Owners of landfill gas-to-energy (LFGTE) projects face market and regulatory drivers that are forcing LFGTE owners to consider new ways to monetize their landfill gas (LFG). This article will discuss alternatives to the electrification of LFG. Included in that discussion will be a consideration of the process for developing non-electric LFG strategies, financing considerations for such deals, and workable deal and financing structures.
For more than 25 years, most LFG deals have been structured in a similar fashion: a landfill owner sold gas rights to a landfill gas project developer/owner who built an LFG-fired power plant from which the developer sold energy, capacity, and RECs to a local utility or other buyer, or into the merchant market. The developer might also have monetized tax credits through the sale of equity interests in the project owner. Based on the stream of income from contracted sales, the LFGTE owner financed the project with tax exempt or taxable debt, including vendor financing. Key to the economics of this traditional model for LFGTE projects was a reasonably high price for electricity and a distinct cost advantage of LFG over delivered natural gas particularly when environmental and tax attributes were taken into consideration.
The economic and regulatory underpinnings for that traditional LFGTE model are now eroding. Fracking and horizontal drilling have dramatically increased US gas production. As a result, the price of natural gas has fallen from a high of $12.41 per thousand cubic feet in June 2008, to $3.71 per thousand cubic feet in March 2015
(US EIA). The growing regulation of coal and the falling price of natural gas have driven utilities to shut coal plants or convert them to natural gas. Electricity prices have become increasingly tied to the price of natural gas. And as the price of natural gas has fallen, so has the price of electricity. Growth in energy efficiency and sluggish economic and population growth have reduced electricity demand in some places and slowed its growth almost everywhere else. Prices for both electric energy and capacity have fallen in response to these market forces. REC pricing, on the other hand, has dropped from over $5 per REC, to below $1 per REC
(US DOE). To be eligible for the production tax credit under Section 45 of the Internal Revenue Code of 1986, as amended, construction on a LFGTE electricity projects must have begun prior to January 1, 2015.
While the economics of the traditional project model have been eroding, other forces have created attractive alternatives to this model. The falling price of natural gas has encouraged the conversion of municipal and commercial car and truck fleets from gasoline to natural gas. The anticipated rising value and increased liquidity of RINs and, in California, credits associated with the low carbon fuel standard (LCFS) have provided a new source of potential revenue for LFGTE owners. New state and local efforts to divert foodstuffs and other green materials from landfills have produced a viable feedstock stream for gas-producing digester projects and threaten the gas production yields for existing landfills.
LFG owners and developers who are seeking alternatives to LFG-to-electricity projects should consider taking advantage of these new market and regulatory advantages. High BTU projects (LFG-to-pipeline gas), compressed natural gas (CNG) and LFG-to-liquids are the alternative project types that have seen the most activity.
The financing considerations for these alternatives to LFGTE projects (“LFGA”) are similar to the financing considerations for LFGTE projects. A common dilemma for many LFGTE projects is that the project to be financed is too small to efficiently bear the transaction and deal costs of a traditional project financing, yet too large to be built completely from developer equity. Many LFGA projects will face this same dilemma. As discussed in more detail below, the availability of state and federal financing programs, and tax-exempt financing, may be ways to address this issue, at least in part.
Corporate guarantees and financing a transaction with a low loan-to-value ratio may also be viable workarounds. But the problem is likely to be a persistent and difficult one for LFGA projects that cost between, say, $10 million and $40 million. In addition, where an LFGTE project is being converted to an LFGA project, owners will need to consider whether an existing loan on the project either prohibits the conversion (or any construction-related shut down of operations) or will otherwise need to be refinanced in connection with the conversion.
In any case, but particularly where the project is the principle security for the loan, the first consideration is to make sure that the project contracts are structured in a way that is suitable for financing your need. For project loans, the borrower will need to have control of the project site and easements and other access rights necessary to construct and operate the project for a period of time, at least long enough to fully amortize the loan and, in any case, several years longer than the maturity date of the loan. The borrower will need clear rights to use the technology employed in the project under the terms of suitable license agreements (which may be contained in the EPC contract or otherwise). All discretionary permits will need to be in place or clearly obtainable as typically verified by an independent engineer or insurance consultant. The gas rights agreement will need to clearly delineate the developer’s rights to gas from the landfill or other source. Gross royalties may be payable to the landfill owner ahead of debt service, but royalty payments must be sized to work within the required debt service coverage ratios of the financing. To the extent that gas studies of the landfill resource depend on the borrower’s rights to use gas from expansion areas of the landfill in order to supply the LFGA project for the life of the loan, the gas rights agreement must clearly grant use rights in those expansion areas.