DOE's Loan Guarantee Proposal Penny-Wise and Pound-Foolish, Say Commentators

On May 16, the Department of Energy (DOE) published its Notice of Proposed Rulemaking (NOPR) regarding loan guarantees for projects that would employ renewable energy systems, advanced nuclear facilities, and carbon sequestration units, among other innovative technologies.  In comments on the NOPR, lending and rating institutions slammed the proposal.

The Energy Policy Act of 2005 (EPAct 2005) authorizes DOE to guarantee loans "not to exceed an amount equal to 80 percent of the project cost of the facility."  In the  NOPR, however, DOE proposed to guarantee up to only 90 percent of a particular loan rather than 100% of a loan covering 80% of project cost.  DOE's proposal also prohibited selling off or "stripping" the guaranteed portion of the debt instrument because DOE wishes (1) to preclude the guaranteed portion of the loan from being sold and (2) to ensure that the lender and later debt holders maintain the same level of financial risk in the project as when the debt was issued in order to spur continued due diligence.

Credit Suisse, Lehman Brothers, Goldman Sachs, Merrill Lynch, Morgan Stanley, and Citigroup expressed concern that the proposed rule "is not workable" because it relegates 10 percent of project debt to an un-guaranteed, deeply subordinated tranche, and, by barring stripping, prevents marketability of the debt instrument.  The "hybrid instrument" created by the NOPR, they explained, has no natural market, and "the higher costs associated with financing [it] would deter sponsors from moving forward . . . [or] increase the risk of default."  Goldman Sachs also submitted very similar comments separately.

Standard & Poor's echoed concerns over the 90 percent guarantee limit and prohibition against stripping.  S&P cautioned that the "rating associated with a partially guaranteed obligation will be substantially lower than the 'AAA' rating of a fully guaranteed instrument" and will result in "a significantly higher cost of debt for the project than if it was fully guaranteed."  A 100 percent debt guarantee and/or removal of the no stripping requirement would lower the cost of debt and is likely essential to "the early commercial use of innovative technologies."

Banc of America Securities, LLC concluded that EPAct itself made clear that 100 percent of the loan is to be backed by the full faith and credit of the United States and the NOPR's proposal is consequently inconsistent with the statute.   The Electric Power Supply Association echoed this congressional intent argument when it urged DOE to guarantee 80 percent of the total project cost and up to 100 percent of the amount borrowed.  The Public Service Commission of Florida agreed, adding that the loan guarantee program "was intended to support the deployment of new technologies that reduce, avoid or sequester greenhouse gas emissions by providing a [100 percent] guarantee for up to 80 percent of project costs," not 90 percent of 80 percent of project costs.

Department of Energy Proposes $9 Billion in Clean Energy Loans

Nine billion dollars could flow to guarantee loans to clean energy projects under a May 10 Department of Energy (DOE) Notice of Proposed Rulemaking (NOPR) under the Energy Policy Act of 2005. Each approved project could receive guarantees covering up to 80% of total project costs.  To be considered by the agency, written comments must be submitted within 45 days from notice in the Federal Register — likely late June or early July.

DOE proposes loan guarantees for ten categories of projects and technologies, including:  renewable energy systems; advanced fossil energy technology, including qualifying coal gasification systems; residential, industrial or transportation hydrogen fuel cell applications; advanced nuclear facilities, carbon capture and sequestration practices; efficiency in electrical generation, transmission and distribution; end-use efficiency technologies; production facilities for fuel efficient vehicles; pollution control equipment; and certain crude oil refineries.

Allocation of the $9 billion in loans will not be equally distributed among the ten categories; rather, $4 billion is reserved for central power stations, $4 billion for biofuels and clean transportation fuels, and only $1 billion for projects involving new technologies for electric transmission or renewable power generation systems.  According to DOE, precise allocation of the guarantees will depend upon the merits and benefits of a particular proposal and the accompanying statutory and regulatory requirements.

While the program is a positive development for the energy industry as a whole, efficient and fair implementation by DOE is critical, and that implementation is the specific subject-matter of the May 10 NOPR.  Provisions of particular interest to potential loan applicants include payment of the Credit Subsidy Cost, assessment of fees to loan recipients, rules on financial structure and eligibility of lenders, regulatory review, and default and audit rules.

Those industries now participating in eligible technologies and those planning expansion into clean energy projects can find public comment and public meeting procedures at Section III of the NOPR.

Anticipating NIMBYism, Vermont Regulator Seeks Help from Consultants

Project developers throughout the U.S. frequently must manage resistance to new energy infrastructure from local communities.  In an unusual twist, a state regulator that foresees potential energy shortages, the Vermont Department of Public Service (DPS), is seeking to hire consultants to help manage the ever-present "not-in-my-backyard" sentiment that continues to thwart energy planning in many parts of New England.

Two-thirds of Vermont’s power contracts expire between 2012 and 2017.  These include long-term deals with Hydro-Quebec and the Vermont Yankee nuclear plant.  While Vermont’s utilities are responsible for replacing these resources, the DPS wishes to engage with the public to help prepare a pathway for the eventual energy supply choices for 2012 and beyond.  The DPS’ solicitation is seeking consultants to assist with educating the public about the realities of power supply through measures such as polling, public meetings, web-based communications, and direct information sharing with citizen groups in an effort to discover areas of consensus before advancing an energy supply plan. 

Constellation, Progress Energy Join Growing Number of Utilities Considering New Nuclear Projects

In the wake of the Energy Policy Act of 2005, a growing number of new nuclear projects are in the works, as both Constellation Energy and Progress Energy recently announced plans to join the ranks of those utilities already considering expansion of their nuclear generation capabilities. 

On September 15, 2005, Constellation and French-based AREVA, Inc. announced the creation of UniStar Nuclear, a joint enterprise that will provide the business framework to oversee the development, construction, and operation of a "standardized fleet" of new nuclear power plants.  Bechtel Power Corporation will also provide architectural, engineering, and contracting support for the undertaking.  UniStar plans to market an advanced power reactor, called the U.S. Evolutionary Power Reactor ("EPR"), which is a 1600 MW evolutionary power reactor designed by AREVA specifically for the U.S.  The U.S. version of EPR is based on AREVA's advanced nuclear power plant, which is already being used across Europe.  AREVA is currently completing EPR's design certification in the U.S., and the new technology should be licensed and ready to deploy by 2015.  Constellation hopes to use UniStar to cultivate joint ventures to develop the new nuclear generators.  Constellation's president, Michael Wallace, referred to the unique business framework as "a one-stop shop approach to design, build, license, and operate a fleet of nuclear power plants."

Progress Energy has also recently announced that it is studying the possibility of increasing its stable of nuclear generating plants by adding a sixth nuclear power plant in the near future.  The North Carolina-based utility notified the Nuclear Regulatory Commission ("NRC") that it expects to select a potential site and vendor by the end of 2005.  While Progress has not made the final decision to go ahead with a new nuclear project, if the process goes as planned, it could apply to the NRC for a construction and operating license by 2008, begin construction as soon as 2010, and start commercial operations by approximately 2015.  Progress currently operates five nuclear plants in the Carolinas and Florida. 

Constellation and Progress are not alone among utilities eyeing an expanded nuclear fleet.  Duke Power, Southern Nuclear Operating (a subsidiary of Southern Company), South Carolina Electric & Gas, and Santee Cooper have all also recently announced plans to consider developing new nuclear generation. 

Congress Enacts Energy Bill

One month after the Senate approved its version of a comprehensive energy bill, see Senate Votes in Favor of Energy Bill, Tumultuous Conference Awaits, Congress enacted the Energy Policy Act of 2005.  Although maligned by energy and taxpayer watchdogs as a "piñata of perks and pork" for big oil, big nuclear and other entrenched energy industries, the 2005 Act, as it affects certain aspects of the power and natural gas industries, promises to profoundly change the structure and prospects of new energy business organizations and the viability of new liquefied natural gas and power transmission projects.

For several years the demand for relatively clean-burning natural gas has increasingly outstripped North American production, giving impetus to efforts to import liquefied natural gas ("LNG").  But concerns over the safety of LNG re-gasification facilities in this country, both on- and off-shore, have seen myriad LNG development proposals from coast-to-coast crash in the face of public opposition.  The 2005 Act will override that opposition in part by consolidating many of the needed approvals, including siting, in one agency – FERC.  State and local authorities are effectively stripped of authority to block the siting of LNG importing and processing facilities.

The 2005 Act also promises to effect fundamental changes in the future structure and operation of power markets.  It does so by repealing the Public Utility Holding Company Act of 1935 ("PUHCA") and amending the Public Utility Regulatory Policies Act of 1978 ("PURPA").  At the same time, it gives FERC the authority to certify a new Electric Reliability Organization ("ERO") that (under regulatory supervision from FERC and its Canadian counterpart) will set and enforce standards for the reliable operation of the Eastern and Western Interconnections and the Electric Reliability Council of Texas.  The confluence of these developments will be profound and will likely force further consolidation of the power industry. 

Since its enactment 70 years ago, PUHCA was amended twice to allow limited holding company investment in power generation — in qualifying facilities under PURPA and in exempt wholesale generators under the Energy Policy Act of 1992.  But otherwise PUHCA confined utility holding companies to a single integrated public-utility system and has policed intra-holding company transactions to prevent cross subsidization.  Repeal of the PUHCA will knock down the barriers to consolidation of geographically and operationally diffuse utility systems.  Pending consolidations, such as Duke-Cinergy and MidAmerican-PacifiCorp, which may well have been barred by PUHCA's single integrated public-utility system requirement, now appear to have been prescient in anticipating PUHCA's repeal.  They likely will prove to be harbingers of other consolidations.

The so-called PURPA put also falls victim to the 2005 Act.  The PURPA-imposed obligation of traditional public utilities to buy the output of qualifying cogenerators and small, renewable generators at an avoided-cost price ushered competition in wholesale power markets into the 1980s.  The Energy Policy Act of 1992 later swelled the ranks of competitive generators by creating an additional class of PUHCA-exempt competitive generators with exempt wholesale generators ("EWGs").  Going forward after implementation of the 2005 Act, qualifying facilities and EWGs will no longer exist.  There will simply be power generators selling at wholesale and, where permitted by local law, at retail.  FERC is empowered by the 2005 Act to review and approve utility acquisitions of existing generating facilities in order to prevent (among other things) undue concentrations of generation market power.  Unclear, however, is who will build new generation under the largely deregulated scheme of the 2005 Act.   Arguably, without the price support of the PURPA put and the investment restrictions of PUHCA, only a shrinking universe of highly capitalized investors or existing utilities will build new generation in the future.  Some of these may ally with Indian tribes and construct power plant on tribal lands since the 2005 Act has special provisions for encouraging Indian energy development.  These provisions include the creation of an Office of Indian Energy Policy and Programs within the Interior Department with authority to pre-approve tribal-energy-resource agreements.

The 2005 Act will also tend to consolidate markets through its introduction of an ERO.  While the stated purpose of the ERO is to standardize, and make enforceable for the first time, rules for reliably operating the bulk power systems of North America, the indirect effect of that standardization will be the consolidation of formerly balkanized markets and the facilitation of increased trading in bulk power.