Authors: Kevin McConville, Tony Valentine and Ketheesch Aran
Principals at Power Holdings and Development LLC
With good intentions and significant federal funding, it would be reasonable to assume that needed and environmentally sound energy projects would be in development, construction and operation nationwide. Unfortunately, this is not the case.
Take for example the “Biomass Crop Assistance Program” or BCAP as it is referred to. BCAP provides payment to farmers and ranchers that sell the residue from harvesting operations to “designated facilities” that burn the biomass in the production of electricity and/or steam. Residue can be the result of many different agricultural operations but this article focuses upon the waste from growing corn, wheat, sorghum, native grass and many other eligible crops.
Without BCAP, a significant portion of residue or agricultural waste is left to decompose, or rot in layman’s terms, creating CO2 and the release of greenhouse gases with little or no benefit to the land.
The BCAP program provides matching payments of up to $45 per dry ton to farmers that enter into supply agreements with BCAP designated facilities, in this example, a power generation facility. Individual farmers are able to participate for no longer than two years to incent a “spreading of the wealth” concept that, as mentioned earlier, is well intentioned but misses the mark of providing the right kind of incentives to investors.
Why? First of all, farmers are incented to charge up to the $45 per ton limit, which in many cases eliminates the economic viability of the power plant. Secondly, by limiting participation to the two year time limit, power plant equity providers can never be assured of long term performance at any price.
Farmers that enter into fuel agreements are not penalized for contractual non-performance as legal remedies are costly, time consuming and generally provide no relief due to insufficient credit of fuel suppliers. From the power plant equity owners and lenders viewpoint, which require 20 years of continuous power generation and sales to a utility or electric co-op for financial success, the lack of certainty in fuel procurement and pricing creates a potent mismatch of inputs and outputs. Utilities and electric co-ops enter into long term purchase agreements, or PPAs, with power plant owners at fixed prices with severe penalties for non-performance. With little or no fuel price and volume certainty resulting from farmers’ participation in the BCAP program, it is easy to discern why investment is stagnant.
Evidently, federal regulators seem to think that forces of nature will always result with all parties acting responsibly. There is nothing wrong with being idealistic, but when asked to invest tens of millions of dollars and borrow multiples of that amount from lenders in order to design, develop, construct and operate a power plant selling power for 20 years at a predetermined, fixed contractual price, fuel uncertainty creates such levels of risk, developers providing equity commitments and lenders providing debt for projects cannot move forward in commercially acceptable ways. After investment is made and the plant is operational, farmers have little incentive to act in the best interests of the power plant. In fact, the incentive is actually quite the opposite; charge the project for fuel as if were a hostage, forcing it to pay whatever it can afford to pay until reaching the point of insolvency. After all, with tens of millions of dollars of plant, property and equipment in place, it is clear who has the upper hand in such a scenario.
What’s the answer? Simply provide the risk takers who have invested in the power plant the ability to contract for fuel at fixed prices from the farmers. This will provide a windfall to farmers that participate by selling agricultural waste to the facility. Additionally, allow farmers to participate for longer than two years, providing the power plant with a more stable fuel supply and creating a more vibrant market place for future agricultural waste sales. BCAP would intervene in the event of non-performance by the farmers or the power plant. This intervention could be structured to perform like a letter of credit or federal guarantee that can be drawn upon in the event of non-performance. Implementing the recommended changes elevates the credit worthiness of biomass fuel suppliers to that of natural gas or coal creating more opportunities for power plant development.
These recommended changes in policy would benefit all; farmers, investors, lenders, electricity consumers and environmentalists. Modifying the program creates credit worthy fuel supply agreements, a fundamental element for responsible development and provide comfort to operators executing long term electric sales contracts and with less cost to the federal government as it would become involved only when contractual disputes arise, rather than providing the matching payments to farmers. In essence, BCAP providing fuel certainty in this manner eliminates the need for direct federal involvement and creates a market where all parties are incented properly. The amount of local revenue generated is significant; a 20 MW plant can consume $4 million per year of agricultural waste and profitably operate on a long term basis. Under the current scenario, federal funds allocated for BCAP are not efficiently utilized, provide no value and create only lost opportunities.
Kevin McConville
Principal, Power Holdings & Development
Power Holdings & Development is a firm that specializes in all phases of energy development with a focus on capital markets, negotiation of key agreements and execution.
