BRIEFING MEMO THE WHITE HOUSE Washington October 25, 20 I 0 MEMORANDUM FOR THE PRESIDENT FROM: CAROL BROWNER RONKLAIN LARRY SUMMERS Renewable Energy Loan Guarantees and Grants SUBJECT: Your advisors seek your direction on implementing the energy loan guarantee program. Tlu'Ce near-telm risks characterize this program: rescission of non-obligated funds; criticism from Hill supporters and stakeholders for slow implementation; and making commitments to projects that would have happened anyway and thus fail to advance your clean energy agenda. In considering these risks, the Department of Energy supports a process that would limit OMB and Treasury review. OMB and TreaslllY SUppOlt the establishment of clear policy principles for project review, recognizing that this may pose a risk that some program funds may not be obligated by thc program's September 30, 20 II sunset date. We also believe you should consider working with Congress to reprogram loan guarantee funds for an extension of the Recovery Act's renewable grant program during the lame duck tax extenders debate. An expanded EDB, including Secretary Chu, will provide an opportunity to discuss the options described below with you tomorrow. DISCUSSION Background The Recovery Act created two new programs to promote deployment of renewable power: the 1705 energy loan guarantee program and the 1603 grant in lieu of tax credit program. 1705 Energy Loan Guarantee Program: The Recovery Act appropriated about $6 billion to enable tbe government to pay for the credit subsidies associated with loan guarantees for renewable energy (and related) projects. The credit subsidy can be thought of as the premium that must be paid for the insurance the government provides in guaranteeing the loan for a project. This program was intended to address concerns about tightening credit markets for renewable projects. It represents a modification of the existing 1703 loan guarantee program, which SUppOltS innovative teclnlOlogies and covers renewables, nuclear, and advanced fossil. To date, the 1703 program has not received appropriations for credit 1 subsidies, thus requiring project developers to pay tbe goverlUuent for the credit subsidy and thereby limiting the interest in the 1703 program among small renewable developers. I /603 Granl Program: Renewables developers may opt to conveli the existing renewable investment tax credit, equal to 30 percent of a project's investment cost, into a grant. Before the financial crisis, renewable developers often partnered with large financials that bad sizable taxable income and could use tax credits, i.e., provide "tax equity." This program addresses concerns about the capacity of the tax equity market for renewables through 20 I O. DOllbling Renewable Power Goal: Based on these Recovery Act programs, the Administration set a goal to double renewable power generation wi thin three years. Ln 2009, the wind industry enjoyed its best year ever with nearly 10,000 megawatts of new installed capacity. Lawrence Berkley National Lab estimated that nearly one-quarter of this capacity would not have been built in the absence of the 1603 grant program. The 1705 1080 guarantee program did not close allY deals on renewable generation in 2009. SIIIIIIII(//Y of J705 Loal/ Guaral/lee Progralll and J603 Granl Program (throllgh Oclober 25) 1705 Loan Guarantee Staff Determination of Receipt 100-200 FTE DOE staff and coutractors Discretionary, renecting deal characteristics and uegotiatious with sponsor 6+ months September 30, 20 II 4/8 III 0/2 III 0/0 2/4 4/6 -80/-1,600 $1.2 billiou / $7.6 billion 1603 Grant 5 Treasury FTEs and 15 DOEFTEs Standardized, subject to eligible technology entering into service 4-6 weeks December 31, 20 I 0 3,851 203 3,571 23 25 29 48 plus DC aud PR -8,600 -$18.2 billion Typical length of review Program suuset date Total number ofprojects (closedlcond itioual for 1705) Number of wind power projects Number of solar power projects Number of geothermal power projects Number of biomass power projects Number of other technology projects Number of states with supported projects Total capacity installed (MW) Total investmeut supported Note: Project sponsors for all power generation projects under the 1705 program have indicated that they intend to claim a 1603 grant ooce they enter into service. The 1703 progJ?am has made conditional commitments for the Southern Company's Vogtle nuclear power plant In Georgia and AREVA's Eagle Rock Enrichment Facility In Idaho. 2 Estimated Benefits 0/ J 705 and J603 to Renell'ables Developers: The combined effect of 1603 and 1705 lowers the cost of a new wind farm by about 55% and solar technologies by about half relative to a no-subsidy case (see appendix table 1). Renewables' intermittency problem limits the deployment of these technologies, which cou ld be remedied by installing liack-up capacity (likely increases the cost by 2 to 4?/kWh). Past experience with the wind tax credit suggests that the 1603 grant and the associated tax credi ts could bave a signi fic ant impact on new wind capacity. Appcndix figure 1 sbows (in shaded regions) the halt to new investment during tbe tlu-ee times the wind tax credit expired since 1999. Loan Guarantee Pipeline and Process: After receiving an application, DOE conducts extensive due diligence work on the technologica l, financial, credit, legal , contractual , environmental, and operational aspects of each project. This due diligence can take months to complete and often results in significant changes to the original transaction stnlctme to mitigate identified risks. In addition to negotiating with the project sponsors, DOE also engages in a back-and-forth with OMB and Treasury, in particular after the deal package has been submitted for review. OMB review of DOE proj ects bas averaged 28 calendar days since September 2009, and 17?business days for the I closing and 3 conditional commitments DOE has transmitted between August 1 and October 15 of this year. DOE notes that the back and forth consumes a significant amount of staff time, thereby mak ing it challenging to move several transactions forward simultaneously. Policy review by Treasury and the White House bas occasionally extended the amount of time a project is under review beyond the time taken by OMB to score a credit subsidy. Last week, DOE conducted an interagency preview of five projects, with the expectation tbat most of these could reach the conditi onal commitment stage within tbe next 4-8 weeks under the current review system . DOE currently has 35 projects in due di ligence, and expects a significant number of new applications when two project solicitations close in the next few weeks. Since loan guarantee funds can only be obligated at closing, conditional commitments will need to occur in the first quarter of20 I I in order to close by September 30, 20 II. Legislative Implica tions The Administration 's approacb to the renewable loan guarantee program and grants has implications for legislative activity, including the FY20 I I appropriations (House mark is $0, Senate mark is $380 million for energy loan guarantee credit subsidies); the tax extenders hill iu which some Memhers would like to extend the 1603 grant; and the FY20 12 budget. Risl{s Characterizing the Loan G uarantee Program Rescission Risk: The 1705 loan guarantee program has been scaled back to about $2.5 billion after reprogramming for Cash-for-Clunkers (May 2009) and the state aid package (August 2010). Tbere has been recent interest in rescinding unobligated Recovery Act balances to pay for other programs. DOE has obligated about 2.5% of the $2.5 billion in the 1705 program appropriations. An additional 9 prnjects have received 1705 conditional commitments, and if DOE closes these deals, the total obligations would be about $500 - $900 million. 3 Congressional Risk: Failing to make progress on renewables loan guarantees could upset the Hill (Sen. Bingaman, Speaker Pelosi), as well as renewables stakeholders, and draw criticism of the White House, which has been singled out as a roadblock on past loan guarantees. Economic Risk: OMB and Treasury, which have statutory obligations to review 1705 loan guarantees, have raised implementation questions, including: "double dipping" - the total government subsidy for loan guarantee recipients, which have exceeded 60%; "skin in the game" - the relatively slJlall private equity (as low as 10%) developers put into projects; and non-incremental investment - some loan guarantee projects would appeal' likely to lJlove forward without the credit support offered by 1705 (including those projects that already exist and for which the loan guarantee simply provides a means for rcfinancing). See the appendix for an illustration of these issues with the Shepherds Flat project. Energy LOlln Guarantee Program Options Option I: Limit OMB and Treasury Oversight Role In the current review process, after working with project sponsors for 6 to 18 months, DOE submits projects for review of the credit subsidy for conditional commitments and policy review by OMB and Treasury. DOE would prefer to eliminate the deal-by-dealreview and instead have OMB and Treasury play roles akin to what they do for other credit programs, such as OPIC and Ex-rm Bank. It should be noted, however, that OPIC and Ex-1m credit programs have a long track record; OMB was more involved in the review of these programs in their early years; and they have boards with representation by other Federal agencies, including Treasury, that review and approve all major projects. DOE would make initial credit subsidy estimates at the conditional commitment stage, and OMB would only review and approve of the credit subsidy used at the time of closing on a deal. Pros o Some Members of Congress may applaud this effo11, Ifit results in a meaningful increase in the rate of granting conditional commitments to energy projects. Cons o Still exposes 1705 program to rescission risk until DOE can move tlu'ougb its pipeline a lot more conditional commitments - up to t"'/ice as lUany in the next few months as have been made in first 20 months of the progranl. o OMB believes that this approach will not remedy the challenge of an insufficient number of frnancially and technically viable projects in the 1705 pipeline. o The economic risks will not likely be addressed. Option 2: Make the Process Work Better by Establishing Clear Policy Principles Treasury and OMB believe that clear policy principles - and associated metrics for evaluation - should be developed for the energy loan guarantee program. These principles would be applied to all projects and address issues like doubling dipping, skin in tbe game, and incrementality of investment (including refinancing). Those proposed loan guarantee projects that have satisfactory measures under each of the key policy prulciples would then be expedited tIU'ough review. Those that do not would require 1110re extensive policy review 4 and possible rejection. It is important to recognize that nnder such an approach, there is a risk that not all of the 1705 appropriation of $2.5 biIHon will be obligated by the program's sunset of September 30, 2011. Pros o EnslU'es the economic integrity of govermllent support for renewables. Cons o Exposes the program to rescission risk through September 30, 20 II. o Some Members of Congress may criticize tillS effort to limit the application of the loan guarantee program. The White House will bear this criticism. Option 3: Reprogram 1705 Ftmds for an Extension of 1603 Grant Program The 1603 grant program expires on December 31 , although the associated tax credits tllat could be converted into grants under thi s program do not sunset until December 3 1, 201 2. A 2-year extension of the 1603 grant program tlU'ough the sunset of the associated tax credits has a $2.5 billion tax score. The Administration could work with Congress dUl'ing the lame duck on the tax extenders bill to reprogram the 1705 funds to pay for the 1603 extension. As a variant of this option, the funds could be reprogrammed to support other clean energy priorities, such as the 48C clean energy manufactUl'ing tax credit. Pros o o Moves fu nds to the 1603 program that has been much more effective in promoting renewable energy, and likely to have a more significa nt impact on renewable energy investment in 2011 and 2012. Reduces economic risks and the rescission risks identified above. Cons o Sen. Bingaman, who views 1705 as "his program," would strongly oppose. o Could signal the fail ure of a Recovery Act program that has been featured prominently by the Admirllstration. o The reprogramming effort entails the risk that Congress accepts the 1705 rescission but fails to deliver the 1603 extension. Option 4: Streamline and Accelerate OMB / TreasUl'y Reviews with Project Prioritization OVP suppOL1s an option that falls in possible middle ground between options I and 2. This approach would create an expedited deal review process, while not doing away with Treasury and OMB reviews altogether. One option to be explored would be to assign higher credit subsidy scores in order to reach faster agreement on the government's risk tolerance and to mol'c quickly utilize the $2.5 billion in appropriated funds. In addition, this approach could prioritize deals with more favorable policy characteristics (e.g., deals with lower total government subsidies). This option would prevent the bolding of the loan guarantee program to a more rigorous policy standard in awarding stimulus funds than other Recovery Act programs. The focus would be on spending all remaining funds wIllie maintaining the necessary risk avoidance and prioritizing policy issues where possible. 5 Pros: o o Parties with equities, including Hill members and industry groups, would view the Administration as supporting a program that they have spent political capital defending. This would be an attempt to fix a broken process, as opposed to a complete and unexpected overhaul which could engender criticism. Cons: o DOE, OMB, and Treasury have tried to reach co=on ground on which to execute the program to date, and success has been limited. o In order to spend the remaining budget authority, the policy principles may be so lax that this option may resemble Option I in practice. 6 Appendix Table 1: Cost of Generating Power from New Capacity Investment by Technology Typc, ?IkWh Natural Gas No Subsidy Cost Cost with 1603 Cost with 1603 and 1705 7.3 7.3 7.3 Wind 8.8 6.7 4.0 Solar Thermal 23.2 16.0 12.6 Source: DOE Energy Information Admini stration 2010. Appendix Figure 1: U.S. Wind Capacity Additions and Pel'iods of No Wind Tax Credit (shaded), 1999-2007 1800 1600 1400 1200 1000 800 600 400 200 ~ i n ~ In ~n o LlliL ",,,, ,II I ",' ",' ~ <:>'Y R IS'- nln~ ",,,> ,0('> ~ 1111, . ~ nnn_ " 1I,llllnll l -:>'> ",'> ",I> [ill &- ",'\ n ~~~~~~~~~?~~~~~~?~ SOll\'ce: Metcalf2009 llsing DOE Energy Information Administration data . ~<) ~ ~ 7 Appendix: Shepherds Flat L oan G uarantee The Shepherds Flat loan guarantee illustrates some of the economic and pubUc policy issues raised by OMB and Treasury. Shepherds Flat is an 845 -megawatt wind farm proposed for Oregon. This $1.9 billion project would consist of 338 GE wind turbines manufactured in South Carolina and Florida and, upon completion; it would represent the largest wind farm in the country. The sponsor's equity is about 11% of the project costs, and would generate an estimated return on equity of 30%. o Double dipping: The total government subsidies are about $ 1.2 bil lion. Subsidy Type Approx imate Amount (millions) Federal 1603 grant (equal to 30% investment tax credit) $500 State tax credits $18 $200 Accelerated depreciation on Federal and State taxes $300 Value of loan guarantee $220 Premiulll paid for power from state renewable electricity standard $1 ,238 Total Skin in the game: The government would provide a significant subsidy (65+%), while the sponsor would provide little skin in the game (equity about 10%). Non-incremental investment: This project would likely move without the loan guarantee. The economics are favorable for wind investment given tax credits and state renewable energy standards. GE signaled through Hill staff that it considered going to the private market for financing out of frustration with the review process. The return on equity is high (30%) because of tax credits, grants, and selling power at above-market rates, which suggests that the alternative of private financing would not make the project financially non-viable. Carbon reduction benefits: If this wind power displaced power generated from sources with the average California carbon intensity, it would result in about 18 million fewer tons of C02 emissions through 2033. Carbon reductions would have to be valued at nearly $130 per ton C02 for the climate benefits to equal the subsidies (more than 6 times the primary estimate used by the government in evaluating rules). o o o 8