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<title>September 2006: The Guarantee Hump</title>
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<p align="left"><font face="Arial"><strong><small>About The Author:<br>
<br>
</small></strong><span lang="X-NONE" style="color: black"><font size="2">
ROGER FELDMAN, Co-Chair of Andrews Kurth LLP Climate Change and Carbon
Markets Group has practiced law related to the finance of environmental and
energy projects and companies for 40 years. In particular, he has analyzed
and executed a wide variety and substantial value of project financings. He
chairs the American Bar Association’s Committee on Carbon Trading and
Finance, serves on the Board of the American Council for Renewable Energy,
and has been a senior official in the Federal Energy Administration. He is
a graduate of Brown University, Yale Law School and Harvard Business School.</font></span></font></p>
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<img src="../images/feldman.gif" alt="Washington Viewpoint by Roger Feldman" border="0" width="375" height="75"><p><b><u><br>
September 2006</u></b></p>
<p align="center"><font size="6"><b>The Guarantee Hump</b></font></p>
<p><strong>by Roger Feldman -- Bingham, Dana L.L.P.<br>
</strong><font face="Arial" size="2">(<em>originally published by PMA OnLine
Magazine: 2</em>006/10/27)<br>
</font><span style="font-size: 10.0pt; font-family: Palatino; color: black">
</span></p>
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<p ALIGN="LEFT">“Energy/Environment” has always been one of Washington’s
great policy paradoxes. There either is an energy crisis, or maybe there
isn’t. Yesterday there was; today, post-Gulf-potential-oil-find, there
isn’t. Same with global warming. Yesterday, scientific doubts; today,
melting iceberg spotted, crisis ahoy.</p>
<p ALIGN="LEFT">Last year, the energy crisis was perceived and EPACT was
passed. It was, of course, a grab bag of provisions, designed mostly to
elicit private response to the perceived crisis. Even then, the crisis was
seen to have an environmental subtext; the need to reduce greenhouse gases
while reducing the threat presented by energy shortfalls. Inevitably — as
for so many other policy problems — technology was seen as the quick fix.</p>
<p ALIGN="LEFT">Which, in due time, has now led the Department of Energy to
issue guidelines for Title XVII of EPACT, providing loan guarantees to
facilitate the financing of these environmentally clean, productive,
innovative, yet commercial energy technologies. The challenge: to boldly go
where some men have gone a little bit of the way before; to deal with a
group of problems which, while each is acknowledged to be important, have
not been linked by a coherent legal framework in the United States rewarding
to those who confront it; to guide America to build the perfect camel to get
us over the current hump.</p>
<p ALIGN="LEFT">To which conundrum for DOE certain other policy guidelines
inherent in the Federal loan guarantee process have been required to be
added, notably: (i) to protect the public by reducing the risk of defaults,
and (ii) to reduce the cost to the Government (whose resources have been
depleted by fighting other wars) of paying for the review of applications
for loan guarantees. Funding issues continue to hang over the program. Only
a portion ($2 billion) of the authorized funds currently are available for
loan guarantee purposes, and it remains to be seen whether Congress will
insist on approving the funding of each project individually (which
currently is the case under the proposed regulations). With all of the
foregoing caveats, a look at a few key features (and quirks) of the proposed
Federal loan guarantee program are in order.</p>
<ul>
<li>
<p ALIGN="LEFT">While Title XVII of EPACT seems to establish conjunctively
both greenhouse gas reduction and new technology improvements as eligibility
requirements, it appears that as long as a project falls within any of ten
identified categories of technology, that project will be deemed to meet the
statutory requirements. The eligible technology net is a broad one. It
ranges from environmental control, to certain advanced uses of fossil
energy, to nuclear, to energy efficiency, to “renewable energy systems.”
Only initial dollar cut-off places distributed energy opportunities at some
greater advantage in being the first projects to be guaranteed. It must be
remembered, though, that these technologies may not be “demonstration
projects.” Indeed, they must be “mature enough to assure dependable
commercial operation,” and generate sufficient revenues to pay the debts
which are incurred. They must, in short, be at a stage where the deal
fundamentals of the demanding lender finds that a market can be met. They
also must meet the Federal Government “scoring” standard which effectively
translates into a requirement that the Government’s perceived risk premium,
i.e., probability of repayment on the loan guarantee, is a fee which must
come out of the developer’s pocket. This is the so-called “subsidy cost,”
which a developer — not the Government — must pay.<br>
</p></li>
<li>
<p ALIGN="LEFT">The loan guarantee will not overcome all of the challenges
to project financing which a developer faces. The eligible amount of
guaranteed project debt is 80% of project costs. It may be, at least it is
the case in the first solicitation, that as little as 80% of that eligible
80% may be guaranteed. The project costs do not include the “subsidy cost”
payable by the developer to obtain the loan guarantee. This is, therefore,
another equity requirement.<br>
</p></li>
<li>
<p ALIGN="LEFT">The possibility that there may be un-guaranteed debt can
create a further issue. If Government foreclosure is necessitated by
deficit, the Government’s lien extends to, and is superior to, all of the
project’s property. The balance of the loan in the project is thus not
only non-guaranteed but junior in its security to that of the Federal
Government. Everything non-Federal is emphatically junior debt. <br>
</p></li>
<li>
<p ALIGN="LEFT">Whereas bundling equity sources while using other
incentives is not precluded, DOE is very interested in project’s sponsor
making a significant commitment and absorbing risk. Consequently and
unfortunately, maximization of potential Federal benefits could be viewed
unfavorably. <br>
</p></li>
<li>
<p ALIGN="LEFT">The full onerousness of this provision is further enlarged
by the fact that, under the guidelines, the guaranteed and unguaranteed
portions of a project loan must be sold on a pro rata basis, i.e., The
guaranteed portion may not be “stripped” and sold separately as an
instrument fully guaranteed by the Federal Government. The
marketability of the guaranteed paper will be harmed (or conversely, the
price that will have to be paid by a developer to market it will be
increased).</p></li>
</ul>
<p ALIGN="LEFT">Some environment/energy loan camels will go though the eye
of the DOE Title XVII loan guarantee needle and (unless and until the law is
changed) through the eye of the Congressional needle as well. Some
improvements on the greenhouse gas and technological fronts are to be
expected as a result of the program’s operation. It is probably to be
expected that the scope of the loan guarantee program will be even further
expanded as Congressional leaders vie to highlight their devotion to various
energy technologies. Loan guarantee programs have, in fact, proved to
be major stimuli to a diverse range of activities deemed to be in the public
interest — but much more so when they are standardized in nature and can
develop stable markets. That is the basic challenge faced here. </p>
<p ALIGN="LEFT">It raises the question whether a loan guarantee, not coupled
with a Federal mandate or a Federal regulatory scheme, has the desired
potential for impact. Can an energy/environment camel in crisis be solved by
offering partial payment to individual camel drivers who will still face
financial risk even if their plans are successful? We’ll find out whether
DOE can get over that hump.</p>
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<p class="MsoBodyText" align="left" style="margin-bottom:0in;margin-bottom:.0001pt;
text-align:left"><font face="Arial" size="2">
<span lang="X-NONE" style="color: black">ROGER FELDMAN, Co-Chair of Andrews
Kurth LLP Climate Change and Carbon Markets Group has practiced law related
to the finance of environmental and energy projects and companies for 40
years. In particular, he has analyzed and executed a wide variety and
substantial value of project financings. He chairs the American Bar
Association’s Committee on Carbon Trading and Finance, serves on the Board
of the American Council for Renewable Energy, and has been a senior official
in the Federal Energy Administration. He is a graduate of Brown University,
Yale Law School and Harvard Business School.</span></font></p>
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