The Absolute Fuels NOV represents the second major enforcement action by the EPA under the RFS. The first action alleged invalid generation of over 32 million RINs by Clean Green Fuel. The Clean Green Fuel action proceeded with a criminal filing by the U.S. Attorney for the District of Maryland and was followed by the EPA's filing of 24 NOVs against the companies that utilized the Clean Green Fuel RINs for compliance with RFS obligations. EPA did not allege that the obligated parties that received the Clean Green Fuel RINs had any knowledge or reasonable basis to have knowledge regarding the RINs' invalidity. This alert provides an analysis of the regulatory basis for these EPA enforcement actions.

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Following a filing last month of criminal charges of wire fraud, money laundering, and violations of the Clean Air Act (CAA) against an individual, Rodney R. Hailey, the EPA issued civil notices of violations (NOVs) to the entities that relied upon the allegedly invalid Renewable Identification Numbers (RINs) generated by Mr. Hailey. The companies involved are obligated parties under the RFS program and thereby, subject to Renewable Volume Obligations (RVOs) designed to demonstrate compliance with the renewable fuel standards set by Congress -- 36 billion gallons by 2022.

Stoel Rives issued a legal update on these matters, among the first enforcement actions initiated by the EPA under the RFS2 requirements.  The entire update can be read here.

The initiative was launched in July 2010 by Boeing, Alaska Airlines, the Ports of Portland, Seattle and Spokane– and Washington State University. Climate Solutions, a Northwest clean-energy nonprofit, managed the stakeholder process that included a wide range of groups across aviation, biofuels production, environmental advocacy, agriculture, forestry, federal and state government agencies, academic research and technical consultancies.  Stoel Rives was proud to be a participant in the process and to provide specific input regarding incentives, and the Renewable Fuel Standard. 

We hope that you find the report useful and informative, see http://www.safnw.com/ for further information.

The battle is not yet resolved but the current compromise is encouraging for these projects. There is a claw back of $18.183 billion in uncommitted funds but these were funds appropriated under provisions that required that the Credit Subsidy Cost to be paid by developers. The Credit Subsidy Cost was the bane of the Loan Guarantee Program as it essentially required the program applicant to cover the present value risk that the project would default on the loan. The Stimulus Bill solved this problem and greatly increased the attractiveness of the Loan Guarantee Program by appropriating funds to cover the Credit Subsidy Cost. Similarly, the current budget compromise appropriates an additional $1.183 billion in funds and allows these funds to be utilized to cover Credit Subsidy Costs. Thus, while the provision claws back funds, these are funds that were not attractive due to program limitations whereas new funds are appropriated to the preferred program. In addition, the proposed legislation imposes an Office of Management and Budget certification of compliance requirement as a control on the program.

The current bill is HR 1473 and is likely to be voted on later this week and thus is still subject to amendments. To obtain the latest details and access to the bill, see the Open Congress site at http://www.opencongress.org/bill/112-h1473/show 

There has been a wave of good and bad news this past week regarding the DOE's Loan Guarantee Program.  On the positive side, Secretary Chu announced on Friday that the Department would be adding an additional compliance period for the Innovative Solicitation.  The current deadline for the Part I application under the program is August 24th.  Secretary Chu announced the applications would be accepted until October 5th thus providing six more weeks of time to applicants.  Secretary Chu did not extend the Part II deadline and cannot extend the September 30, 2011 start construction deadline as that deadline was established by the Stimulus Bill itself.  Still, the extension was generally viewed as a respite and perhaps an indication of a willingness to further extend the program.

On the bad news side, the Senate approved the FMAP state aid bill to avert teacher layoffs and pay for Medicaid which is to be funded in part by taking $1.5 billion in funds that the Stimulus Bill appropriated to the DOE Loan Guarantee program.  Clearly driven by Pay-Go requirements, this is a reminder of the $2.0 billion fleecing that the Loan Guarantee Program suffered when Cash for Clunkers program was passed.  While it has been promised that the funds will be restored, the fact that the Cash for Clunkers funding has not yet been restored raises concern about whether the restoration will occur. 

The proposed rule contains two other notable components:  tentative but retroactive RIN credit for canola, sorghum, pulpwood and palm oil biofuel producers; and a petition process for foreign countries to avoid the onerous feedstock obligations that now apply in favor of the aggregate approach available within the US.  The referenced feedstocks have been under consideration by EPA for Life Cycle Analysis since prior to the original RFS2 Final Rule was released but the work has still not been completed.  The severe challenge for this group of biofuel producers is that EPA has previously indicated that RIN generation would trigger only when the pathway was certified.  EPA's proposed new flexibility is an improvement but still falls short of providing full RIN value for these producers due to the lag time and uncertainty associated with the approach.  The proposed petition process for foreign countries is an apparent attempt to level the playing field for foreign producers who now must trace and certify feedstocks such as soy and corn in a manner not required within the US.

The rules will be published in the Federal Register shortly and the public comment period will likely run to approximately August 13th.

Several deadlines relating to the implementation of RFS2 are rapidly approaching and should be strictly followed by renewable fuel producers to avoid loss of the value of RINs under the new system. Producers who miss the registration deadline of July 1, 2010 will be unable to generate RINs until they have completed the registration process and 60 days have passed. Thus, a producer who completes registration on July 2 will not be able to generate RINs until September 1.

All producers must provide the following registration documents to EPA by the July 1 deadline:

• Engineering Review of the Facility – this must be done by a third-party qualified engineering firm and meet RFS2 requirements.
• Process Heat Fuel Supply Plan – this plan is required, as process heat is one of the aspects of plant performance that EPA considers in evaluating GHG performance.
• Records of actual production or copies of applicable air permits to allow EPA to determine the facility’s baseline volume.

For producers who use yard waste, food waste or the biogenic portion of municipal solid waste as their feedstock, a feedstock plan must also be submitted.

Additional RFS2 compliance information is available on the RFS website: http://www.epa.gov/otaq/fuels/renewablefuels/.

In addition to the registration requirements, deadlines are also approaching regarding the technical amendments EPA promulgated to RFS2, published in the Federal Register on May 10 at Volume 75, No. 89, page 26026. The EPA published these amendments, some of which have generated controversy, through the use of a direct final rule. To request a public hearing, commenters must provide notice to EPA by May 25, 2010. Adverse comments must be filed no later than June 9, 2010. Further details and the technical amendments are available at http://www.epa.gov/otaq/fuels/renewablefuels/regulations.htm

Missouri will use its SEP funds to increase energy efficiency through various measures, including the expansion of existing home efficiency programs, building energy codes, and training programs. Missouri will also examine its most energy-intensive industrial/manufacturing sectors for energy-saving opportunities and will increase energy efficiency through a program that may include energy audits, rebates, and low-interest loans. After demonstrating success in the execution of its plan, Missouri will receive more than $28.6 million of additional funds, for a total of over $57 million.

New Hampshire will use its SEP funds to advance energy efficiency and renewable energy through building codes, competitive loans and grants, and financial and technical assistance to businesses and other institutions. New Hampshire will also support energy efficiency upgrades to colleges, universities, and state-owned buildings. After demonstrating success in the execution of its plan, New Hampshire will receive more than $12 million of additional funds, for a total of over $25.8 million.

North Carolina will use its SEP funds to promote energy efficiency and renewable energy through competitive grants, revolving loans, and education and training programs designed to encourage investment in energy-related technologies. The state will also establish a training program in its community colleges and universities to prepare workers for the green economy. After demonstrating success in the execution of its plan, North Carolina will receive $38 million of additional funds, for a total of $76 million.

In apparent response to this, President Obama has singled out registered lobbyists and regulated their contacts with the executive branch.  His directive provides that “executive department or agency officials shall not consider the view of a lobbyist registered under the Lobbying Disclosure Act of 1995, concerning particular projects, applications, or applicants for funding under the Recovery Act unless such views are in writing.”  Officials are directed to inquire regarding the possible presence of registered lobbyists both upon the scheduling and commencement of phone calls and in-person conversations “with any person or entity concerning particular projects, applications, or applicants for funding under the Recovery Act.”  If any registered lobbyists are detected, the directive forbids them from attending the meeting or participating in the phone call.

Not surprisingly, the American League of Lobbyists (ALL) has objected to the Obama Administrations restrictions.  In a demonstration that politics does indeed sometimes make strange bedfellow, ALL has been joined by the ACLU and the Citizens for Responsibility and Ethics in Washington (CREW).  In a letter to the President released Tuesday, these three groups requested that President Obama rescind the constitutionally offensive provisions of the directive immediately.   

As tempting a political target as they may be, registered lobbyists have a place in our political system and rights under our Constitution.  The President should heed the groups’ advice and tailor his directive to enable transparency while not muzzling any voices--including those paid to advocate.

2008 was a terrible year for makers of ethanol and biodiesel. Huge spikes in the prices of raw materials, natural gas and transportation and drops in the prices they received for their main products have driven many of them to cut back production, shutter plants or even seek bankruptcy protection.  In addition, U.S. biodiesel producers saw themselves faced with an antidumping investigation by the EU that might affect their export market.

If you thought it couldn’t get any worse, hang on.

The National Grain and Feed Association reports that at the International Feed Expo in Atlanta on January 27, Dr. Daniel McChesney of the Food and Drug Administration spoke about studies the agency has reviewed concerning distillers’ grains, the main by-product of ethanol, and glycerin, the main by-product of biodiesel. The information presented by the FDA’s Center for Veterinary Medicine is of concern to anyone in the biofuels industry, as well as anyone who feeds livestock or purchases, processes or consumes meat and poultry.

The FDA has tested 45 samples of distillers’ grains from ethanol plants and in over half of them detected antibiotics, including virginiamycin, erythromycin and tylosin. NGFA later learned that the concentration of those antibiotics exceeded the level (0.5 ppm) from a letter of no objection relating to virginiamycin issued in 1993 to the predecessor of Philbro Animal Health. There are no safe levels established for the other two antibiotics in feed grain. The FDA has 15 more samples to test and intends to make its final report available this summer.

With regard to biodiesel-derived glycerin, Dr. McChesney stated that the FDA does not consider it to be GRAS, or generally recognized as safe, for use as animal feed. Two issues raised concerns: 

·         Many samples contained more methanol than the 150 ppm level recognized as safe for animal feed; and

·         Samples contained salt in concentrations as high as 16,500 ppm.

Accordingly, the FDA will be conducting a safety review of glycerin as a by-product of biodiesel. This will focus on the type of feedstock used, the manufacturing process and how the glycerin is introduced into feed. 

Developing markets for by-products has been a significant challenge for the emerging biofuels industry. The latest news of the FDA’s concerns about both distillers’ grains and glycerin will increase those challenges in an already difficult environment.

Kudos to renewable energy leaders like Senator Cantwell and Representative Inslee who have steadily advocated for the industry. Unless one of the pending bills is successful, the sun will set on the Production Tax Credit, Investment Tax Credit and several related measures that have proven highly effective in the expansion of the wind, solar and biofuels industries. Congress is scheduled to adjourn on September 26th for the electoral season and perhaps the remainder of 2008. Absent a quick Congressional action compromise behind a unified bill, these renewable industries will suffer from lost investment, delayed projects and the dark cloud of future uncertainty.

The Production Tax Credit (PTC) applies to facilities utilizing wind, open and closed-loop biomass, landfill gas, geothermal, hydropower and waste to produce energy. The “placed in service date” in the PTC determines whether qualifying facilities will be eligible for crucial federal subsidies to improve their project economics. The solar energy and fuel cell Investment Tax Credit (ITC) provides powerful subsidies to these promising industries. The biodiesel blenders excise tax credit is crucial to the growth of this industry that is seeking to diversify into next generation feedstocks. While not strictly in the renewables sector, carbon sequestration, energy efficiency, plug-in vehicles, smart grid expansion and incentives for idling reduction units in heavy duty trucks are other promising energy programs awaiting extension or approval.

As referenced above, it is not the renewable energy sources, efficiency measures, or energy innovations that create the central dispute but the issue of “pay go” or “pay as you go”. A broad consensus has emerged that a diversified energy policy is an imperative. The problem arises from the price tag. The simple concept of “pay as you go” is that Congress should simultaneously appropriate or otherwise pay for any expenditures that it includes in a particular piece of legislation. The price tag for the comprehensive new energy package has been in the range of $17 to $18 billion dollars over the next 10 years. Notably, even the use of the 10 year cost evaluation period has caused recurring problems for the renewable energy industry as it encourages Congress to pass shorter term measures that cost less under the pay as you go accounting rules.

The two key pending bills in Congress illustrate the controversy vividly. The “Comprehensive American Energy Security and Consumer Protection Act” (HR 6899) passed the House on September 16th. The “Energy Improvement and Extension Act of 2008” (HR 6049) is the bill that was passed in the Senate with the sponsorship of Senators Baucus, Grassley and Reid. The two bills would both address the price tag issue by repealing some oil and gas domestic production tax subsidies and changing the rules for the calculation of foreign oil and gas extraction income. Renewable industry proponents had recently been encouraged that tentative compromises would allow one of the bills to be passed, thereby extending the sunset dates on the energy programs.

The hurricane and the crisis in the financial markets have shortened the time opportunity for Congress to work out the details of the compromise. There is speculation that even if Congress fails to act this year, a compromise will be reached next year that will be retroactive to January 1st. In other words, If Congress fails to act this year to extend the credits, they will act sometime next year and provide credits to the respective industries for the time when no credits were in place.

This role is particularly critical in the new energy sector. Unlike the dot.com sector to which it is often inaccurately compared, the new energy sector requires substantial investment, hard asset infrastructure and downstream compatibility. Successfully penetrating the energy sector necessitates competition with the commodities and products of some of the largest, most successful and most profitable companies in the world. Six of the ten of the largest companies in the world derive their revenues primarily from fossil fuel discovery, extraction, refinement and marketing. These industries have been in existence for 100 years, have solved daunting challenges, and have built the most expensive and remarkable distribution infrastructure in the world.

Renewable energy businesses that seek to penetrate this market must develop their energy source; make it compatible with existing downstream demand or create a new demand market; and compete on price. The PTC, ITC and other government programs have been great successes in leveling this playing field and enabling success. Solar installations have increased by double digit figures annually in the US for the last several years. Wind power has grown by factor of four over the past four years from 5,000 MW of installed capacity to 20,000 MW.  Biodiesel production in the US has increased by a factor of twenty over the three years that the incentive has been in place.

From an overall contribution to the America’s energy portfolio, wind has made the greatest inroads, now providing 1.5% of the nation’s massive energy needs and ramping up on schedule. As stated by the Executive Director of the American Wind Energy Association, Randall Swisher, “Wind energy installations are well ahead of the curve for contributing 20% of the U.S. electric power supply by 2030 as envisioned by the U.S. Department of Energy. However, the looming expiration of the federal renewable energy production tax credit (PTC) less than four months from now threatens this spectacular progress.  The PTC has been a critical factor in wind’s very rapid growth as a part of the nation’s power portfolio.”

In our practice, we have already begun to see the impact of the lack of extension impact on our clients’ development and investment activities. For some time, developers have been attempting to speed projects to completion to ensure that the wind turbines would be placed in service within the scope of the existing PTC. With the deadline approaching, forward wind turbine sales in the US have declined substantially. Given the dramatic growth in wind energy globally, many of these wind turbines have already been committed overseas and will no longer be available for 2009 US projects. In other cases, developers and investors have sought to assign the risk of a PTC termination in the contract negotiation to one party. As one might anticipate, neither party has been enthusiastic about taking on what has sometimes been labeled the “political risk”.

Similar challenges have beset the biodiesel industry. While wind turbines are the focal point in the wind sector, vegetable oils such as soy oil (known as feedstocks) are the dominant cost component in biodiesel. When there is a longer time horizon on the federal blenders excise tax credit, biodiesel producers are able to buy feedstock forward at a fixed number or based on a discount to a commodity index. They can then sell their finished product forward on the same basis and lock their margin. Such forward procurement and sales enables planning, stability and expansion. With the blenders credit expiring in three months, the opportunity for long-term procurement and sales are severely hindered. This challenge is faced not just by existing industry participants but also by those who seek investment to develop additional production capacity.

In the area of solar photovoltaic distributed generation, problems have also begun to arise due to the lack of extension. Some developers in the industry are demanding that integrators indemnify the developer against loss of project value if the ITC for a project is lost due to the project not being completing by the sunset date. This indemnification includes assuming the risk that the project is not placed in service due to a matter outside the integrators control: the inability of the local utility to timely inspect and approve the interconnection.   As one might expect, some prudent and responsible larger integrators are unwilling to take on this risk. As a result, integrators which are undercapitalized or otherwise less qualified, but who are willing to take on the political risk, are getting some projects. 

The US renewable energy industry has made great strides in the last decade to achieve feasibility and scale sufficient to make an impact on the nation’s energy needs. In many respects, federal programs in this area have been a success story. In the wind, solar and biofuels industries, the US has emerged as a leader but federal political support has been a key component of this success. Already, wind turbines are being diverted away from the US due to the delayed extension of the PTC. With the immediate action of Congress, the short term political risk to these industries can be addressed. Longer term, the incoming administration and Congress will have the opportunity to expand the timeline on these programs and reap greater benefits from the same investment.

Hopefully, this process will yield substantial success. As an early participant in the US biodiesel industry, I can attest that the benefits of biofuels appeared quite compelling and almost self-evident as compared to conventional petroleum fuel. Those in the industry with a strong interest in environmental issues typically considered corn ethanol and soy biodiesel as transition fuels that would establish the viability of a more diverse transportation energy portfolio by leveraging the existing farm economy. After market entry with these transition fuels, the road would be paved for superior feedstocks as we are witnessing today with cellulosic material, waste feedstock material and even algae.

In retrospect, the Roundtable of Sustainable Biofuels should have been founded a decade ago rather than last year. With an earlier start, such an organization might have achieved great progress in injecting some objective criteria into the “food vs. fuel” debate and propelled the industry in a more sustainable direction. In the absence of these criteria, some of the debaters have used these crucial (and emotional) issues to advance their own agendas and the biofuels industry has lacked the framework to establish its own best practices.