10.05.09Roger Feldman, Counsel, Andrews Kurth LLP

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It is the 40th anniversary of Woodstock, the Moon Mission, the Miracle Mets, and the Joe Namath Jets. Everything was possible in 1969. It was the year before the business cycle bubble burst for a decade, and energy prices became a national rather than a consumer issue, as a result of the first oil embargo. NEPA and the environmental movement were emerging green glimmers. The "energy crisis" as well as the "global warming crisis" were not on many radars. The impact on America of sustaining the drain of war on an overheated economy was not fully appreciated. Concern with "fuels mix" might have involved a new herb, potion, or cocktail. It was a simpler time.

Since then, the Federal government has striven at various times to solve pending problems in energy areas (as well as elsewhere) through price controls, deregulation, mandatory consumption pattern rules and target quotas, high tech innovation sponsoring agencies, tax credits, loan guarantees, grants, and/or environmental credits of different types.

The debates over these solutions--which implicitly tilt as well to various fuel mix solutions and technological fixes--have been articulated (some would say camouflaged) with several broad, legally related themes:

• Federal Preemption vs. State Rights
• Public Interest/Consumers vs. Private Interest/Producers
• Regulation vs. Deregulation

Through it all there have been two constants: an abundance (ever growing) of lawyers on both sides of the issues, and the dogged pursuit on the part of the investment community of marketable financings based on the regulatory detritus. Out of their joint efforts has emerged what is now a third constant: the increased emphasis on "project finance," which had originally been a natural resource and a real estate financial technique: the leveraging of developer equity investment in projects by borrowing against the promise of production of future revenues derived from offtakes from the projects.

Recognition of the potential of legislation to facilitate "good" (i.e., support of the favored policy of the moment) project financing has itself become a relevant criterion for weighting the merits of legislation, i.e., what will it do to the ability of private parties--whether utilities, independent companies, natural resource producers or sponsoring governments--to raise capital in reliance on the energy markets?

A generation of lawyers has feasted not just on the "policy" arguments which have shaped various pieces of energy legislation, but also has parsed the feasibility of applying it on a case-by-case assessment to the creation of the structured transaction financings. As it were, they have been ironworkers aloft on construction beams, erecting skyscrapers capable of swaying, without breaking, under buffeting winds of market shifts and regulatory change.

Recognized, though not emphasized in policy debate, is that facilitating the competitive advantages of competing fuel sources is what the issue frequently is about, enhancing the economic choice of one fuel over another.

Certainly many of the debates over the regulation and control of environmental impacts also have had a significant component of conflict of fuel selection choices: oil vs. other hydrocarbons, coal vs. nuclear, natural gas vs. coal, renewables vs. hydrocarbons.

These debates have become harsher as costs are de facto legally assigned to the negative "externalities" of different fuels' utilization, thus modifying the economic comparison among them. The pot is further stirred by the creation of trading markets for these externalities, markets designed to satisfy newly-created legislative policy goals. The confluence of these trends since Woodstock--the focus from a project finance perspective on legislatively based market measures for the internalization of environmental externalities -- have reached a new major crescendo with the push for cap-and-trade legislation which has now cleared the House, although its ultimate passage is in doubt. The confluence of fuels policy, environmental policy, and project finance has become a clear reality.

The Waxman-Markey bill, for example, may drive market receptiveness to use of renewables, natural gas, and nuclear -- and reluctance to use coal -- in part by its impact on the project finance of the respective competing fuels and the infrastructure for their delivery. Fortunately, for broad brush analysis purposes, the basic requirements of successful project finance are fairly straightforward:

• Firmness of contractual arrangements and resulting project revenue streams
• Depth and fluidity of markets so as to provide risk hedges
• Feasibility of aggregation of revenue streams from multiple projects and multiple energy or environment credits

In evaluating proposed cap-and-trade legislation, application of those criteria as they relate to the creation of carbon credits under a carbon trading scheme, translates into five basic question clusters:

• How can greenhouse projects be structured to maximize the ability to qualify for the Federal program (or regional and/or state programs in absence of a Federal program)? Which governmental agencies and NGO stakeholders will determine the rules for each aspect of GHG offset credit eligibility and credit trading? Are the definitions and applicable rules sufficiently definite? Which registries will be eligible for early action or transitional credit into the mandatory market?
• Are GHG credits clearly defined as a marketable commodity, separate and distinct from the Federal renewable energy and energy efficiency credits? Does crediting under one program foreclose the other? How are carbon emission reductions credited (or not) in the proposed Federal program?
• Is the possibility of regulatory change in international GHG credit markets sufficiently accommodated and cushioned by the operation of the proposed U.S. system?
• Do the proposed legislation and rules facilitate aggregation and pooled financing, most notably where there are evolving technologies and low carbon practices in fields such as forestry, agriculture, and biomass?
• As a consequence of the interaction of these and similar issues, will anticipated price curves for various carbon investments converge in uniform commodity pricing, or will various sub-markets develop for different project types? How does one structure a transaction to reflect this uncertainty? Can counterparty risk be evaluated in light of uncertainties presented by proposed Federal legislation and its potential effect on credit portfolios, business models, and viability?

Frankly, candid answers to these questions suggest the existence of practical obstacles to achieving a fully functional statute. Carbon credit offsets authorized by the proposed legislation may not serve the related policy roles they were intended to play, i.e., an expansion joint to preserve what will be a very structured and potentially costly cap-and-trade system, unless large volumes of offsets are created, a "thermostat to control the overall costs of reducing greenhouse gases." If they don't do so, the operability of the entire cap and trade scheme that would be difficult to correct.

It's not 1969 anymore; evaluation of Waxman-Markey from a project finance perspective is in order, lest the clogged roads leading to Woodstock becomes a metaphor for the impact of well meaning environmental legislation on the assurance of a fuel mix which represents a secure energy supply for the United States.

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Reader's Comments

Date	Comment
David Webb 10.28.09	Very, very interesting. David - Touch Financial Factoring

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