Confronting and Solving “Chicken or Egg” Conundrums in renewable project development

cycleLooking to turn vicious project financing cycles into virtuous cycles?  

This case study in developing a small-scale Bio-LNG plant offers cautionary tales and a way forward.

By Tim Sklar, special to The Digest

In July 2014, Biofuels Digest had published an article titled “Connecting The Dots” that describes how we reached a decision to develop a waste-to-LNG biorefinery. At that time, we had just completed a preliminary fact finding in order to assess how best to use the wood wastes that are available in our area to make bio-fuels. The article also provided highlights of those bio-fuels pathways that appeared to work best in making a range of more common bio-fuels out of wood wastes and other refuse derived feedstock (RDF).

The focus this article then shifted to an examination of those processes that could make higher value bio-fuels such as bio-diesel and bio-jet fuel from wood waste streams. The specific bio-fuels pathways that emerged as being the most suitable for our client’s needs was one that could successfully convert wood waste into syngas and produce either jet fuel from syngas, using a recently developed “small scale” F-T catalytic and hydro-cracking process, or “bio-LNG”, using a proven commercially available and less expensive “small scale” liquefaction process. The article makes a case for initially considering the bio-LNG pathway over the bio-Jet Fuel pathway.

The overall conclusion reached in this article was that that” choosing among alternative waste-to-bio-fuels pathways is not a simple exercise. This has since proven to be an understatement.

Based on subsequent findings and it is our recommendation that our client actively pursue the development of a bio-refinery that will convert locally available forestry wastes into syngas and then convert this syngas into Liquefied Natural Gas (LNG).

S&A’s client is a non-profit association of business leaders and county and local officials that has already agreed with our preliminary conclusions and endorsed our recommendations. They have since asked us to continue with its fact-finding efforts to better determine if developing a small-scale waste-to-LNG bio-refinery could succeed.

Progress to Date

The following are some of the milestones we have reached in our project development efforts:

  • The two pathways that have been chosen for further consideration rely on wood waste as the primary feedstock.
  • Technology providers that offer proven processes have provided provisional estimates of metrics and costs.
  • Consensus has been reached as to how best to convert wood wastes into syngas and to reform syngas into jet-fuel or to liquefy it into LNG.
  • Viability assessments have been made using preliminary estimates.
  • A number of participating firms (a.k.a., “Parties-in-Interest”) have already provided time, proprietary information and contacts, to help S&A in the project definition. These firms now include:
  • A wood waste procurement firm that is in position to “guarantee” a sustainable supply of forestry wastes at favorable prices;
  • A leading provider of “proven” gasification technology that has designed a small scale process that produces high yields of methane rich syngas from chipped and pulverized wood waste;
  • A leading provider of “proven” small scale gas clean-up and liquefaction processes and LNG handling & storage systems; and
  • A leading LNG marketer and distributor who has expressed interest in being a major off-taker of the 52 million gallons per year of LNG that the proposed bio-LNG plant should produce, once it becomes operational.

S&A’s preliminary financial viability assessment of this project indicates that in all likelihood, it should generate significantly high profits and cash flows as well as high rates of return on invested capital, and that such expected returns would be high enough to manage the levels of risk that may reasonably be encountered.

Finding A Project Sponsor

The First Confrontation With Chicken or Egg Conundrum-Obtaining Letters of Interest

Ideally, in order to attract a viable project sponsor, a project developer should try to obtain formal “Letters of Interest” (LoIs} from Parties-in-Interest To date, we have not been able to do so, as we not able to solve the conundrum of having all the key parties interested in participating in the project except a project sponsor. This in turn, limits our ability to attract the seed investment we need and further impairs our ability to attract a project sponsor with the background needed to put the project together.

Ongoing progress is being made that will lead to getting LoIs, as a dialogue has been established with a number of the companies who have expressed an interest in participating in The Project. And many have already contributed to the fact-finding efforts and have shared proprietary information and contacts. In addition written communications are on file, where interest in The Project has been articulated. And we now have four private sector companies that have expressed interest in wanting to participate in the project. Other organizations and government entities that have also expressed interest include: The US Forest Service, The Client, The State Port Authority, local port management and the County Government.

As project development continues, it is expected that additional expressions of interest will be obtained from other potential LNG marketing and distribution partners as well as from those who are interested in serving the LNG needs of maritime users that can call on the Port for fueling.

The Second Confrontation With Chicken or Egg Conundrum- Preparing a Credible Feasibility Study

In order to attract a Project Sponsor, a credible feasibility study will have to be completed. Otherwise potential project sponsors will conclude that we have not adequately thought through a strategy on what has to be done and how to overcoming obstacles that we can expect to encounter.

This “study” should not only include adequate disclosures demonstrating that the technology to be used is sufficiently “proven” and has been adequately been demonstrated. This study must also be based upon costs and metrics derived from adequately detailed engineering assessments. Further, this study should contain explicit marketing plans and be backed up by a sufficient number of written expressions of from those that will in all likelihood, be responsible for the project’s marketing and distribution. This “feasibility study” should also contain risk assessments and incorporate a business plan that provides a plausible strategy for developing The Project.

Also needed are preliminary financing plans tailored to the perceived needs of each potential project sponsor being called upon. This financing plan must suggest alternative financing structures and alternative sources of financing that could best be used.

Unfortunately the preparing of feasibility studies and other supporting documents will require the services of a number of professionals and their services will require seed financing. This is another Chicken ‘n Egg Conundrum that can only be overcome if assistance is obtained in finding the funds that will be needed. The Client, and other Parties-in-Interest could be instrumental in finding funding sources of seed capital, Further there are still a number of grants programs that are being offered by US DOE, USDA and by State agencies that foster renewable energy projects.

The Ideal Project Sponsor

An ideal Project Sponsor for The Project is one that believes in the future of bio-fuels as a viable business opportunity and that has the organizational depth:

  • To contribute seed capital and raise the first tranche of financing;
  • To engage EPC professionals to design and build the bio-fuels plant;
  • To integrate the licensed technology and processes that are to be used; and,
  • To enter into contractual relationships with other participants and get the project up and running.

It is then up to The Project Sponsor to decide on the level of equity participation it expects to provide, the amount of project risk it is willing to assume, the role it wants to play in project development, the amount of operating control it plans to have once the plant is operating, and what its exit strategy ought to be, as well as what it expects in the way of terminal value.

S&A’s Initial Attempts in Finding a Project Sponsor

Bio-fuels Venture Funds and Private Equity Funds

Over the years, S&A has tried to obtain “Project Sponsors’ for bio-fuels start-ups from this category of candidates, with little success.

S&A recently identified one such candidate firm that appeared to be ideally suited to take an interest in The Project. This private equity firm had been referred to S&A from an industry source and their web site suggested that they were involved in a variety biogas and biomass projects. They claim to have offered project financing services and related professional services in a number of related renewable energy project development categories. And they also claim to have participated in other biogas projects that appear to be similar to The Project we plan to develop. However, after exchanging significant amounts of information with one of their officers that is in charge of their renewable fuels programs, he indicated that their portfolio of such projects is now full and at this point in time, there no interest by the company in being part of another one.

Observation: This pullback of project financing for renewable energy projects is not unique, as most renewable energy projects that have been announced are often plagued by delays and many of those that get completed, have under-performed. As a consequence, S&A has concluded that in all likelihood, finding a project sponsor for this project will not be found among this category of investor.

Parties-in-Interest as Affinity Investors and Project Sponsors

S&A has already approached executives of the organizations that had expressed an interest in providing products and services to The Project as to whether they would also consider participation as equity holders, and perhaps, take a leading role as project sponsor.

In conversations with principals who are interested in providing gasification and liquefaction technology, each of them made it clear that they have no interest in investing in the project, let alone assuming the project sponsorship role. And they opined that any “excess” liquidity they do have is earmarked to support their own business growth.

Observation: It has been our experience, that as a group, bio-fuels technology providers are generally under-capitalized want to sell process technology, not finance projects in which they participate nor do the seek any ownership interest in them.

We then identified a few organizations that resell LNG they acquire from LNG plants. We then exchanged large amounts of information with one of them that is active in our region. As with the technology providers, we found that they too expressed no interest in being part owner in The Project or sponsoring its development. They explained that their policy is to use the investment capital they are able to obtain to build distribution infrastructure that they need. With respect to finding affinity investors among shipping lines who are investing in LNG powered vessels, we “struck out” there as well. In particular, we identified a shipping line that plans to be using large numbers of LNG powered containerships on scheduled service between foreign and US ports. We also found that this shipping line has regular service into and out of two deepwater ports that were within barge distance from our local port. We then tried to get them interested in our providing LNG to one or more of the LNG vessels they may want to use. We got nowhere, as they would not commit to using LNG vessels on using these routings using LNG powered vessels any time soon. Nor did they express any interest in committing to a specific source of LNG, even if they did.

Observation: It has been our experience in dealing with shipping lines and ship owners, they are notorious for not making commitments to port owners, let alone investing in port infrastructure, even if it offers large potential savings. We have since concluded that it will be a futile exercise to try to convince ship owners and shipping lines to be affinity investors in a bio-LNG plant.

The remaining project sponsor “targets” could probably be found among those that own and operate port facilities or those that are in the oil and gas industry that invest in processing facilities and have a market need for bio-fuels such as LNG.

Observation: Port operators tend to require customers that have specific infrastructure needs, such as a LNG storage facility, to invest their own capital. And those who are established LNG plant operators that are part of integrated oil and gas companies favor investment in large-scale facilities that offer lower unit costs.

However, an opportunity for obtaining a project sponsor for The Project could come from oil rig servicing firms that decide to support South Carolina off shore drilling and could use LNG to fuel a fleet of service vessels. Observation: The chances that this will happen at all, let alone any time soon, is a long shot.

Alternative Strategies Yet To be Considered

It appears that there are three strategies available to further the development of The Project. They are: “The Chicken or Egg” Strategy; The Chicken and Chicken Strategy; and, “Build it and They Will Come” Strategy.

“The Chicken or Egg” Strategy

This approach would require that we continue to search for a project sponsor or a group of sponsors, such as existing port operating companies, natural gas pipelines, LNG terminal operators, integrated oil and gas companies and/or oil rig service firms. But this strategy depends on circumstances that cannot be controlled. Each of these targeted groups will first have to be convinced that they can use the LNG produced in the proposed bio-LNG plant and that they can readily market it to specific captive groups of end users.

We have since concluded that, little progress can be made, if this strategy is relied upon, as its success is dependent on the events that we cannot control. This in turn, undermines our efforts to obtain seed funding and impairs our further project development efforts.

“The Chicken ’n Chicken” Strategy

This do nothing strategy is equivalent to “throwing in the towel” on further project development. As it implies project development efforts would have to be put on hold until demand for bio-LNG produced in our area emerges, that the price that LNG can command remains high enough to “guarantee” high rates of return to The Project owners, and that The Project’s technological and financial risks have been sufficiently mitigated.

“The Build It and They Will Come” Strategy

Historically, end-users of bio-fuels avoid direct participation in bio-fuels related projects. Instead, they prefer waiting for fuels suppliers to build the bio-refinery capacity and produce the fuels. End users also believe that they will always be able to buy bio-fuels they may need at spot prices, without committing to take-or-pay requirements or to long term price arrangements. There is no reason to believe that this will change any time soon, especially with oil prices and natural gas prices being depressed. With respect to bio-fuels, incentives to promote their use or subsidize the cost of using them have proved to be uncertain over time, undercutting potential investors incentives to invest in bio-fuels projects.

What is needed are investors willing to commit to such projects over a time horizon that will be long enough for the market for the bio-fuels to be produced to develop and be sustained.

A Recent Case That Succeeded

A recent example of such a strategy that appears to be working is the Red Rock Aviation Biofuels Project that appeared in the March 3, 2015 issue in Biofuels Digest. Red Rock was founded in 2011, when 10 former employees of Pacific Ethanol with extensive technical and business backgrounds in oil refining and in biofuels, formed Red Rock Biofuels, a company that had plans to design, construct, commission and performance test a biorefinery with the capability of converting 140,0000 dry tons of wood waste, forest thinnings and other woody biomass into 12 million gallons of bio-jet fuel.

They enlisted the support of Fluor, a refinery construction and engineering firm to advise them as to how best to integrate a woody biomass gasifier to be provided by TCG Global with a micro-channel Fischer-Tropsch reactor to be licensed from Velosys and hydro processing technology designed by Haldor Topsoe. They then made a grant application to the USDA, US DoE and the US Navy and were awarded a $70 million Defense Production Act (DPA) Title III grant, to commence construction of a $200 million biorefinery designed to produce military jet fuel.

Red Rock entered into provisional agreements to secure a supply of wood waste at indexed prices that assure price stability. And having assembled a top set of technology providers and EPC contractors they were then able to meet Flagship Ventures criteria for investing in biofuels start-ups. Flagship Ventures then agreed to provide seed capital and commit additional equity financing that would be needed at varying stages of construction. Flagship Ventures also agreed to be the Project Sponsor and accept responsibility for finding the debt financing that could amount to ~$103 million.

The key to this financing was Red Rock’s success in overcoming its “Chicken ‘n Egg Conundrum” first, by obtaining commitments from the US Navy as off-taker, second, by obtaining the $70 million DPA Title III grant as contributed equity, and third, by getting Flagship Ventures to be Project Sponsor. These circumstances mitigated project risk, making it easy to proceed using a “build it and they will come” strategy. And there are no longer chicken ‘n egg issues as all parties have committed to play their role.

How The Project Could Find A Project Sponsor

As previously explained, at this point in time the Parties ‘n Interest to The Project are either playing Chicken ‘n Egg games or are just plain “Chickens.” as they are waiting for further progress before making hard commitments. In addition. The Client has not agreed to anything tangible and the project remains unfunded and without a sponsor.

Under the assumption that a Project Sponsor cannot easily be found any time soon, in order to break this Chicken ’n Egg conundrum, The Client is being asked use its influence with The County for them to become the interim project sponsor. The County is also being asked to set up a subsidiary similar to the Local Solid Waste Authority (SWA) so that this Authority can become an operating entity financed by public and private investment that can be self-sustaining. Sources of funding of this waste-to-bio-fuel “authority” would be varied, making use of a combination of grants, government backed bonds and private securitization vehicles.

Based on the Red Rock experience it is envisioned that seed financing could be obtained using Federal Grants, matching State funding and limited amount raised from local private sector donors. As a Public-Private Partnership the major capital expenditures could probably be financed using Government backed bonds, and from privately sourced securitized debt. Equity needs could come from specialty private equity funds, similar to Flagship Ventures, from capital lease arrangements, and from stock paid for by in-kind contributions provided by affinity investors.

Development of the plant could take place in stages, to allow financing to be arranged in stages. Initially, a small gasifier could be installed to make syngas out of low cost RDF supplied by the local SWA. And the syngas could then be supplied to the local utility for use in generating power, that could then be sold back to local users.

Additional gasification capacity could then be added and used to gasify modest amounts of forestry wastes after wood waste pre-processing capacity is installed. Once the quantity of syngas produced increases to an amount needed to support its liquefaction, and a local market for LNG identified, a small liquefaction process could then be installed, even if it is not operated at full capacity.

And as the expected demand for LNG materializes, the full build-out could take place and additional investors can then be brought in to take out some of the County’s financial obligations, with excess capitalization being returned to the county taxpayers. Over time, this facility could be privatized or it could operate as a stand-alone economic entity producing ongoing positive cash flows for County taxpayers.

So much for Chickens, eggs and conundrums!

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