The Valley of Fog: As Sundrop Moves on from Louisiana, What’s up and What’s Wrong with Loan Guarantee Programs?

August 16, 2017

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by Jim Lane (Biofuels Digest) In Louisiana, reports surfaced in Alexandria’s TownTalk online paper that Sundrop Fuels has struck an agreement to sell the 1200-acre site where it once planned to build its $450 million, 50 million gallon capacity first commercial plant to produce green gasoline from woody biomass.

The company selected the site, the former location of the Cowboy Town entertainment complex, in November 2011 and completed the purchase in January 2012.

The CEO of Central Louisiana Economic Development Alliance, Jim Clinton, told TownTalk that “The company tried extremely hard to make this work. Sundrop management did everything within their power. By the time they got to the point where they could build the plant, the economics had changed and the politics had changed.”

Sundrop has now confirmed that “It has become clear given the new politics in Washington that our application through the DOE Loan Guarantee program is not going to progress further. As such we are not going to be able to finance and build the facility in Louisiana so there is no point in tying up money there.”

So, an unfortunate step backwards for the manufacturing sector — and an interesting proof point that the DOE Loan Guarantee program success is closely tied to the revival of domestic manufacturing. We hope a temporary one — Sundrop’s technology and team march on, with we hope another project emerging soon. Perhaps offshore, perhaps one with financing not tied back to Washington’s shifting sands. Asia has long been in the long-term focus of the company.

Sundrop’s vision

Sundrop said that its Louisiana site could support, when fully built out, more than 225 million gallons of capacity for 87-octane biogasoline.

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Alexandria area emerged as a promising location because of its access to major electrical and natural gas supplies and because of the abundance of wood byproducts the region boasts. The state’s targeted incentives for workforce training and research and development helped Louisiana win the project over several other states in the South and Southwest.

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The plant expected to salvage wood waste from renewable forests in Central Louisiana and adjacent regions and use that biomass as a feedstock.

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Veronique de Rugy, Senior Research Fellow at George Mason University, testified in a devastating fashion before the House Committee on Oversight and Government Reform, Subcommittee on Regulatory Affairs. Here’s an excerpt that gives you the flavor.

The failure of Solyndra has attracted much attention, but the problems with loan guarantees are much more fundamental than the cost of one or more failed projects. In fact, the economic literature shows that every loan guarantee program (a) transfers the risk from lenders to taxpayers, (b) is likely to inhibit innovation, and (c) increases the overall cost of borrowing. At a minimum, such guarantees distort crucial market signals that determine where capital should be invested, resulting in lower interest rates that are unmerited and a reduction of capital for more worthy projects. At their worst, these guarantees introduce political incentives into business decisions, creating the conditions for businesses to seek financial rewards by pleasing political interests rather than customers. This is called cronyism, and it entails real economic costs.1

So what can we make of these figures? First, it should be noted that very few permanent green jobs were created under the 1705 loan program, or any of the other loan programs…o the extent that green jobs were created, the $6.7 million taxpayer exposure per job is quite spectacular.

Second, our data demonstrates that under the 1705 program most of the money has gone to large, established companies rather than to startups. Companies that benefited included established utility firms, large multinational manufacturers, and a global real estate investment fund. In addition, the data shows that nearly 90 percent of the loans guaranteed by the federal government since 2009 went to subsidize lower-risk power plants, which in many cases were backed by big companies with vast resources.

Quoted in the New York Times recently, David W. Crane, NRG’s chief executive, explained, “I have never seen anything that I have had to do in my 20 years in the power industry that involved less risk than these projects,” he said. “It is just filling the desert with panels.”

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One thing that all parties agree on, loan guarantees have been developed to address the market’s failure to back certain projects. Meanwhile, the data demonstrates is that almost all the money went to solar, and precious little to bioenergy, or other advanced technologies.

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If the original access to credit market is caused by serious industrial problems — what are those problems, aside from late-stage industry failure? They generally refer to four failures:

1. Late-stage company failure. Loan guarantees and bailouts have been criticized for tying up capital in support of failing companies at the end-of-life stage.

2. Trade and currency imbalance. Public intervention has sometimes been caused by currency valuation problems. A currency that is overvalued relative to industrial output (because, for example, of the financial appeal of a fungible, low-risk, basket currency) can lead to excessive costs for domestic production relative to imports.

3. The lack of interest in debt markets for projects that have perceived technology risk, because of the low rates of return on these projects discourage appetite for risk. It’s the Valley of Death problem — projects can’t get financing until they are demonstrated at scale to work, but they can’t be demonstrated at scale to work until they get financing.

4. The most unique benefit of green technology — reducing carbon emissions — goes to society and not the project itself. Or the financial benefit to the project is considered unreliable (e.g. RIN credits under the Renewable Fuel Standard).

Loan guarantees in the modern sense of the DOE program generally address #3 and #4. In a loan guarantee program, the public steps forward through government entity to invest in the project to realize the social benefit — though the public role is limited to issuing debt or guaranteeing debt issued by commercial financiers.

Problems, perceived or real?

Cronyism, backing projects that would have financed anyway and simply offering them a lower-cost loan, the problem of the government “picking winners” between competing companies and technologies and sectors, the moral hazard of removing the incentive for deep project due diligence — these are objections that are typically raised by critics of Loan Programs.

In general, programs get caught between two problematic outcomes. If the default rate is too high, there is criticism of the public cost and accusations of lax oversight. If the default rate is too low, it can indicate a healthy program, or one that is simply competing with the private sector in backing commercially-feasible projects, rather than focusing on higher-risk, higher-reward projects.

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In our view, the market failure lies in the due diligence problem — advanced projects struggle to get a fair “day in court” because banks don’t have the technical resources for the underwriting that complex projects require, and projects themselves rarely have the financial resources.

The Valley of Death is actually a Valley of Fog that people avoid because, who knows, maybe it’s filled with coyotes and rattlesnakes. Markets have long dealt with commodity price risk for both raw materials and refined product: after all, petroleum has that risk, too, as does agriculture. But technology risk is more about the uncertainty of whether something works as designed, rather than the problem of peering into the future of prices. The most attractive solution is intelligence — as opposed to hedging, insurance or transfer of risk to the broader public.

If there is a social benefit to be realized, a co-operative public-private effort to develop better, faster and cheaper due diligence is a far less costly adventure than guaranteeing loans that can’t get financing because of insufficient risk profiling. Rather than founding new programs to take elevated risks, why not minimize risks? READ MORE