As project developers evaluate the impact of incentives on the proposed project, it is important to understand the net value of incentives and the benchmarks that must be met to qualify for specific incentives.
Value of Incentives:
Ethanol incentives have historically been of two types:
The most valuable ethanol incentives are generally production credits or payments. Such incentives have periodically been available from the federal government. Several states also provide some form of ethanol production incentive. Ethanol project developers should review applicable federal, state and local business incentives that may have an economic impact on the project. Such incentives may also be a consideration during the site selection process. Project developers can often obtain detailed information about general business incentives from state and local economic development authorities. These same sources should be aware of incentives that may be applicable to the production of ethanol specifically or to biomass derived products generally. Project developers should develop a value estimate of incentives that may be available to the facility.
An Overview of Incentive Programs
Tax incentives can play an important role in the profitability of ethanol plants and other biofuel projects. Project financiers will also expect an analysis of incentives for which a proposed facility may be eligible.
Following is a general overview of incentives that may be available to an ethanol plant depending on eligibility requirements of the various programs.
Various federal incentive programs have been designed to meet the primary objectives noted above: to encourage the production and utilization of ethanol and other biofuels.
Additional factors including the implementation of a national Renewable Fuel Standard in 2006 serve as an effective catalyst for increased biofuel production and use. For the purposes of a project impact analysis, only those incentives applicable to the proposed project should be considered.
Federal incentives that may be applicable to an ethanol project include the following:
1. Excise Tax Incentives
Since 1979, the federal government has provided various levels of exemption from federal motor fuel excise taxes for qualified alcohol fuels (specifically those not derived from petroleum, natural gas, coal, or peat). Most ethanol sold in the United States incorporates the federal excise tax incentive (VEETC) as opposed to another mechanism designed to encourage ethanol use, the income tax credit for alcohol fuels.
2. Income Tax Credit for Alcohol Fuels
Like the federal excise tax noted above, the federal income tax credit for blenders of gasoline and ethanol is currently in the law until 2010. The incentive is presently fifty one cents per gallon. While the credit can be carried forward, it is non-refundable and nontransferable. Therefore, it is of little value to entities that have no federal income tax liability.
3. Ethanol Production Incentive
Incentives discussed above have focused on mechanisms intended to increase the use of ethanol fuels.
These incentives may be of limited value to new ethanol projects.
However, various incentives have been crafted to encourage development of production facilities.
During the past fifteen years a variety of incentives have been available through federal government programs.
These incentive programs are summarized below.
Income Tax Credit
The income tax credit discussed above has generally been considered as an incentive to increase ethanol use. This perception is based on the fact that the application of this incentive is tied to the blending of all components of the finished fuel, i.e., ethanol and gasoline. Although seldom applied as a production incentive, this credit may be narrowly viewed as an incentive for ethanol production.
Income Tax Credit for Small Ethanol Producers
Effective January 1, 1991, certain small fuel ethanol producers are eligible to receive an income tax credit of ten cents for each gallon of qualified (denatured) ethanol fuel produced. The provision limits the qualified ethanol fuel production of any producer for any taxable year to no more than 15 million gallons per year produced at a facility whose total production capacity does not exceed 60 million gallons per year. The tax credit is included in income and is therefore taxable, is nonrefundable and nontransferable, but can be carried forward into future taxable years.
Loans and Loan Guarantee Programs
Fifteen years ago Congress authorized a series of programs to encourage development of alternative energy enterprises in the U.S. Among the primary incentives available through these programs were loans and loan guarantees.
The Departments of Energy and Agriculture have administered loan and loan guarantee programs for which ethanol projects were eligible. Under the programs, qualified applicants were eligible for loans or loan guarantees that provided direct financing or guaranteed loans for capital construction. Funding and authorization for the ethanol related provisions of these programs are extremely limited under Department of Energy programs today but USDA programs authorized under the 2002 Farm Bill include several applicable programs.
Grant Programs
In past years the Departments of Energy and Agriculture have administered grant programs for which ethanol projects have been eligible. In most cases the grants have been for projects that met specific criteria. However, the availability of grants can often provide leverage for project financing. Because grants are, in effect, a gift, they do not dilute equity or encumber a project with additional debt. The DOE and USDA both administer programs for which plants meeting specific criteria may qualify.
Cooperative Financing
The federal Bank of Cooperatives has been an important source of financing for many ethanol projects built in the Midwest. Ethanol ventures that are structured as cooperatives are eligible for project financing. The Bank of Cooperatives has been active in direct loan and loan guarantee programs during the past decade. The Bank remains an active participant in ethanol ventures today. This source of debt financing is often more accessible to new ethanol ventures than conventional lenders.
Feedstock Incentives On many occasions the federal government has provided commodities to meet specific needs or policy objectives. This mechanism has also been used as a production incentive for ethanol. The Commodity Credit Corporation has provided corn and other commodities to ethanol producers as a production inducement and an inventory control measure. While this mechanism has been used only on a limited basis, it serves as an example of an incentive that can stimulate ethanol production. At present, a federal biofuels production incentive is available for new or expanded ethanol production.
Other Federal Incentives
The primary challenge of encouraging investment in new ethanol production facilities is to create an environment that mitigates risk. Many of the federal incentives are designed to reduce risk in different ways. The value of incentives is often dependent on specific projects. For example, some start-up projects may find incentives most useful if they help attract capital. Companies that are capable of financing projects internally may find market-based incentives like contract preferences to be more valuable. Some incentives are designed to provide a supplement to costs that are typically applicable to all projects. Infrastructure grants and job training grants are examples of these incentives. While these grants may be administered by state agencies, the federal government provides the funding for these programs. Infrastructure incentives simply decrease total project cost to the developer if such costs are borne by other entities. Job training grants typically offset the cost of training new employees for operations at the ethanol facility. Since the skills required might not be generally available in a local labor pool, training costs can be expensive. Job training grants offset the direct cost to the project developer, thereby making funds otherwise spent on this activity available for other project needs.
Like the federal government, many states have elected to encourage ethanol use through a variety of incentive mechanisms. Most incentives have been in the form of excise tax reductions in the state fuel tax rate. States have adopted this form of incentive to encourage ethanol use. These incentives are generally adopted to support existing ethanol production and are seldom effective in stimulating new production. Many states have also adopted innovative mechanisms to stimulate the production of ethanol fuels. The specific components of incentive programs vary from state to state as a result of differing public policy objectives and state constitutional provisions. The following sections of this report examine different incentives used by various states to encourage ethanol development.
Oxygen Standard
Similar to the federal oxygenate program, a related state incentive program is the so-called Minnesota Model. This program established a statewide oxygen standard in Minnesota that is most economically met by using ethanol. The program is in effect year around and the market stability generated by the program has helped to significantly increase ethanol production in Minnesota since implementation of the program in 1998. A similar law designed to encourage the use of biodiesel has been effective in expanding the production and use of biodiesel statewide in Minnesota.
Fuel Tax Incentives
As noted above, fuel tax incentives are frequently adopted as a means of encouraging ethanol use. State legislatures have adopted a variety of at-the-pump incentives to stimulate ethanol use. Depending on the fuel tax structure of a specific state, the incentive may be in the form of an excise tax reduction or fuel tax credit. All such mechanisms are intended to provide an incentive that encourages ethanol use.
As noted previously, these incentives are seldom an effective means of stimulating ethanol production but may help to stimulate ethanol demand in local markets.
Targeted State Incentives
Several states have recognized the need to focus incentives to meet specific needs of ethanol project developers. During the past decade, the states have enacted a variety of laws that provide incentives designed to stimulate ethanol production. In several cases, the specific form of incentive is based on local considerations. Targeted incentives specifically designed to attract ethanol production facilities have been very successful in some states. Following is a summary of incentives specifically intended to attract ethanol production facilities to states.
1. Ethanol Production Payments and Credits
During the past decade several states have aggressively targeted development of ethanol plants through production payments or credits. These targeted recruitment efforts have generally been an effective means of attracting companies to a specific state. In some instances, the production incentive has been a deciding factor in the sitting of plants. States have provided production incentives directly, through a payment from the state to the ethanol producer, or indirectly, through a credit mechanism that can be sold for cash. Production incentives are typically performance-based incentives requiring an ethanol producer to manufacture specified quantities of ethanol in order to earn the incentive.
2. Loan and Loan Guarantee Programs
Like the federal loan programs described earlier, several states have adopted loan and loan guarantee programs to provide a source of funding for ethanol and other alternative fuel projects. Often times these programs are designed to serve as a sort of lender of last resort. As a result, projects perceived to be high risk proposals are often the participants in these programs. The challenge of these programs is to balance sound lending practices with the fact that some projects may, in fact, be high-risk ventures
Risk may be attributable to uncertain feedstock availability or price, untested technology, inexperienced management or other factors. Coupled with the risk assessment factors is the need by project developers for favorable loan terms. Conventional lenders end to impose extremely difficult terms on high-risk ventures if they participate. Such terms are obviously contrary to the needs of the project. Loan and loan guarantee programs, to be effective, must recognize these challenges at the outset. One variation of these programs is the so-called forgivable loan, which is, in effect, a grant to the project in the event of project failure. This feature is attractive to project developers and can be designed with more stringent eligibility criteria to help improve the aspects of a successful venture.
Ethanol Tax Credits
Several states have used tax credits as a mechanism to attract ethanol production. State credit programs are designed in much the same manner as the federal credits described earlier. Tax credit programs can also be viewed as performance incentives since they require specific objectives to be met before incentives can be collected. This mechanism can be effective, especially as a means of inducing expanded production at existing facilities. However, the tax credits are useful only to the extent they offset tax viability that otherwise must be paid. Start-up ventures often have little tax liability in the early years of operation. Therefore the value of these incentives may be less than anticipated.
Other Tax Credit Incentives
Tax credits are a common incentive in state business recruitment programs. Tax credits can be targeted to specifically apply to activities related to ethanol production, or they can be designed to encourage specific aspects of ethanol production. For example, California officials are in the process of examining credits that may effectively stimulate ethanol production from biomass and waste materials. Credits can be designed to specifically encourage this type of investment. Plant size may be another factor. The federal Small Producer Tax Credit, discussed earlier, is an example of a preferential tax credit specifically designed to encourage investment in small ethanol plants.
Other tax credits may be based on employment or capital investment criteria that are pertinent to ethanol production facilities.
Equity Investment Programs
Several states have offered targeted equity investment programs specifically designed to provide capital financing for ethanol projects. These programs provide the means for a state to take an active role in the development of targeted projects. Equity investment provides risk sharing by the state and reduces the debt load of start-up projects, thereby making them more attractive to potential lenders.
Bond Programs
Some states and political subdivisions have authority to issue bonds used to finance capital construction projects. This mechanism can be targeted to give preference to ethanol or other alternative fuel projects. This approach has been used for ethanol projects in the past and ventures meeting specified investment criteria may seek project development funds from such a source, especially if preferential provisions are extended to ethanol projects.
Tax Abatement and Tax Increment Financing
Tax abatement programs are a tool routinely used by states in business recruitment programs. While this is not an effective primary incentive, it can function as a useful supplement to encourage investment. This type of incentive may have applicability to plants in many states, especially where state tax law is designed to encourage the location of processing facilities in underdeveloped areas. Such incentives, including tax increment financing programs, typically help attract financing to a project by improving overall economics of the venture.
Other Production Incentives
States use a variety of incentive packages to attract processing facilities to their respective states.
Many of these conventional incentives can be adapted to ethanol projects. These preferential incentives are typically tied to a specific public policy objective. For example, Iowa designed a program specifically intended to spur investment in value-added processing facilities located in rural areas of the state. Incentives tied to such criteria have been successful in stimulating investment in ethanol related projects. Feedstock cost rebates are another mechanism that can be used to encourage ethanol production. Feedstock costs are a significant portion of the operating cost of ethanol plants. Feedstock rebates may be used to offset the cost of specifically targeted materials. This approach provides more stability to projected economics of a project and may help mitigate risk for potential lenders or investors. Guaranteed purchase contracts are another form of incentive that can lend stability to the economics of a start-up venture.
Local Incentives
Local incentives are typically in the form of site concessions that may include cost underwriting or similar concessions to make a specific location more attractive. Other mechanisms are tax increment financing, assumption of infrastructure costs, tax abatement, financing via a local bond authority, or other mechanisms that make one site more attractive than a competing site. The competitive nature of industrial recruitment generally fosters an environment in which the developer of a project can negotiate a variety of concessions that make the project more economically attractive to lenders and investors. These factors should be recognized and quantified when specific sites are considered. Project analysts should also review existing incentives for projects constructed in specified areas of the state. These incentives should be quantified to determine value within the context of the total project cost.
A wide variety of factors affect the economics of ethanol production. These factors include feedstock and energy costs, capital and debt financing costs, the value of products produced and plant design and efficiency. A host of other factors will also affect production costs and profitability. Many of these factors have been discussed and additional factors should be quantified during the site specific feasibility study.
These value factors will be essential to the financial pro forma and sensitivity analyses conducted during a detailed project evaluation.
Value assumptions typically include input from the project development team as well as consultants and other advisers on the project. A sensitivity analysis will provide an indication of value ranges for input factors used in the financial pro forma. Many of the input factors represent potential risk. For example, a rapid increase in feedstock or energy costs that may occur concurrently with a strong downward trend in ethanol prices will considerably change the financial outlook for the project. Risk management practices can often mitigate risk and help to insulate the projects exposure to rapid swings in cost and price scenarios. Risk mitigation strategies are essential to the long term viability of most ethanol projects. Project developers should evaluate risk management strategies and consider the impact of these strategies during the financial analysis of the project.
Any person contemplating an investment in an ethanol plant should evaluate a variety of criteria to determine suitability of the investment under consideration. Agribusiness lenders with Farm Credit Services of America offer the following tips for evaluating investment in an ethanol plant:
Sensitivity Analysis
A sensitivity analysis conducted as part of the financial evaluation of project economics will help determine economic viability of the proposed plant. This process will also help identify variable costs that will have the most profound impact on project economics.
The economic analysis should incorporate a variety of factors. These include:
As the project development team continues to assess the prospects for developing an ethanol production facility they should consider the type of business entity that is most practical. The team should consider a range of options and factors that include:
As the project development team considers formation of the business entity, the group should evaluate these and other factors that may affect development of the project, eligibility for financing through various sources, or tax eligibility implications. The project development team may wish to engage financial advisers and legal counsel to assist in evaluating the most beneficial business entity for the specific venture. The planning committee may wish to consider forming an originating board of directors that is capable of designing and defining a comprehensive plan for forming the business entity. With assistance from legal counsel, the project development team or originating board of directors should also consider and understand the requirements of applicable governance concepts and legal documents including:
As the project development team or organizing board considers the needs of the venture and evaluates business entity options with the aid of legal and financial counsel, the group should determine the best form of governance for the specific project. Regional differences may have an impact on this decision. Excerpts from: A Guide for Evaluating the Requirements of Ethanol PlantsDeveloped by: The Clean Fuels Development Coalition and The Nebraska Ethanol Board in Cooperation with The U.S. Department of Agriculture.
Let us maximize your yield and profit!
For our optimization assessment, please contact us at: service@infosecpro.com or call: 732-763-2814