Caution to the wind

Two lessons are emerging from a recently ended US loan guarantee programme for renewable energy projects. The first lesson is straightforward. The second is more subtle – and it has implications for future US government infrastructure and PPP financing programmes.

Part of the US stimulus legislation enacted in 2009, Section 1705, temporarily expanded the scope of the US Department of Energy’s (DOE) Loan Guarantee Programme to include renewable energy projects using commercial technologies. Section 1705 also dramatically expanded the scale of the programme. Through the expiration date of September 30, 2011, the DOE completed 28 transactions with total loan guarantee exposure volume of $16.1bn – comparable in size to established financing government programmes like TIFIA or the European Investment Bank’s PPP loan portfolio.

The first lesson from the Section 1705 portfolio is an obvious one: don’t do dumb deals. Readers in the US (and many in the UK) will likely have heard of Solyndra, a solar panel manufacturer that received a $535m loan guarantee – and went spectacularly bust less than two years later. As details emerge, the picture is not pretty. According to news reports, there was abundant evidence that the company’s business plan was fatally flawed, which the DOE apparently ignored due to incompetence, political pressure, or some combination of both.

Unsurprisingly, opposition politicians and their aligned media commentators have seized on Solyndra as an example of all that is wrong with economic stimulus policies, the Obama administration, green policies and government in general.

Much of the current firestorm of publicity seeks to characterise the DOE’s Section 1705 portfolio as filled with Solyndras. But in fact the portfolio is predominantly exposed to relatively low-risk project finance loans. Almost 90% of the deal volume involves power generation infrastructure projects that use commercial or near-commercial wind and solar technology and whose output is sold under long-term contracts to regulated utilities.

What’s more, over one-third of these project finance deals were done through a sub-section of 1705, the Financial Institution Partnership Programme (FIPP). This used a financial public-private partnership approach wherein the DOE acted like a large participant in a syndicated project finance bank loan, taking up to 80% of the risk.

At least 20% of the loan remained unguaranteed and was held by qualified private-sector lead banks and other financial institutions, which ensured that a FIPP project was commercially financeable and its debt structured on market terms.

But unfortunately these facts about the Section 1705 portfolio only seem to redirect, not defuse, criticism.

Even before the Solyndra debacle, a large FIPP transaction – the Shepherds Flat Wind Farm – was blasted in a Wall Street Journal editorial as being "too safe". The specific charge was that the DOE’s $1bn loan guarantee was unnecessary, doing nothing more than creating unwarranted windfall profits for the project’s large corporate sponsors.

Now that there is a politically fuelled spotlight on the DOE’s loan guarantee programme, other Section 1705 power generation projects with large corporate or utility sponsors are also attracting negative attention. Critics argue that since the sponsors could have raised all of the financing privately or just written a cheque themselves, the DOE’s loan guarantees were simply egregious corporate welfare.

This criticism is more sophisticated than simply claiming that all Section 1705 deals are worthless mistakes like Solyndras, but it is similarly unfair. Section 1705 was intended to relieve the effect of the credit crisis on the aggregate debt capacity available for renewable energy project finance, and thereby allow more viable projects to proceed than otherwise would have been possible.

In this, the programme doubtless succeeded, even if it is not possible to identify which transactions on the margin would have been slowed or cancelled in the absence of Section 1705. Other policy-oriented benefits include more efficient, larger-scale projects, faster acceptance of new technology and the development of new capital sources.

This is the second lesson from Section 1705: it is not enough to simply avoid losing money. A government-financing programme must clearly demonstrate that the public is getting value for the capital invested, even when such value is not easy to evaluate or explain.

An objective like ‘increasing credit capacity for low-risk power generation infrastructure’ does not make a great soundbite. But since that’s what the Section 1705 programme mostly did, and why its results can be justified, the DOE and the administration should now be relentlessly defending it on this solid basis, not with vague references to ‘green jobs’ or ‘winning a race to innovation’.

A failure to present a convincing argument for the value of Section 1705 loan guarantees for clean energy power generation projects will have an impact on future US government-financing programmes not only for renewable energy, but for other infrastructure and PPP as well. It is already happening.

The Solyndra debacle was repeatedly referenced as an example of ineffective government financing in a recent Congressional hearing on the proposed national infrastructure bank. The negative storyline will only build over time if left uncorrected. It is too late for the DOE to apply the first lesson to the Section 1705, but there is still an opportunity to act on the second.