US Government Loan Guarantees for New Nuclear Construction

Loan guarantees from the US Government, specifically regarding those to new nuclear projects, are often misunderstood and misconstrued.

US Loan Guarantee Program – Incentives For Innovative Technologies

US Government loan guarantees for new nuclear construction originate from Title XVII of the Energy Policy Act of 2005. Title XVII is called Incentives for Innovative Technologies covering a wide range of energy technologies. The loan guarantee program was designed to promote private investment in carbon-reducing energy technologies that are typically required to pay higher interest rates than many other business investments due to the inclusion of a risk premium. Loan guarantees should enable private investors to acquire capital at a lower interest rate because the unpaid principal and interest on a guaranteed loan will be paid by the government should a company default on the loan. This lowers the risk to the lender, thereby lowering the interest rate.

Eligible Projects for Loan Guarantees

The eligibility requirements for loan guarantees are clearly spelled out in Sec. 1703 Eligible Projects. Any project that [1] avoids, reduces, or sequesters air pollutants or anthropogenic emissions of greenhouse gases (emissions from human activities); and [2] employs new or significantly improved technologies as compared to commercial technologies in service in the US at the time the guarantee is issued, is considered meeting eligibility requirements with one additional caveat.

In order for a project to be considered (above and beyond the two criteria listed above), it must be from one of the following categories:

• Renewable energy systems
• Advanced fossil energy technology
• Hydrogen fuel cell technology
• Advanced nuclear energy facilities
• Carbon capture and sequestration practices and technologies, including agricultural and forestry practices that store and sequester carbon
• Efficient electrical generation, transmission, and distribution technologies
• Efficient end-use energy technologies
• Production facilities for fuel-efficient vehicles
• Pollution control equipment
• Refineries, meaning facilities at which crude oil is refined into gasoline
• Gasification projects (which essentially are certain types of natural gas, coal, petroleum, and biomass technologies with a large volume of details pertaining to each, such as “shall be located in a western state at an altitude greater than 4,000 feet” as an example of the degree of minutia)

You will notice that just about every type of energy generation technology can be covered by this list, not just nuclear energy. Any utility can make a case for a project that is from one of these categories and meets the two criteria and receive a loan guarantee, provided they pass the rigorous financial review.

Loan Guarantees are NOT Subsidies

So What IS a Loan Guarantee?

A common misconception is that loan guarantees are subsidies and cost the taxpayers money. This is not true. A loan guarantee as defined in Title V §502(3) of the Federal Credit Reform Act of 1990, which the Energy Policy Act of 2005 defers to for this definition, is:

The term “loan guarantee” means any guarantee, insurance, or other pledge with respect to the payment of all or part of the principal or interest on any debt obligation of a non-Federal borrower to a non-Federal lender, but does not include the insurance of deposits, shares, or other withdrawable accounts in financial institutions.

This means that the government will step in to repay a lender for unpaid loan principal and interest should the company default, else the government has no expenditures related to the loan guarantee. Loan guarantees are more like insurance than anything else. Theoretically, the government could guarantee $54 billion in loans and actually generate revenue, rather than cost the tax payers, if none of the loans are defaulted on.

Contrast this with the definition of subsidy from the Merriam-Webster online dictionary:

a grant or gift of money: as a : a sum of money formerly granted by the British Parliament to the crown and raised by special taxation b : money granted by one state to another c : a grant by a government to a private person or company to assist an enterprise deemed advantageous to the public

Subsidies are basically monetary gifts from a government to a company. Loan guarantees are  contract whereby the government agrees to pay back a lender if a guaranteed borrower defaults on the privately-held loan. This indicates the government may not ever have to lay out funds for the loan guarantee, only if the loan is in default.

How Much Are Loan Guarantees Going to Cost?

This is always a moving target as market conditions change, however §503(d) of Title V of the Federal Credit Reform Act of 1990 makes it clear that these cost estimates are to be reviewed annually for accuracy and adjusted as needed. The definition of the cost of a loan guarantee is also clearly spelled out in Title V of the Federal Credit Reform Act of 1990, in §502(5)(C):

The cost of a loan guarantee shall be the net present value, at the time when the guaranteed loan is disbursed, of the following estimated cash flows:

(i) payments made by the Government to cover defaults and delinquencies, interest subsidies, or other payments; and

(ii) payments to the Government including origination and other fees, penalties and recoveries;

including the effects of changes in loan terms resulting from the exercise by the guaranteed lender of an option included in the loan guarantee contract, or b the borrower of an option included in the guaranteed loan contract.

So, what does that mean? The Congressional Budget Office develops an estimated default rate on guaranteed loans and forcasts the cash outlays the government may have to make in order to fulfill the loan guarantee obligation. They subtract from that cost the receipt of monies from borrowers from the application process as well as forecasted penalty collections based on the default rate assumed. They then use net present value methodology to value the potential cash outlays expected in today’s dollars. That is how the estimated “cost” of a loan guarantee is calculated. It is also important to note that the borrower must pay the Treasury this estimated cost before the loan guarantee is granted, so the guarantee is fully paid for by the borrower before the project even starts.

Currently, there are two dramatically different estimates for the cost of loan guarantees. Steven Chu, the US Secretary of Energy, believes the fee paid by borrowers should amount to one percent of the loan guarantee’s principal value. Peter Orszag, the Director of the Office of Management and Budget, feels that borrowers should pay a ten percent fee. The difference in their opinions originate from a vastly divergent view on the likelihood of loan defaults. The Congressional Budget Office believes the loan default risk to be much higher than Chu. The point critics and the Congressional Budget Office are both missing is that their information is based on outdated circumstances pertaining to a different generation of reactors coupled with fierce anti-nuclear activist groups halting construction through the courts. If the Government is to guarantee a multi-billion dollar loan you can be sure that a Combined Construction and Operating License will be issued for the new nuclear reactor. Since a loan guarantee for new nuclear construction cannot be issued unless the project has already obtained a Combined Construction and Operating License, there should be no regulatory delays, which will greatly lower the default risk.

Financial Conditions for Appropriation of a Loan Guarantee

No loan guarantees can be made to companies that do no meet several financial qualifications. First, the cost of the loan guarantee must already be appropriated in the Federal Budget. Second, the Treasury must have received from the borrower a payment in full for the cost of the obligation. Third, the guarantee may not exceed 80% of the estimated total project cost.

Additionally, no guarantee may be made unless there is reasonable assurance the debt will be repaid. The sum of the loan guarantee plus amounts available to the borrower from other sources must be sufficient to carry out the project or else they will not qualify for the guarantee. The term of the loan that is guaranteed must be the lesser of 30 years or 90% of the useful life of the facility. In the instance of a nuclear energy plant that can last anywhere from 60 to 100 years or more, the term of the guaranteed loan would be 30 years. The interest rate on this loan will not exceed a level “that the Secretary (of Treasury) deems appropriate, taking into account the prevailing rate of interest in the private sector for similar loans and risks.”

Should a borrower of a guaranteed loan declare bankruptcy or other restructuring proceedings, the federally guaranteed loan is the number one repayment priority. This means that no other debts held by the borrower may be paid until the government receives payment for the guaranteed loan.

US Government Loan Guarantee Key Take-Aways

• Loan guarantees can be made to a wide variety of innovative energy technologies and projects, not just nuclear energy
• Loan guarantees are not subsidies – they are a form of debt insurance
• The estimated cost of the loan guarantee is covered up-front by the borrower, not the tax payers
• The government will only have to step in if the loan is in default, which should happen rarely based on the rigorous credit and financial review required in the application process
• The guarantee can only be made for 80% of the total project cost with the remaining 20% coming from other financing sources available to the borrower
• In 2009 the DOE issued changes to Title XVII of the Energy Policy Act of 2005 with the discussion revolving mainly around collateral for debt obligations, the discussion of which can be read by clicking here.

Hopefully this information is helpful to those who are unfamiliar with US Government loan guarantees and how they are different from subsidies. All too often I read about people discussing the “heavily-subsidized” nuclear industry. The nuclear energy industry is not subsidized and loan guarantees are not subsidies. Loan guarantees are extremely important for our energy future as they can help minimize the enormous financing costs associated with building new nuclear construction as well as renewable energy sources that will provide our nation with clean, safe, reliable energy for decades or more.

Image Credit

A Storm was Coming courtesy of Flickr user MiiiSH under the CC license.