuseAction =IssueItems. Detail&IssueItem_ID=8cba3517-a4c44876-841c-4fe40c964f7&Month=4& Yea=2009.

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