Fuel risk often hampers US biomass developers. Yet instead of switching sectors, some of them have now decided to shift their business upstream. Sponsors of the few biomass projects in North America have been able to limit the risks from variable fuel costs by insisting that these costs are passed through in power purchase agreements. “The biggest risk is the fuel supply,” says Rahul Culas, co-head of the Carlyle Group’s energy mezzanine opportunities group. “A pass-through contract is the golden ticket.” A senior banker in New York adds: “You could come to me with a rock-solid 20-year PPA with Southern California Edison, and I’ll immediately respond: ‘Do you have a fuel pass-through contract?’”

The original developers of the 37.5MW Plainfield biomass project in Connecticut did not have one. A new set of sponsors was able, improbably, to get close to closing a commercial debt financing in mid-2011 despite the absence of the fuel pass-through. Then, thanks to the eurozone crisis, European lenders’ cost of capital climbed again, prompting them to rid themselves of trickier deals, including Plainfield. So the new sponsors of Plainfield, led by Enova Energy Group, settled for a costlier mezzanine debt package from Carlyle, which closed in late 2011.

Only one biomass generation project has been financed in the US since – and none in Canada.

Putting out pellets

This dealflow might suggest that the biomass sector in North America is close to extinction, but at least two biomass generation projects in North America are likely to reach financial close in 2013. And several fuel processing plants that will produce wood pellets are in development in the US, particularly in its south-eastern states.

The processed fuel would principally be used in Europe, particularly in the UK, as well as in Belgium and the Netherlands. These US suppliers would sell this fuel to European generators and utilities for use in (probably repowered) coal-fired or cogeneration facilities.

Ambitious European carbon dioxide reduction targets, and the shift away from coal, gas and nuclear are the biggest drivers of the fuel manufacturing push in the US south-east. The UK renewable obligation certificates (ROCs) regime includes incentives for biomass generators.

“The economics of this UK-US arrangement theoretically work because of the subsidies,” says an energy investment banker in New York.

Alternatives to repowerings of existing coal-fired projects exist, but they are typically costlier. “Utilities in the UK don’t want to assume the capital costs of replacing coal,” says a US-based developer who closely monitors European utilities. “Biomass run through an existing generator is cheaper compared to building an entirely new offshore wind farm. Nuclear is tough politically, especially after the Fukashima disaster in Japan. Nuclear plants are expensive, require complicated permitting and take 5-7 years to build. They’re very capital intensive and you need to deal with the waste.”

US-based producers are betting that Europe lacks sufficient wood supply to satisfy generators’ appetite for at least 30 million metric tonnes of wood pellets per year until 2020. “We have the supply chain set up, we have the sustainable forests to source the fibre from,” says Seth Ginther, executive director of the US Industrial Pellet Association in Richmond, Virginia. “We have management teams out there executing these long-term offtake agreements.”

The pipeline

European utilities are moving upstream. Georgia Biomass, a subsidiary of Germany’s RWE, opened the world’s largest wood fuel pellet plant in Waycross, Georgia, which has a capacity of 750,000 metric tonnes per year.

But US developers are also active. In February 2012, Enviva, a Maryland-based manufacturer of processed biomass fuel, signed a multi-year agreement with E.ON to supply the European utility with 240,000 metric tonnes per year of wood pellets from its facilities in the south-eastern US. Enviva, backed by private equity firm Riverstone Holdings, expects to reach an annual capacity of 1.72 million tonnes at its plants by the end of this year.

Enova is also moving upstream, deciding to draw on what it had learned about fuel supply from Plainfield, as well as the expertise of its shareholders, which include large timber landowners in Georgia. Enova has formed a new subsidiary Enova Wood Pellet Group. It is developing two projects for Georgia, and another in South Carolina. Enova plans to sell the pellets to private and public utilities in Europe. Other biofuel manufacturers operators in the south-eastern US include FRAM Renewable Fuels, Green Circle Bio Energy, Westervelt and German Pellets.

“In the south-eastern US, you have positive regulation and the infrastructure is all there,” says the New York-based investment banker. “So a lot of companies are looking at manufacturing pellets. The question is: can they build a sustainable business or are these mostly one-off facilities.” Biofuel offtake agreements typically span two to 15 years, and some traders are prepared to stand between producers and utilities.

Biofuels new to credit markets

As an early borrower in an evolving market, Enviva’s financing push in 2012 was bumpy. It had sought a $120 million term loan B and a $70 million delayed-draw facility, each with five-year tenors, plus a four-year $25 million revolver, says a market observer. To attract investors, it offered a margin of 425bp over Libor, upfront fees of 200bp and an original issue discount of 2% Enviva also lined up contracts for 87% of its plants’ capacities, though the terms of these contracts may not have been completely lender-friendly.

In November 2012 Enviva closed a $120 million senior secured credit facility, the company’s first corporate borrowing. Barclays, Goldman Sachs, Royal Bank of Canada and Citigroup were joint lead arrangers and joint bookrunners on the debt, which is intended to complete construction on two 500,000 metric tonnes per year pellet mills, in Virginia and North Carolina, and to expand storage capacity at Enviva’s deep-water terminal in Chesapeake, Virginia to 100,000 metric tonnes.

But biomass fuel producers, like biomass generators, have not managed to fully shake off the burden of variable input costs. Wood pellet manufacturers that lack fuel pass-through contracts will not have hassle-free financings. With a strong offtake agreement and a wrapped engineering, procurement and construction with a respected player – like in Plainfield’s case – sponsors can negotiate around the fuel risk.

“Project credit quality improves if feedstock supply is based on a robust, long-term contractual commitment with an investment grade counterparty and no ability to renegotiate or otherwise frustrate a project with technical outs, absent some form of significant reserve or compensation mechanism,” says Bruce Ells, senior vice-president at DBRS in Toronto.

Some third-generation pellet contracts with European utilities will be embedded with collaring mechanisms to share the economic costs of fibre, diesel and transportation, to provide for some risk sharing, notes Andrew Rosenbaum, director at RBC Capital Markets in New York. And bankers are hopeful that some large timber companies will offer longer-term agreements to mitigate the impact of variability in the fibre market.

Still, few creditworthy fuel suppliers have shown interest in locking in volumes or prices beyond 10 years, lenders say. “Biomass has fragmented fuel suppliers,” Culas explains. “It’s a subsidised technology with a variable fuel supply.”

Generation’s journey

Since 2010, five utility-scale biomass generation projects have closed debt financings in the US. Just one, a $394 million financing for American Renewables’ $500 million 100MW project in Gainesville, Florida, would be considered a classic project financing, judging by lenders’ initial reception to the deal and the eventual pool of participating banks. Bank of Tokyo-Mitsubishi UFJ, Crédit Agricole, ING, Natixis, Rabobank and Société Générale were the lead arrangers on the deal, which closed in June 2011.

A $133 million financing for Atlantic Power’s 53.3MW Piedmont biomass project, located in Barnesville, Florida, ultimately resembled a traditional bank deal. But its path to financial close says otherwise. The original developer, Rollcast Energy, struggled to put together a bank group beyond Mitsubishi UFJ Financial Group. Natixis was expected to participate, until senior bank executives initiated a strategic review of all fuels except wind and solar, a freeze that lasted until Gainesville in 2012. Société Générale was also rumoured to be attached to the deal, but was not among the banks in the final club. Finally, Investec and DZ Bank filled the lender holes to enable Atlantic to close in October 2010.

Eleven months later, Prudential and two other insurance companies participated in a $200 million private placement for Cate Street Capital and Starwood Energy’s 66MW Burgess BioPower, located in Berlin, New Hampshire; Key Bank was the placement agent on the bonds, which closed almost three years after developer Laidlaw Energy Group originally announced a debt deal. But that 2008 deal collapsed amid permitting issues, legal challenges and rising costs, prompting a restructuring in early 2011.

Then there are the two most recent project financings, for Plainfield and Green Energy Team’s $73 million 7.5MW biomass project near Koloa, Hawaii. Deutsche Bank led a construction loan for Koloa, which the US Department of Agriculture’s Rural Utilities Service – not a regular project finance lender – will refinance at completion with a 20-year loan. WestLB was the initial lender on Koloa, but couldn’t close by 30 June 2012, the last day before it transformed into portfolio management company Portigon.

Not mainstream

And Plainfield, despite its struggles in the bank market, still had an intrinsic advantage over subsequent biomass generation projects in the US, because it could qualify for the US Department of Treasury’s cash grant, equivalent to 30% of the project’s cash costs. Most of the biomass projects in development will no longer qualify.

“Traditional commercial banks would rather focus their time and energy on more mainstream projects,” says Ralph Cho, most recently of WestLB in New York, referring to the challenge of addressing feedstock supply. “Unless the sponsor can come up with a creative solution around this problem or negotiate into the PPA the shifting of this risk to the counterparty, I would imagine this asset class remains a niche play.”

Project lenders seeking higher yields are most likely to contemplate biomass. Indeed, biomass deals have higher pricing than gas-fired, solar and wind deals. Gainesville priced at an initial margin of 275bp over Libor, about 50bp over the market floor, though still competitive against other fuels. Piedmont priced at 350bp over Libor, while Koloa is said to have a margin north of 300bp. “Biomass typically isn’t a Libor plus 300bp deal,” Culas suggests.

Only one of these financings was a bond deal. DBRS, for instance, has reviewed some preliminary inquiries from sponsors, but as of January 2013, there have been no rated bond deals for biomass or fuel projects in Canada.

This wave is different

Ginther, however, distinguishes between US biomass projects and fuel manufacturing plants for UK generators. Europe, he notes, boasts strong climate change policies, whereas the US has a “fragmented biomass policy based on different states’ renewable energy portfolio standards.”

“From a project finance standpoint, you’re getting to the point where wood pellets are becoming commoditised,” Ginther says. “Supply chains are being institutionalised. Existing players are performing. You’re going to see a lot of interest from the project finance community.” Agricultural banks and long-standing timber investors, such as Hancock Timber Resource Group, could be potential players, notes the New York-based investment banker.

Enova is aiming to launch a debt financing in the first quarter of 2013 for its three maiden manufacturing projects in the south-eastern US. The three projects are expected to cost about $330 million all together. Enova plans to meet 80% of their costs with debt, potentially using a structure featuring A and B tranches, or a private placement.

Enova will come to market with stable-priced, investment-grade feedstock contracts of longer than 10 years for all three plants. It is in discussions with European-based utilities about signing contracts with fuel pass-throughs.

Leading the fuel to market

It is no coincidence that Enova, Georgia Biomass, Enviva and their peers have concentrated on the south-eastern US. The region boasts ready timber and short growth cycles. “I believe the cheapest source of wood is in the south-eastern US,” says Zach Steele, Enova’s chief executive officer.

Contracts with buyers of wood pellets can be structured to ease lender concerns about the impact of transportation costs, Ginther says. Manufacturers can enter into free-on-board (FOB) contracts that pass transportation risk to utilities, meaning they pay once the fuel reaches the side of the ship. “There are plenty of utilities out there that will sign FOB contracts,” he notes. Enova’s projects, for instance, have FOB contracts.

Transportation is a particular concern for biomass generators in the US and Canada. “Project financiers will have to get comfortable that the project can demonstrate it has stable access to fuel,” says Cho, noting that biomass projects are highly sensitive to diesel prices. “Sensitivities will be run analysing supply of fuel within a 100-mile radius.” In their analysis of biomass projects, bankers must decide whether there is sufficient fuel should a competing project sprout nearby, and that it does not suffer a significant fluctuation in price.

Closing the loop

In the pellet space, notes RBC’s Rosenbaum, owners and developers are also exploring the ability to option land for future development by paying in advance, through a structure that can support a project financing.

Green Energy Team, the sponsor of the most recently closed project financing in North America, is building a closed-loop biomass project. Standardkessel Baumgarte Contracting, a shareholder in Green Energy, is designing the project, which will burn woodchips from trees grown and harvested on the Hawaiian island of Kauai. The arrangement resembles those in Brazil, where sugar cane growers develop biomass projects that run on bagasse, the waste from turning cane into sugar or ethanol. Such a set-up assuages lenders’ concerns about the availability of, and transportation infrastructure for, fuel.

A Florida-based sponsor, Green Valley Energy, is attempting a similar strategy for its $100 million 35MW project in Santa Barbara, Honduras. The project will be located on a 5,500-acre plantation and use king grass, which will be grown on-site, as fuel. Green Valley is seeking an offtake contract with Empresa Nacional de Energia Electrica to complement a power purchase agreement with local textile producer Grupo Karim.

Fengate Capital Management, a Toronto-based investment manager, and Dalkia expect to finance two C$175 million 33MW biomass generation projects in British Columbia this year. The fuel for the projects, Fort St. James and Merritt, will be sourced locally.

“They’re located in the timber resource basket of Canada, near large saw mills,” says George Theodoropoulos, senior vice-president at Fengate in Toronto. “A lot of wood comes from that fibre resource – and we can harvest the fibre ourselves.” Neither project benefits from a fuel pass-through contract, however, but the provincial government has agreed to tariffs that include partial indexations to inflation. And Dalkia has committed to providing fuel to the plant under an electricity price agreement with utility BC Hydro.

Plainfield may lack a fuel pass-through agreement or the ability to harvest its own fibre, but it has something of a monopoly in Connecticut. Its power purchase agreement with Connecticut Light & Power was approved before the state removed biomass as a qualifying fuel for its renewables portfolio standard, which has served to discourage would-be competitors to Plainfield.

Plainfield’s market is roughly three times oversupplied, enabling it to offer attractive prices to waste wood suppliers.