Presentation to APPAFebruary 17, 2005

Larisa Dobriansky, Deputy Assistant Secretary, DOE Policy Office David Berg, Chief Advisor, DOE Policy Office

Andrew Paterson, Principal, Environmental Business International

A Risk Framework Approach

Policy Approaches & Incentivesin Financing Gasification Plants

www.ClimateVISION.gov

2

President’s Climate VISION Initiative

• On February 14, 2002, President Bush set a goal to reduce U.S. GHG emissions intensity.

• Based on public – private partnerships, engaging a dozen industry groups.

• Emphasizing voluntary actions and accelerated commercial use of advanced technologies.

• And achieving National Energy Policy goals.

“My administration is committed to cutting our nation’s green-house gas intensity over the next 10 years.”

-- February 14, 2002www.ClimateVISION.gov

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Climate VISION Private-Sector Partners

Alliance of Automobile Manufacturers

Aluminum Association

American Chemistry Council

American Forest & Paper Association

American Iron & Steel Institute

American Petroleum Institute

Association of AmericanRailroads

The BusinessRoundtable

International Magnesium Association

National MiningAssociation

Portland CementAssociation

Power Partners

Semiconductor Industry Association

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Why Is DOE Interested in Gasification?(for Coal and Other Industrial Applications)

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Aging U.S. Coal Fleet: 70% over 30 in 2010

In two years, over 50% of US total coal-fired generating capacity will be 30 or more years old. Environmental pressures and legislative reforms could push many of these plants into retirement.

While excess capacity has caused plant retirements and the postponing or canceling of projects in some regions, other regions remain—and will continue to be—short of power.

(Source: Platt’s)

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Advantages of Gasification

• Higher potential efficiency >50% v. 40%, if fuel cells added later.

• Removes S, Hg, and other contaminants before combustion, eliminating scrubbers.

• Wider range of feedstocks and variability in feedstock quality.

• Easier to capture by-products for sale• Less input water use needed: post-

combustion flue gas desulfurization is not needed, as with conventional coal boilers to reduce SOx emissions.

• Less-cooling water discharge (-30%) than conventional coal.

• Most gasifiers in operation today are used for processing refinery wastes and making chemicals (ammonia, syngas, methanol).

Next speaker, Jim Childress, will cover these points

Next speaker, Jim Childress, will cover these points

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Clean Coal: Leading Questions

• Market factors and business risks have shifted since 2000 to favor consideration of clean coal (e.g., sharp spikes and volatility in natural gas prices).

• Yet, few IGCC plants being ordered. Is it primarily a matter of elevated capital costs? Other business risks?

• Which risks most deter construction of commercial clean coal plants?

• Which policies could encourage commercial adoption of “clean coal gasification” (e.g., environmental regulations, state & federal financial support)?

• How can federal credit approaches be coupled with state incentives to improve the prospects for clean coal gasification plants?

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Market Failures in Power Sector

Trigger Evaluation of New Approaches

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Market Failures in Power Sector

1. Advanced gasification systems for coal face skepticism.

2. Owners of early plants face “first mover” penalties (higher cost and technology risk, more delays, than later movers).

3. Customers of early plants also face “first mover” penalties from higher cost and lower reliability.

4. Classic externalities (e.g., pollution) hinder action by prospective owner / operators and their customers.

5. Regulatory bias in rates (defacto) impacts technology choice—PUCs allow generators to pass through marginal fuel cost price spikes, but restrict cost recovery of capital.

6. Regional differences are vast (fuel use, urban v. rural…)

• Solving issues requires collaborative approach, nationally.

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Why Are So Few IGCCs on Order?

DOE: CCPI buys down demo plant cost by 40% to 50%, so why are so few utilities considering IGCC ?

Utility: Even if DOE puts up $500M on a $1 billion plant, we still have $500M at risk if the gasifier fails to perform. Reliability is king in our business—power. We don’t want to be ‘guinea pigs’. Let someone else try first.

Utility: A gasifier looks (and smells) like a chemical plant. We are not in the chemical business.

IGCC technology vendor: We make only a component of the total plant and don’t want to be liable for delivering power. Our units make fuels and by-products.

PUC commissioner: What does gasification cost per KW? Who stands behind the performance guarantee to protect my rate payers?

Lab: Our research shows that IGCC may not be the best choice for low-rank coals (sub-bituminous, lignite – with higher moisture).

?

Excerpts from interviewsExcerpts from interviews

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Risk Profile of Clean Coal Technology

Faces Market Failures,

Suggesting the Importance of Risk-

Targeted Assistance

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Risk Framework Built to Project Timeline

Market failures require an assessment of risks.

“Risk framework” approach is…• Not a technical framework, e.g., RD&D roadmap.• Not a regulatory framework, e.g., IPCC.• Not biased toward any specific fuel source.• Not based solely on economic analysis.• Not another “barriers” study.

• Based on the analysis of “business risks” from the perspective of project development and plant owner.

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Overview of Risk Framework Approach

Power Plant Project

Development Timeline

Risk Analysis of Coal Project Development

Stages

Risk Analysis by Stageof Project Development“Showstoppers”:• Air regulatory issues?• Tech performance and availability?• PUC rate approval?

Major Risk Category• Technology / Design• Development / Siting• Regulatory• Construction• Operating performance• Fuel price, supply• Demand• Dispatch • Waste, byproducts• Transmission

Rating and Ranking of Risks by Stages

Evaluation, Application

of Risk Mitigation

Mechanisms

Interview and Rating Approach .

• Design of survey instrument

• Work with industry groups for interview candidates

• Selection of interview candidates

• Contact of candidates

• Interviews, risk ratings

• Evaluation of risks

• Workshops with industry on results

Evaluation of Mitigation Mechanisms

• Financial model and sensitivity analysis (conducted by utilities)

• Delineation of mechanisms

• Matching of possible mechanisms to risks

• Evaluation of risk coverage for each stage

• Determination of measures, legislation needed to implement

• Negotiations

TimelineEvaluation .

• Delineation of key development stages for power plant

• Matching of development stages with financing events

The risk framework approach builds on work done for the “Business Case for Nuclear Power” (www.nuclear.gov)

This diagram depicts the study’s logic flow and approach to the analysis.

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Risk Questionnaire: 33 Respondents

Utilities, IPPsAEP

Cinergy

EPRI

Excelsior Energy

Tennessee Valley Authority

Tri-State Generation

Engineering Firms & Energy Cos.Alstom

Bechtel

Burns & McDonnell

Conoco Energy

CONSOL

Eastman Chemical

Technology Firms, Labs, DOE

Air Products & Chemicals

ChevronTexaco Gasification

Gas Technology Institute

Gasification Technology Council

Powerspan

Siemens

TMS

DOE & NETL

Financial CommunityCS First Boston

JP Morgan Chase

EBI

Rosenberg & Associates

Fluor Engineering Foster Wheeler USA

Kennecott Energy

Global Energy

Southern Co.

Tampa Electric

WE Energy

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Risk Rating Recap: Highest Risks

Risk Area for IGCC A B A x B

Highest Risks Probable Severity Rating-11 High capital cost 4.4 4.7 20.43 Excessive downtime 3.7 4.4 16.5

5 Lack of standardization 3.7 3.5 12.918 No state policies for IGCC 3.3 3.7 12.119 Nat'l policy on IGCC lags 3.4 4.2 14.426 PUC rate approval fails 2.9 4.6 13.2

27 Financing difficult 3.7 4.5 16.5

Tech

nica

l

Reg

ulat

ory

Mar

ket

Clean coal systems offer public benefits, but are not fully proven. High capital costs magnify risks. State and national policies not yet clear. Financing large plants poses challenges… Risk-informed credit-based assistance may help address them effectively and efficiently.

Clean coal systems offer public benefits, but are not fully proven. High capital costs magnify risks. State and national policies not yet clear. Financing large plants poses challenges… Risk-informed credit-based assistance may help address them effectively and efficiently.

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Risk Profile: Too High Early in Plant LifeR

isk

Pro

file

Plant Project Timeline Development & Engineering

Construction Operations & Maintenance

• High capital costs• Excessive downtime• Regulatory uncertainty• Electricity competition

1. Not enough coverage of operating risks and technical performance at startup.

2. Too much risk coverage after successful operations: Buydown of costs reduces generation cost over life of the plant. Cost to government unnecessarily high.

Selection for support $

Startup

Tax credits don’t provide enough lift early on, and offer too much over life of plant.

Tax credits don’t provide enough lift early on, and offer too much over life of plant.

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IGCC Risk Traits – 1,2,3: Observations

• Industry rates technology risks of IGCC, other advanced technologies as too high without government support.

Top concerns: Technical: High capital cost and excessive downtime, which

make financing difficult. Warranties appear to be inadequate.

Regulatory: Potential for big advantage in CO2, but owners remain skeptical of full valuation, near term, of CO2 advantage. IGCCs have apparent edge on capture of mercury, plus on water and solid wastes.

Market: Note that risk of decline in gas prices rates as a low probability, high severity event. Gas price rises make clean coal plants more competitive.

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IGCC Risk Traits – 1,2,3: Observations

Other observations:• State policy can help, but probably will be insufficient in

most states. PUC dispatch preference, rate approval, or ROI assurance would usefully mitigate risk.

• Electricity competition is a concern due, in part, to uncertainties about regional impacts of market reforms.

• If government accepts significant technology risk, then adequate EPC warranties probably could be negotiated. Also, government reliability backing should reduce contingency in price of plants by >$100 / kWe.

• Workforce risks (for construction and operation) rate low.

(continued)

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Designing Risk-Targeted Assistance

for the Power Generation Sector

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New Financing Approaches Needed?

• Tax credits and co-funding are inefficient and expensive for the federal budget. They are not targeted to specific risks.– Compounded by tying tax credits to “heat rate” for electricity

or by allowing conventional plants to qualify for tax benefits

• Government (federal and state) risk-sharing with advanced clean coal plant owner / operators could offer more flexibility on financing and ownership structures. – Could better allocate risks (e.g., higher capital cost on first

units, technical performance uncertainties)

• Federal credit process could force healthy negotiation and independent credit analysis—and it would complement state actions. Credit process would add rigor and improve project quality, and it may dampen earmarking.

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Risk-Targeted Assistance for IGCC

Risk Area

• High capital cost

• Excessive downtime

(poor availability)

• Lagging national policy

• Lagging state policy

• Lack of standardization

Possible Assistance Targets

• Enhance financial returns

• Improve warrantees

• Backstop cash to avoid

default

• Helpful national policies

• PUC, environmental roles

• Financial support for standardized designs

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Next Steps through Climate VISION

For discussion… • Collaborate with states, NARUC, EPA, EPRI, CURC,

GTC, APPA and NCC on further risk analysis work.• Evaluate how to target potential assistance on critical

business risks that hinder orders of early commercial plants.

• Conduct sensitivity analysis of federal assistance options, including credit. Review results across DOE and with OMB, Treasury.

• Consider complementing state incentives with potential federal credit (or other) assistance.

www.ClimateVISION.gov

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www.ClimateVISION.gov

Contact us:Larisa Dobriansky 202-586-1524Deputery Asst. Secretary, DOE Policy Office

David Berg 202-586-1117 david.berg@hq.doe.govChief Advisor, DOE, National Energy Policy Office

Andrew Paterson 619-807-3267 adpaterson@aol.comPrincipal, Environmental Business International

FINISH

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Backup Slides

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Beyond IGCC ?

• Many advanced energy technologies are reaching commercialization, but most face market entry difficulties.

• These technologies improve energy efficiency, electricity transmission, nuclear power, and renewable energy.

• NEP advocates rapid commercial use of a portfolio of such advanced technologies—if, long term, they can compete.

• Market use of advanced energy technologies developed with DOE support rewards taxpayer support for applied RD&D programs—and advances U.S. energy security.

• Traditional government deployment assistance tools are not targeted on key market risks—and they are expensive.

• Negotiated federal credit tools, teamed with state incentives, could address specific risks to accelerate market adoption effectively—at a lower cost.

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The Climate VISION Challenge

• Climate VISION – Challenges industries to make voluntary commitments to adopt cost-effective systems, technologies, and best practices to reduce GHG emissions.

• Commitments from 12 industries and Business Roundtable; thousands of companies; nearly 45% of U.S. GHG volume.

• Climate VISION partnership:– Industries commit to make meaningful commitments toward the 18%

intensity reduction goal and to report emissions in 1605(b)

– Partners identify, implement cost-effective solutions for reducing GHGs

– Partners develop and use the tools to calculate, inventory, and report GHG emissions reduction, avoidance, and sequestration

– Government recognizes voluntary mitigation actions

– Partners develop enabling strategies across the economy to further reduce GHG emissions

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Climate VISION Enabling Initiatives

• Goal: Garnering private actions to extend voluntary commitments across entire economy.

• Current focus: Major energy end-use sectors, such as transportation, buildings, and electricity system.

• DOE, industry exploring enabling initiatives in key sectors: – Efficiency in buildings, starting with new homes

– Advanced Clean Coal power generation

– Acceleration of renewables and bioenergy

– Others based on analysis

• Potential goal for new homes: 50%+ market penetration of energy efficient new homes by 2012.

• Potential goal for clean coal power generation: Build first of several new plants in a series starting in 2006 – 2007.

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Climate Vision Promotes Energy Security

Secure Supply Alternative supplies for fuels helps insulate users from import disruptions;Diversification of fuels (e.g. biofuels) and sources enhances options.

Less Price Volatility Alternative supply eases demand on natural gas, reducing price spikes;More stable generation or distributed generation moderates price swings.

Electricity Reliability Replacing an aging fleet with new plants and improved transmission systemsimproves emission control as well as enhancing overall reliability.

Energy Affordability Maintaining low cost energy and electricity supports competitiveness ofU.S. industry and reduces energy cost drag on U.S. households.

Source Flexibility Developing fuel and power options enables industry and consumersto adopt more efficient consumption patterns with lower emissions.

Modernization Upgrading grid and pipeline systems reduces disruptions and allowsfor smart adaptation to fend off shutdowns or bottlenecks, reduce emissions.

Energy Security goals adapted from “Energy Challenges” in NEP (May 2001)

Climate VISION approaches contribute to overall energy security goals.

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Oil & Gas Price Volatility Continued in 2004

Crude OilAscent of crude oil prices in 2004 has hindered full economic recovery, and provides a painful reminder of U.S. commercial vulnerability due to import of more than 60% of our crude oil, the primary fuel for all transport modes.

Natural GasNatural gas volatility, varying more than 80% within a 12 month period, has aggravated industries dependent on gas as a primary feedstock or heating fuel, such as chemicals, fertilizers, metalworking and cement. LNG terminals are facing stakeholder resistance.

Market volatility not being addressed.Market volatility not being addressed.

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Competitiveness in U.S. Chemical Sector

Letter to the President (Nov. 19, 2004)

“Mr. President, we believe that the high and volatile price of natural gas is the number one threat to our ability to compete in global markets. All consumers are paying a terrible

price. Solving this problem will require committed leadership on the part of the next Energy Secretary. I urge you to select an Energy Secretary who will champion the cause of the consumer and tackle the problem of high and volatile natural gas prices head on.”

Thomas E. Reilly, Jr.

President and CEO

American Chemistry Council

National Petroleum Council

The NPC calls for increased energy efficiency, greater flexibility in industrial and residential fuel choices, immediatedevelopment of new sources of supply, and enhanced infra-structure investment.(gas report, 2003)

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Coal’s Leading Role in Power Sector

-

1,000

2,000

3,000

4,000

5,000

6,000

2002 2012 2020

Ele

ctri

city

Gen

erat

ed (

Bill

ion

KW

hs)

Coal Nuclear Gas Dual fuel

Hydro Bio+MSW Wind Solar

By 2020, EIA forecasts that U.S. will still use coal for 45% – 50% of U.S. electricity…

Climate VISION:

How do we best use coal to economically sustain industrial competitive-ness and energy security with minimal environmental impact?

EIA forecast for U.S. Electricity Generation, 2002 – 2020 (AEO 2004)

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IGCC Risk Study – 1: Questions

TECHNOLOGY & OPERATIONS RISKS (system performance)

• Risk: Electric price is materially higher for IGCC due to high capital costs.

• Lack of competitiveness of electricity due to higher labor or operating costs.

• Excessive IGCC breakdown, downtime, non-routine engineering & repair costs.

• Poor technical performance of IGCC relative to specs (e.g., higher heat rate).

• Lack of standardized IGCC systems (higher costs or reduced performance).

• Lack of skilled workforce to build IGCC plants to specifications.

• Lack of skilled operators to properly run IGCC plants to specifications.

• Lack of materials and engineering progress keep system costs high (>$1,500/KWe).

• Acute accidents generate penalties or severely damage the plant.

• EPC or vendor fails to provide adequate support of IGCC to maintain performance after startup.

• Waste disposal risk (e.g., price of disposal rises sharply or location is closed).

Risks are evaluated based on “probability of occurrence” and “severity of impact”, if risk is realized.

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IGCC Risk Ratings – 1: Technical

0.0 5.0 10.0 15.0 20.0 25.0

High capital cost

High labor/operating cost

Excessive downtime

Poor tech performance

Lack of standardization

Lack of workforce to build

Lack of skilled operators

Lag in engineering progress

Damage from accidents

Thin EPC/vendor support

Waste disposal disruption

Rating of IGCC Risks (probability x severity)1) Technical Risks

Problem: no real standard IGCC system

IGCC system not fully developed, and faces extra downtime early on to fine tune performance. Lack of EPC confidence shows up here.

Workforce issues are not rated as high risks.

25 ratings33 ratings

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IGCC Risk Study – 2: Questions

REGULATORY & POLICY RISKS (differentiation for IGCC)

• Risk: State-level air permitting delays fail to deter conventional coal plant orders.

• Federal mercury regulations favor conventional coal (e.g., PC) plants.

• Federal SOx and NOx regulatory delays favor conventional coal plants.

• Economic value of carbon capture fails to materialize, reducing advantage of IGCC.

• Risk that IGCC is regulated (by states or EPA) based on NGCC performance.

• Cost of carbon sequestration for PC plants approximates that for IGCC.

• Regional and state policies fail to provide any or sufficient incentives for IGCC

• National policies provide insufficient rewards, incentives for IGCC (e.g., tax, NSR, etc.).

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IGCC Risk Ratings – 2: Regulatory

0.0 5.0 10.0 15.0 20.0 25.0

State air permitting on PC

Fed mercury regs favor PC

Fed SOx/NOx regs help PC

Little carbon capture value

IGCC reg tied to NGCC

No cost edge on CO2 sequest

No state policies for IGCC

Nat'l policy on IGCC lags

Rating of IGCC Risks (probability x severity)2) Regulatory Risks

Regulatory issues are not seen as "deal-killers", though doubts remain about national policy commitment and that carbon capture value will ever materialize.

25 ratings33 ratings

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IGCC Risk Study – 3: Questions

MARKET & FINANCE RISKS (dynamics of demand and supply)

• Long-term electricity demand (for utilities, IPPs) fails to grow as fast as forecast.

• Erosion of coal transportation infrastructure raises delivered cost of coal over time.

• Competing “old coal” generation reduces dispatch of IGCC, thereby curbing revenues.

• Low natural gas prices make NGCC more competitive (reducing dispatch).

• Coal prices rise markedly, inflating IGCC electricity generation costs.

• Interest rates rise in the medium term, penalizing new capital-intensive projects.

• State PUC does not approve long-term contract or rate review to cover IGCC costs.

• Financing of IGCC is difficult, or requires lots of equity, even at low interest rates.

• Revenues of IGCC by-products (e.g., sulfur, slag) fail to materialize as forecast.

• Customer of IGCC suffers significant losses and cancels IGCC project midway.

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IGCC Risk Ratings – 3: Market

0.0 5.0 10.0 15.0 20.0 25.0

LT electric demand

Coal transport erosion

Old coal competition

Lower gas prices

Coal prices rise

Interest rates rise

PUC rate approval fails

Financing difficult

By-product revenue lags

IGCC customer fails

Rating of IGCC Risks (probability x severity)3) Market Risks

Vulnerability to interest rate rises is keyed to high capital costs; though some buyers have access to low rate debt. PUC approval and financing are still viewed as problematic.

The competitive position of coal might have improved with recent gas price spikes and volatility. "Old coal" poses some challenge, but not overwhelming because of its low efficiencies. Most believe that gas prices will stay higher now.

25 ratings33 ratings

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Example Terms: Three Risk Mitigants

1. Standby credit facility:

A. Default coverage

• Purpose: For the first few new plants, address startup risks due uncertainties about the system technology and scale-up. Default coverage will not be provided for contractor fault or utility actions that lead to abandonment of a plant. In the event of technical failure, government...

• …would reimburse a negotiated % of project equity + debt.

• The likelihood of such default is much lower after three years of successful operations, and the coverage can expire.

1. Standby credit facility:

B. Interest coverage during commissioning delays

• Purpose For the first few new plants, address startup risks due uncertainties about the system technology and scale-up. Default coverage will not be provided for contractor fault or utility actions that lead to abandonment of a plant. In the event of technical failure, government...

• …would cover a negotiated portion interest payments during startup downtime. Payments would convert to project loans at negotiated terms.

• If a loan is executed, the likelihood of repayment is high once plants are full operational, dispatch as baseload and generate positive cash flow.

2. Direct loans • Purpose: Address high capital cost and downtime risk, and leverage private sector financing, so plant financial returns reach utility investment requirements. The government…

• …would provide part of plant costs in the form of loans to the project at Treasury rates, which would be repaid over ~25 years after commissioning.

3. Power production incentive (PPIs), as loans

• Purpose: Reduce market risk and address high plant cost, so plant financial returns reach utility investment requirements. The government…

• …would buy power at negotiated elevated rates (above market) for a period of time. Payments would be converted to loans (~25 years). Repayment begins after other government payments are completed.

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Power Project Timeline

Different risks arise at each phase of power projects; value in matching appropriate tools to particular risks.

Long Lead-Time

Procurement

Start-Up

$CloseFinancing

Regulatory Approval Engineering Construction Operation (or delay)

$

Development

Operations and generation

ScheduledStartup

$ Repayment of debt and equity from future revenues

Industry Investment$

Power Project Timeline

“Go / “No Go” decision

40

Long Lead-Time

Procurement

Start-Up

$Close

Financing

“Shakedown”

Regulatory Approval Engineering Construction Operation (or delay)

1

Standby Credit Facility for Regulatory & Commissioning Risk: Debt + Equity1a) Coverage of interest payments in downtime1b) Loan guarantees for debt coverage(established before close of financing)2) Direct Loan for Engineering & Construction

$

Development

Timing of Mitigants: Combined

Possible early downtime

Scheduledrampup

$

1b) Loan guarantees

1a) Interest Coverage

Repaymentof governmentcredit from future revenues Industry Investment

Government Credit$

$

Power Project Timeline

3

Direct Loan2

3) Power productionincentive for X years

1