The Valley of Death. A common topic at renewable energy conferences is how to help companies cross the valley of death between technical validation at the pilot stage and full-scale commercial production.

Companies have a much easier time collecting the millions required to get to pilot stage than the hundreds of millions required to scale up. The risks with commercialization are too high to appeal to the debt market but the expected returns are too low to appeal to the equity markets.

This problem has been a concern for several years and the Energy Policy Act of 2005, Title XVII-Incentives for New Technology, authorized the Department of Energy to provide loan guarantees for promising renewable energy projects. Title XVII has had many challenges but one of the most significant was the lack of appropriations for credit subsidy costs to support loan guarantees until much later.

What is the credit subsidy cost and why does it matter? The law firm of Baker and McKenzie provides the following definition: “A credit subsidy cost is the net present value, at the time the loan guarantee is executed, of the expected payments of the US government to cover defaults, delinquencies, interest subsidies, fees and other payments resulting from the loan guarantee provided under the program”.

The Federal Credit Reform Act of 1990 (FCRA) required federal agencies to include the credit subsidy cost in their annual budgets to provide transparency on the actual costs related to Federal credit programs. The credit subsidy cost is paid into a special government wide loan loss reserve account and the goal is to balance the contributions by the various government organizations issuing loan guarantees against the expenses borne by the government in executing the loan guarantees.

The subsidy cost is a percentage of the loan value and is paid up front. The rate varies for each loan and frequently ranges from 5-15% of the loan value with 10% appearing to be the average rate assumed by most analysts for renewable projects.

For example, if an agency is allocated $5 billion to make guaranteed loans and their average credit subsidy rate is 10% then they can make $50 billion in loans ($5 billion / 10%). Each time they make a loan guarantee, the appropriate subsidy cost is deducted from the budget. The subsidy cost is non-refundable even if the guaranteed loan is subsequently paid in full since the account needs to pay for the loans that default and lose more than 10%. If an agency is authorized to make a guaranteed loan but is not appropriated money to pay for the subsidy then the borrower has to pay the subsidy.

Moving beyond Title XVII. Title XVII has structural problems as well and many members of Congress have been looking for fundamental changes to the process of commercialization of promising clean technologies. Over the past year staffers from both houses of Congress have been working on a solution.

Michael Carr, Counsel for the United States Senate Committee on Energy and Natural Resources, is one of the architects of the CEDA proposal and was kind enough to provide an overview of CEDA to Green Car Congress.

CEDA Introduction. CEDA’s charter will be to provide financial support for clean energy technologies that have been technically validated, have broad societal benefits and commercial potential but lack commercial support because of perceived risk. CEDA will be able to use a variety of financial instruments to achieve this goal and they can participate in the project’s upside though fees and profit participation to be more self sufficient.

We had three watchwords behind the creation of CEDA: Fast, Flexible and Funded. Just having the money up front is a big deal with how fast you can get something going. We have some streamlining provisions to give them some guidance to develop their processes before they open their doors; we’ll be able to incorporate best practices from Title XVII; and we want the Office of Management and Budget to pre-bless their processes rather than having them tussle over every project.

—Michael Carr

CEDA Structure. CEDA will be an independent administration within DOE, like the Federal Energy Regulatory Commission (FERC). It will be run by a board of directors, with the majority of the directors coming from outside of the government. The administrator will have a five-year term and the directors will be appointed to staggered five-year terms. It will have an independent advisory council comprised of leaders in their technical field who will be appointed to staggered five year terms with the opportunity to be reappointed. Five of the advisory council members will be chosen by the Secretary of Energy and three by the board of directors.

The vision is that the advisory council will develop a methodology for assessing the technologies based upon our three part clean energy definition:

1. Improved energy efficiency in use, distribution, or transmission.
2. Energy security - diversifying our sources of energy supply as long as there is a favorable balance of environmental effects.
3. Greenhouse gas reduction.

The advisory council’s methodology will essentially be a scoring system to rank the technologies based on their technical ability to meet the goals. Independently, you will have a financial team assessing the economics behind the technologies and combining the results from the two teams you’ll be able to get an idea of a technology’s societal benefit and financial viability.

—Michael Carr

The legislation is technology-agnostic. “We’ve found that listing technologies ends up being more confusing than clarifying and we wanted to have equal rules of the road and let the best technology win,” commented Carr.

The legislation is also sector-agnostic. The projects can be in (but are not limited to) energy efficiency, improved transmission, electrical power generation, energy storage, biofuels, fuel efficiency or the manufacturing capability to support clean energy technology deployment.

Finally, the legislation is financial-instrument-agnostic. The CEDA will have flexibility to use a variety of financial instruments to fund their programs and it will have the ability to replenish the fund with fees and profit participation.

One of the more interesting, albeit abstract, examples of what CEDA will be able to do is to provide support for an aggregation of projects, for example, related to energy efficiency.

Suppose you develop a brand new insulation technology for houses that costs $3,000 and takes 3 years to pay back in energy-savings costs. Some regional bank may say “we think there is an opportunity here, as long as we can give these homeowners a long term loan and we can get something secured”. CEDA can step in and say “we’ll underwrite these loans as long as you have the following origination standards: The homeowner is employed, the notes are between 5-10 years, the interest rate is no more than 6% and the homeowner has positive equity in the house, and the energy savings are sufficient to return value to the homeowner in under 3 years.”

—Michael Carr

Carr goes on to add that having an outside underwriter, or aggregator of debt, for the loans makes it a much more attractive package for the bank’s management.

CEDA’s funding and duration. In addition to authority over unspent monies in the Title XVII Loan Guarantee Program, CEDA will be funded with an initial payment of $10 billion and it will be the organization’s responsibility to manage that fund well into the future. All of their expenses will be deducted from the fund (including administrative expenses) but any revenue they receive through fees and profit participation will be reimbursed to the fund.

For example, if CEDA provides a $500 million loan guarantee for a cellulosic ethanol plant and the credit subsidy rate is 10%, it would have a $50 million charge to its $10-billion pool. But if it were able to get $50 million worth of profit participation from the cellulosic plant operator over time it will replenish its investment pool and it will be able to fund another $500 million project.

A $10-billion fund with no replenishing and a 10% credit subsidy cost could support $100 billion worth of projects—but since CEDA can recoup their credit subsidy cost with profit participation and fees they may be able to fund much more.

To make sure that CEDA will not crowd out private capital that might otherwise be available in energy markets, CEDA will be focusing primarily on breakthrough technologies which are promising but too risky for private debt financing. Nor is it intended to be a permanent program.

“We expect the CEDA administration to take risks and to fail on some technologies,” said Carr. The goal is not to create a perpetual organization but for “CEDA to eventually spend down its fund. The bill is written so that CEDA disappears in 20 years unless it is reauthorized,” Carr said.

Resources

• H.R. 2212: 21^st Century Energy Technology Deployment Act. Proposed by Representatives: Jan Inslee (D- Washington), Steve Israel (D- New York), John Dingell (D - Michigan), Deborah Halverson (D - Illinois), Ellen Tauscher (D - California) and Anthony Weiner (D - New York).

• S.B. 949: The 21^st Century Energy and Technology and Deployment Act of 2009. Proposed by Senators: Jeff Bingaman (D-New Mexico), Lisa Murkowski (R-Alaska), Byron Dorgan (D-North Dakota), George Voinovich (R- Ohio), Debbie Stabenow (D-Michigan), Richard Lugar (D- Indiana) and Jeanne Shaheen (D- New Hampshire).

• H.R. 2454: American Clean Energy and Security Act of 2009. Proposed by Representatives: Henry Waxman (D-California), Edward Markey (D-Massachusetts) Passed in House 29 June 09.