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6 Common Causes of Development Delays for Biofuel Projects

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Written by Stan Wendzel MBA, CPA, LEED AP   



As of this writing (October 2006) producing biofuels is a highly profitable business. For example, in the U.S. profits from a typical dry mill ethanol production plant can exceed $1 per gallon based on the current prices of ethanol, corn, natural gas, and distillers dried grains with solubles. When you consider this figure for a typical sized 100 million gallon per year plant you realize each day of development delay equates to approximately $250,000 of lost profits.

 

If ever there was a need for speed to market within an industry, development of a biofuels plant would be it. Given the substantial lost profits caused by project delays, and considering there is essentially a race to become a producer while still under the 7.5 billion gallon mandated threshold (US Energy Policy Act of 2005), speed to market should be a mantra of any prospective biofuels producer.

 

Despite these amazingly high lost profits figures and a rapidly closing window before we reach the 7.5 billion gallon mandated level, a majority of ethanol plants under development today are behind schedule. Why? What are the typical causes for such delays?

 

We have identified what we have witnessed to be the 6 most common factors as to why the development of a biofuels project does not meet its schedule:

 

1. Overall project feasibility is questionable plant – If you are trying to build an ethanol and cannot demonstrated that there is an ample supply of grain - good luck. The capital markets will quickly reject a project with questionable feasibility. Basic elements of ethanol project feasibility like access to ample corn, natural gas, and electricity, being proximate to major highways and rail for transportation, and having a strong local market for selling co-products are each important if you wish to see your project come to fruition.

 

2. Lack of site control – In many instances the prospective producer does not have a purchase agreement, option to purchase, or a ground lease for all the necessary land or such agreements expire prematurely. Sometimes this is due to the prospective producer underestimating the time and complexities associated with negotiating and finalizing agreements with multiple parties. Regardless of the reason, development can’t begin without adequate site control.

 

3. Extended time frame to obtain entitlements and permits – It is common for producers who are developing their first facility to underestimate the time it takes to obtain full entitlement and permits to allow grading and building of the intended development. City council delays, EPA permitting delays, legal filings by affected residents are just some of the causes that can delay the entitlement and permitting processes.

 

4. Proforma economics are not in the top tier (top 1/3 of new projects) – Most sources of financing (both debt and equity) want to invest in plants with projected gross margins and profitability that are in the top tier of new projects being built - usually assessed on a per gallon basis. With few true competitive advantages among ethanol and biodiesel plants, the common view is that efficiencies and economies of scale will dictate which plants will survive during difficult times in the future. There is some logic to this approach; however, the financing community may not be adequately considering other factors which suggest that a plant has long-term staying power.

 

Regardless of whether or not this “top tier economics” approach is appropriate, it is a reality among most lenders and therefore must be considered by project developers. Projects that do not fit into this top tier consistently find greater difficulty in accessing both debt and equity capital which usually translates into significant delay.

 

5. Team members not perceived as top tier – Similar to the need for top tier project economics, the project team that is selected, especially the engineering process technology and the EPC contractor, is crucial to the project’s success. The finance community has a strong bias toward 4 or 5 top process technologies and perhaps a half-dozen perceived best contractors. While selecting good, proven process technology certainly makes sense, the bias towards certain contractors is puzzling. A dry mill ethanol plant is a fairly simple project to construct and given complete construction documents most large, experienced contractors should be able to do the job and provide appropriate cost guarantees. Nevertheless, right or wrong, the finance community has this bias, so make sure you select top tier firms for both roles.

 

This brings to light a specific cause of delay currently affecting plant developers. Many of these top tier EPC and engineering firms have such a backlog of work that they are simply not available within a reasonable time frame. For example, as of today, the top two engineering process technology firms cannot be queued up for a new project until mid 2008. The only answer to this is to survey all the top tier firms, post a deposit, and lock in the spot for your project. When it comes to EPC contractors and process technology engineers it is clearly a sellers market today, and given the rapid growth of biofuels this is unlikely to change in the near term.

 

6. Delay or inability in raising sufficient equity capital – Despite doing everything else correct, we have seen numerous projects stumble because they did not approach the equity raising process correctly. Common problems are attempting to retain an unrealistic level of ownership, not knowing the appropriate private equity firms to approach given their project’s characteristics, or issuing an ill conceived private placement memorandum. The point is that regardless of the equity source, without sufficient equity you cannot proceed with development, and many lenders will not seriously consider your project. This means that not only is your project delayed, but you will also not obtain a good market insight on all available senior and subordinate debt financing options. A good capital advisor can make sure you are not delayed, know the minimum equity threshold you need, and make sure you get that good read of the senior and subordinate debt markets.

 

Despite all the complexities of developing a biofuels production plant, generally it comes down to the six factors described above as to why a project is delayed. If you plan for these potential bottlenecks and engage competent consultants and advisors, you will likely see these factors become non-factors. There are numerous instances where prospective ethanol producers have remained in the planning stages for years as they refuse to hire outside help for many key roles that could help them eliminate these bottlenecks. When you consider the tremendous cost of delay this brings to mind the old phrase, “don’t be penny wise and pound foolish.”

 

You might have noticed that four of the above six factors are finance-related. The reality is that most of the potential “non-finance” delays for a biofuels development project can be solved through careful planning, site selection, project management, and entitlement experience. Consequently, capital and the capital markets largely dictate how fast your project comes to market.

 

If capital is such an important bottleneck wouldn’t it make sense to include a qualified capital advisor on your team? A good capital advisor will smooth and expedite the financing process by identifying potential issues early, mitigating those issues, and then getting your well conceived project in front of the right people.

 

These advisors generally get paid only upon successfully procuring the project’s financing, and a good advisor will make sure to align incentives for mutual interests and eliminate the risk that a producer will pay an inappropriate fee. By eliminating or reducing these finance-related factors you can worry about the things a developer is supposed to focus on such as site selection, team selection, entitlement, permitting, and project management.

 

A capital advisor may actually have the greatest impact of anyone on your team in eliminating project delays, and as most developers realize, given the cost of delay ($250k+ per day) engaging a qualified capital advisor can be a sound investment.

 

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