The prolonged slump in natural-gas prices has driven farmers to shut down or scrap plans to build manure-to-energy systems known as anaerobic digesters, despite government encouragement.
A look at 12 key points that explain the current state of the U.S. waste-to-energy sector.
Federal and State Renewable Energy Tax Credits have been specifically credited with the explosive growth in the solar and wind industry. As such, investment tax credit (ITC) financing has become a critical component in virtually every project financing assignment we review.
Credits are available for eligible renewable energy generating systems placed in service on or before December 31, 2016 including solar, biomass, fuel cells, small wind turbines, geothermal systems, microturbines and combined heat and power (CHP):
In general, the original use of the equipment must begin with the taxpayer, or the system must be constructed by the taxpayer. The equipment must also meet any performance and quality standards in effect at the time the equipment is acquired. The energy property must be operational in the year in which the credit is first taken.
State Renewable Energy Tax Credits are purchased at a discount, and can be used to offset corporate income tax, franchise tax, insurance premium tax and/or bank shares tax. The type of taxes that these credits can be used against varies from state to state. Currently, 24 U.S. states issue renewable energy tax credits.
- ITC investors are very risk adverse, perhaps even more so than senior debt lenders. Projects must be creditworthy, often with third-party guarantees, and developed by experienced developers. ITC investors are typically the last party to the table, once all the other components are in place.
- State ITC require an investor with tax liability in a particular state, and thus have more limited appeal. States with a high state ITC, such as North Carolina, tend to attract a disproportionate number of projects, and thus tend to exhaust the local ITC availability.
- ITC origination fees are expensive, and are paid by the project. Legal and accounting fees alone are at least $600,000-$700,000 for the most basic transactions. Pooled or composite deal fees run higher. As such, most institutional ITC investors are not interested in ITC transactions less than about $10 million.
- Federal and State ITC pricing, like everything in the financial marketplace, is driven by supply and demand. Currently, ITC supply is overwhelmingly biased toward solar development, based upon the perceived lack of operating risk. As such, qualified solar projects have tremendous negotiating leverage. Non-solar renewable energy projects will have an exhaustive search for ITC interest.
There is a renewed interest in waste-to-energy throughout the world, but such projects have unique and stringent financing requirements. Many budding developers, particularly those from a wind, solar or real estate background, underestimate the operating and technological risk, and seek financing on conventional terms. About half the projects we see cannot be financed on any terms.
• Waste to energy and recycling projects have a high failure rate. This has an enormous influence on the reception by lenders and third-party equity providers.
• A technology provider is not enough. The project needs an EPC with the financial capacity to offer performance guarantees. The operator must be able to demonstrate ongoing operating capability.
• A technology is “proven” when it can operate on a commercial scale. Feasibility studies and white papers have no value in the financing market. Pilot plants offer some validation, but are not proof of concept. They too frequently fail at scale up.
• Most conventional project finance is real estate or asset-based, which offers a high investment recovery rate if the project should fail. Waste-to-energy projects have little or no marketable assets or real estate. A failed project is virtually a complete write-off.
• Generally speaking, lenders are not comfortable with waste to energy on a project finance basis. Smaller lenders do not understand them; larger lenders understand them, but are only interested in larger (greater than $50-$75 million) projects from larger clients with established or desirable relationships.
• Highly leveraged projects, in the current market, are a myth. We are frequently contacted by budding developers seeking high leveraged loans, and investment tax credits for the entire equity contribution. And unfortunately, some investment banks promote such nonsense.
• Eligibility for tax-exempt bond financing does not alter the loan underwriting criteria. Mutual funds and bond investors are not dumb money.
• We have seen a number of investment banks issuing term sheets for such projects. Investment banks are financial intermediaries. A term sheet from an intermediary is not only useless, it is deceitful. Only a term sheet from a direct lending or equity source that has the actual capability to write a check, has relevance.
• Many private equity firms in alternative energy state that they are interested in waste-to-energy; but what they really want is wind and solar, which they (think) they understand and is considered risk-free. Few financial investors understand the technology and operating risks behind WTE, and are ultimately willing to close.
• Developers must generally have their own early stage pre-development money.
• Viable projects require long-term feedstock and offtake agreements. Merchant facilities are exponentially more difficult to finance.
• Unlevered project IRR of high teens to mid-twenties is necessary to attract private equity.
• While investment tax credits are generally available for larger wind and solar projects, waste-to-energy is often considered too risky. Investment tax credit providers want equity returns with debt security. Their terms and conditions often conflict with and are incompatible with debt.