BioCycle May 2011, Vol. 52, No. 5, p. 47
Value seekers are looking beyond solar and wind for renewable energy investments, with renewed focus on biomass, including anaerobic digestion.
Kelly Sarber

CAPITAL continues to flow into renewable energy at a rate that is outpacing other industry sectors, as venture capital companies, private equity firms and large corporations boost their opportunistic investments in this fast growing sector. Value seekers are looking beyond solar and wind for opportunities, with renewed focus on biomass-to-energy since it is not an intermittent power source, creates a constant, predictable annuity stream and is not dependent on weather or geography to generate power.
Anaerobic digestion (AD) facilities are likely to become more popular in this space due to factors such as the dual income streams generated from both the power sales and waste disposal services, the fact that use of biogas will meet Renewable Portfolio Standards (RPS), and a low technology risk. Market forces are expected to converge to make AD a growing niche in the biomass-to-energy sector in the future. This sector also includes wood waste, biogas from landfills and traditional waste-to energy technologies for municipal solid waste (MSW) including mass burn, gasification and pyrolysis.
Compared to combustion facilities, AD systems are more acceptable to the public, making their permitting and siting relatively easier. Locating these facilities close to urban centers where both the organic waste is being generated and the energy demand is located is also popular from a sustainability standpoint. Climate change goals are influencing solid waste decisions, as policy makers connect the dots in promoting practices that reduce greenhouse gas emissions by reducing organics disposal in landfills. For example, and using climate change as the cause, California set Strategic Directive 6.1 as a goal to get 50 percent of organics out of landfills by 2020. And, as carbon markets continue to evolve within the U.S., monetizing the credits from the capture and reuse of biogas from organics becomes an independent revenue stream that may provide an underlying economic boost to a project’s economic proforma.
Generally speaking in the environmental industry, business opportunities follow regulations and public policy. Traditionally, lenders and investors have always had interest in waste management due to the strong regulatory environment and the financial strength of municipal markets and public utilities as guarantors of debt. In particular, banks and other institutions have a history of doing project finance in this sector either with strategics (companies in the industry) or developers pursuing stand-alone projects. Typically, projects will be financed either off cash flows, if the company has excess capital it wants to deploy, or through some combination of debt and equity – although the combinations can get exotic in these days of tax equity, grants and loan guarantees.
How much of that revenue comes from tipping fees versus energy revenues doesn’t really matter, as long as the revenues cover costs and have a return that is attractive with risks appropriately allocated. The typical rule of thumb is at least 25 percent equity if not more. Some states require equity in this range in order to qualify for lower interest guarantee programs.

ASSURED FEEDSTOCK FLOW AND PPA
How can history be helpful in understanding how to finance anaerobic digestion projects today? In the late 1980s and early 1990s, banks lined up to finance waste-to-energy projects because those deals generated long-term annuity streams and provided energy and disposal for municipalities. While flow control questions and deteriorating tip fees in certain markets made some of these deals unattractive as time passed, the fundamentals of the underlying business structure – with assured (reliable and long-term) feedstock flow and a solid power purchase agreement (PPA) in place – remain viable as a financing mechanism for AD. In fact, banks and other debt and equity players are financing a lot of biomass-to-energy deals today, depending on the technology and with the caveat being that the feedstock guarantees and PPAs are credit worthy.
Understanding the potential for better financing terms at the start of the development cycle for AD projects may help attract the best financing package. Project fundamentals boil down to having “bankable” contracts for both feedstock guarantees with a city, commercial entity or waste hauler, and a PPA with a strong off-taker or end user, such as an electric or gas utility. The terms of these agreements are typically married up to the term of the project’s life cycle, which will mirror the life cycle of the technology and underlying equipment packages related to the more expensive pieces or systems.
From a capital cost standpoint, the larger the capital cost, the longer the life cycle of a project will be in order to decrease principal payments that flow through to the per ton fees to make these rates more reasonable and/or competitive. A 15- or 20-year tenor of finance (length of time until a loan is due) with two, 5-year options is typical for the finance industry with capital costs in the tens of millions.
To make these contracts bankable, the project developer must make sure that guarantors on both the feedstock supply and PPA have the capabilities to deliver/use what they are guaranteeing. On the feedstock supply side, this means having the capability to deliver the contracted volumes, whether that be in relation to long-term organic flows based on franchise collection contracts from a collection company or municipal flow control from a city or county. On the PPA side, the utility or power purchaser must be perceived as being able to receive electricity, gas or biofuels over a long-term period with the ability to pay the purchase price over time. These two contracts are the most important aspects of successfully financing, constructing and operating an anaerobic digestion facility.

SOURCES OF CAPITAL
Federal and State Dollars: Many of the federal programs that emerged during the Great Recession to try to stimulate the economy have created a boon in the renewable energy industry that also applies to development of AD facilities. Some of these programs are part of the American Recovery and Reinvestment Act (ARRA) of 2009 that included outright grants and tax equity provisions, such as the Section 1603 Renewable Energy Grant that can be taken in lieu of a tax credit. Section 1603 may expire at the end of 2011 but projects in construction may benefit from the grant if 5 percent of the construction costs are expended prior to the end of this year. While these incentives are helping to promote the industry, unfortunately the long lead time it takes to develop AD projects means that many currently in development will not qualify since they will not be in construction by the end of 2011.
Other sources of federal grants funds are available from the U.S. Department of Agriculture loan guarantee program, the Department of Energy’s Small Business Innovation Research (SBIR) program and the National Renewable Energy Laboratory (NREL). In some cases, biomass projects have received substantial grants and or loan guarantee packages, exceeding $100 million in several cases. Some projects have been successful at cobbling together grants to leverage into even more matching funds. Depending on which state a project is progressing in, it is prudent to research possible energy and/or green job programs that may apply to a biomass-to-energy project from both the federal and state standpoints. (See “Funding Anaerobic Digestion Facilities,” March 2011, for a summary of federal and state programs.)
Strategics: Strategic companies in the industry may help to bridge the investment gap in the capital markets since they have a long-term motivation to maintaining or growing market share through the securing of waste volumes. Waste disposal corporations are recognizing that both wet and dry systems for creating energy from organics is a way to accomplish this objective. Waste Management has already made several strategic investments in the waste-to-energy and organics sectors including Harvest Power, Enerkem, and compost company, Garick. San Francisco-based Recology has made significant investments in its partnership with the East Bay Municipal Utility District (EBMUD in Oakland, CA) by partnering with them to create more biogas from organics with a future plan to develop a stand alone digester that will provide biogas to EBMUD for additional power production.
In addition to solid waste management companies providing parent guarantees for projects developed in-house, buying projects outright or participating as a feedstock provider, utilities are becoming interested in AD from an investment perspective and as a participatory player. Large utilities like San Diego Gas & Electric and Southern California Gas have created very aggressive biogas divisions that are identifying new partners or technologies that will allow them to supplement their natural gas with biogas or to create biomass renewable energy projects to help them meet state dictated portfolio standards for green energy. In fact, Sempra Generation is considering offering to condition the biogas prior to it going into their natural gas line in a wheeling arrangement similar to electricity, which alleviates the risk from meeting stringent contractual requirements to meet stringent natural gas standards.
Other strategics – companies that may not be a utility or in waste management but interested in the energy sector – remain attracted to the opportunities but see the barriers to entry as high due to the complexity of assembling the components. Venture and private equity funds are teaming up with technology and waste companies to pursue projects. The value of these projects once permitted or completed will bring added value to those interested in getting a head-start on the competition. If the solar and wind industry is any indication, there appears to be a ready market of buyers who don’t want to take the project development risk but may choose to purchase the project or company once the facility or pipeline of projects is permitted and/or constructed. Ultimately, these entities are participating because they are interested in either being acquired by a strategic or want to create a platform to grow a company for possible Initial Public Offering (IPO) to take advantage of the value that the public market places on renewable energy.
Equity: A number of different capital providers may participate in project finance from an equity side. Angel investors are typically high-worth individuals willing to invest $250,000 to $4 million per deal or company. Venture capital funds may actually focus on industry niches like biogas and would invest typically in the range of $4 million to $50 million with some going lower or higher. Many times, venture capital funds will invest with other funds in the space as a way to mitigate individual funds’ risk. Private equity groups will typically invest in ranges between $50 million to $100 million and normally will look for less risk with more commercial application.
All of these capital providers are looking for exit strategies in relation to how soon they can get their money back and at what returns. When speaking to individuals representing these various audiences, aligning a project’s capitalization tables in a manner that shows where money is coming in and going out and at what rate is an important component to attracting the right partners.
Tax equity investors are typically large banks that invest in the renewable energy industry. Basically, they are acting on their own behalf or are brokers for large corporations with huge tax burdens trying to identify write offs. Large banks (e.g., JP Morgan, Bank of America, Citi Group, Credit Suisse and Union Bank of California) invest in ranges of $50 million and up but mid-size banks will do deals that are lower, especially if they are local to the area where the development is occurring. In fact, many banks that were in the low income housing tax equity market are moving into renewable energy deals and may be amenable to doing tax equity deals at much lower dollar amounts.
Debt: Debt financing takes many forms including straight bank loans, bonds or mezzanine structures that carry many levels of debt. Limited/nonrecourse debt offers the least risky form of capital financing and therefore offers the lowest returns. Mezzanine/sub-debt capital sources offer slightly higher returns because they are paid after limited/nonrecourse debt.

REDUCING RISK
From a finance perspective, the cost of capital as it relates to interest paid on debt will always boil down to risk and reward and current market interest rates. One of the ways to reduce the cost of capital is by lowering the risk that the technologies work under an arrangement called an EPC – Engineering, Procurement and Construction – wrap. An EPC is a common form of a contracting arrangement within the construction industry as a way to reduce the cost of financing. Under an EPC contract, the contractor will design the installation, procure the necessary materials and construct it, either through its own labor or by subcontracting part of the work. The contractor carries the project risk for schedule as well as budget in return for a fixed price, called a lump sum.
An EPC wrap gives the owner or project developer one point of contact. It is easy to monitor and coordinate and normally it makes it easier for the owner to get post-commissioning services. Usually, the developer or the owner of the project that enters into an EPC contract will define the following: Site of the project with permits; Scope and the specifications of the technology or project components; Project duration, and; Cost.
Depending on the technology and the EPC contractor, there will be equipment wraps that marry up to the EPC contract so that manufacturers of key equipment are assuming the risk that their equipment will work as promised under a flow through agreement to the primary contract. The operator usually assumes the risk that the facility will operate once it is constructed with the biogas upgrade/conditioning technology provider taking the risk that its equipment will meet the gas production required.
Without key parties taking these types of risks, it leaves an unknown that must be accounted for. When those risks are not allocated, a third party such as an engineer will be paid to step in. But then it gets more expensive to pay for this “insurance policy,” which drives up the overall price of the project. In many cases, this is why developers will seek out companies that can provide the EPC wrap versus hiring an engineer to design a facility where there is no underlying parent guarantee. The key element for project developers from a technology risk side will be to demonstrate that the preprocessing to make a fuel suitable for the anaerobic digester works and is practical from a biogas generating standpoint based on the long term tip fees being negotiated in the underlying feedstock commitment. Entec biogas USA is one of the few AD technology vendors in the U.S. offering an EPC wrap.
As the organics recycling industry enters a period of what many of us hope is explosive growth in opportunities, there are also going to be challenges to navigate the path to create the best conditions for financing projects. It is the responsibility of the developer to ensure that the process has created a fundamental contractual framework that gives the project the best chance for success.

Kelly Sarber is President of Strategic Management, a national environmental project development and financing company based in San Diego, California. She currently works for MaxWest Environmental Systems to deploy its renewable energy system that gasifies biosolids and is also developing an anaerobic digester for the Port of San Diego.
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PROJECT POSITIVES
Here’s a checklist to improve a project’s potential to receive financing:
• Site has preexisting infrastructure including water, power hookups and transportation access close by.
• Power purchase agreement is negotiated with a strong end user or utility.
• A feedstock contract has been negotiated from an entity that controls the organic waste over the term of the project’s financing.
• Permit process is well understood and scoped out with milestones.
• Public and politicians are favorable to the project.
Several organizations host finance forums for further education and information. These include ACORE (American Council on Renewable Energy), Clean Tech Group and Infocast.