Hot-Potato Policy

Deck: 

DOE loan guarantees degenerate into a political game.

Fortnightly Magazine - December 2007

Once upon a time, the U.S. Congress started a game of hot potato. The potato, otherwise known as the EPAct Title XVII Loan Guarantee Program, has been bouncing around Washington, D.C., since 2005.

For a long time it bounced among executive-branch agencies and Congress. Finally, DOE issued regulations in October, effectively putting the potato back in Congress’ lap. Legislators can end the game by funding the program.

But now that the industry is getting a good look at the potato, it looks decidedly funky—stuffed with caveats and half-measures. Whether that’s good or bad depends largely on whether you believe the government belongs in the potato game in the first place.

Not On My Watch

EPAct Title XVII directed the energy secretary to guarantee loans for projects that “avoid, reduce, or sequester air pollutants or anthropogenic emissions of greenhouse gases; and employ new or significantly improved technologies.”

The DOE, however, never seemed to embrace Congress’ assignment. Publicly, of course, DOE officials have supported the program, but their actions seem aimed at scuttling it—or ensnaring it in bureaucracy until President Bush’s term ends.

For example, the DOE’s proposed regulations in May 2007 made the program unworkable. They capped the guarantee at 80 percent of project debt, and subordinated the non-guaranteed debt to the federal government’s lien. In other words, the government would get first dibs on all project assets in event of a default, whether they were financed with guaranteed funds or not. Uncovered lenders could be left without any kind of security, which in practical terms closed off access to the remaining 20-percent slice of non-guaranteed debt.

Also, the rules forbade syndication of guaranteed loans. Sponsors could not re-finance project debt, forcing them to carry high-cost construction financing for up to 30 years.

“They took what could be a very effective instrument, and added quirky elements that made the program clunky,” says Ken Hansen, a partner with Chadbourne & Parke in Washington, D.C., and formerly counsel for both OPIC and Ex-Im Bank. “They were essentially poison pills. DOE could not be serious about raising capital for these purposes when they put in those terms.”

Institutional Memory

The likely reasons for DOE’s reticence are complicated, dating back to the Jimmy Carter and Ronald Reagan years.

A series of commercialization programs in the ’70s and ’80s involved the DOE in coal-to-liquids, ethanol and geothermal development. Some of these projects failed spectacularly—for various reasons, not all involving technology—and billions in taxpayer dollars went up in smoke, or vanished into dry holes.

The institutional memory of those failures remains fresh at DOE. A recent report from the department’s inspector general recalled costly examples of fraud, misappropriation and delay, and noted “agency officials [have] not always … appropriately acted to protect the Government’s interest in the case of default” (See Friedman, Gregory H., “Loan Guarantees for Innovative Energy Technologies: Memorandum for the Secretary,” DOE Office of the Inspector General, Sept. 19, 2007).

Since then, the DOE has provided direct funding and loan guarantees under various schemes, such as the Clean Coal Technology program of the 1980s and ’90s. These programs yielded some noteworthy successes, but the dollar commitments were small compared to the new Title XVII program. Its first iteration would cover $9 billion in loans, and that’s just the beginning (theoretically).

The program’s proponents emphasize DOE won’t be issuing loans, and the loan-guarantee costs—which under the DOE rules are termed the “credit subsidy cost”—are supposed to be paid by the borrowers themselves, sort of like a mortgage-insurance policy. Irrespective of these facts, however, the Title XVII program now stands in a precarious position, vulnerable both to political attack in Congress and administrative obstruction by DOE and OMB.

Souring the Milk

While the final rules are significantly more palatable than the DOE’s May 2007 draft, they retain peculiar provisions that seem designed to marginalize the program.

First, the rules allow the government to guarantee up to 100 percent of the debt for a project, as long as that debt doesn’t exceed 80 percent of the project’s costs—in concordance with the language of Title XVII. But they add an important caveat: Such loans must be issued by the U.S. Treasury Department’s Federal Financing Bank.

This requirement might be driven by the Treasury Department, which doesn’t want to see tens of billions of dollars worth of U.S.-backed commercial debt in the capital markets, effectively competing with Treasury securities.

But by putting Treasury money on the line, the DOE is changing the political story of the Title XVII program; proponents can no longer say the U.S. government isn’t providing the loans. It also partially defeats the program’s secondary purpose—helping advanced-technology projects access the capital markets.

For project sponsors that want to use private capital, most notably long-term syndicated loans, the DOE will guarantee only 90 percent of the project debt. And the remaining non-guaranteed 10 percent will be subordinated to the federal lien. “It seems like they give with one hand and take away with the other,” says Jim Liles, a partner with Milbank, Tweed, Hadley & McCloy in Washington, D.C. “You can go to a commercial lender, but you have to go through this bureaucratic rig-a-ma-roll, and the lender is basically at risk for losing the non-guaranteed part.”

Dropping the Potato

Today as always, the Title XVII program hinges on politics. Congress might refuse to grant DOE’s requested $9 billion loan-guarantee authorization. And with $25 billion worth of requests already queued up, plus numerous multi-billion-dollar nuclear projects behind them, sticker shock easily could complicate the appropriations process.

And even if the appropriations survive, DOE can kill the program with a strict methodology for calculating credit-subsidy costs. DOE provides few clues into its thinking, except to say its methods will be more rigorous than those used by Ex-Im Bank. Rigorous pricing for commercialization risk might yield very high credit-subsidy costs.

“With Title XVII loans, there is no track record,” Hansen says. “The program focuses on technologies that in the world’s most advanced capital market aren’t financeable on their own. If you’re looking for poison pills, the subsidy is likely to be one.”

Maybe poison is just what’s needed. After all, if DOE doesn’t like what Congress wants it to do, maybe that’s because it recognizes something Congress doesn’t want to face. Namely, whether it’s betting Treasury dollars or full-faith-and-credit chits, the U.S. government is lousy at picking winners and losers in the innovative-technology game.

The fact is, no loan-guarantee program can spur the broad, systemic changes necessary to accomplish Title XVII’s implicit purpose. If members of Congress really want to encourage investment in innovative energy technologies, they should enact greenhouse-gas constraints that reflect the true costs of carbon emissions. At the same time, DOE should assert some leadership and analyze the country’s energy and environmental strategies in the bigger context of U.S. economic, trade and foreign policies.

The industry will respond much faster, and much more efficiently, to policy leadership and clear economic signals than it will to any kind of hot-potato investment program.