I N C E N T I V E S :

  1. Federal Incentives

  2. State Incentives

  3. Economics of Production

  4. Sensitivity Analysis

  5. Formation of Business Entity

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.

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 siting 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.

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.

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