Panda Hereford Ethanol: Cow fired

Ethanol emerged as a distinct asset class in 2006, one that moved from the preserve of agricultural banks and B loan providers to attracting the interest of mainstream commercial lenders. Panda Ethanol was not the archetypal ethanol financing, since other producers raised more financing, some of it more cheaply, for more conventional assets. But Panda, a newcomer to the sector, produced a technologically compelling project coupled to a mix of all of the new sources of debt finance – banks, municipal finance and hedge funds.

Panda is a familiar name to project lenders – a venerable developer of independent power projects both in the US and overseas. Among its projects have been contracted power plants in China and Maryland, and merchant projects in Texas and Oklahoma. These ventures have enjoyed chequered operating histories, but Panda maintains a devoted bank following.

The origins of the Hereford project lie in Panda's desire to diversify out of natural gas and into other sources of fuel for power generation. According to Michael Trentel, Panda Ethanol's CFO, the developer had spent 2004 examining the cattle feedlots of Texas after considering the potential of cow manure as a source of biomass for electricity generation.

"The economics didn't stack up," says Trentel, but Panda noted that while cow manure did not have the calorific content to generate electricity at a sufficiently attractive cost, it did produce enough heat to distill corn into ethanol. It thus also serves as a replacement for expensive – and volatile – natural gas.

This last element is important, since the economics of an ethanol project rely upon the interaction of three volatile commodities – corn, natural gas, and petrol. While gas and gasoline are frequently correlated, and thus the fuel arrangement does not remove all volatility, it does benefit from lower operating costs.

But this ability to run on manure comes at a price – a capital cost roughly $40 million higher than the equivalent gas-fired ethanol plant. Financing this increase in a cost-effective fashion meant looking to other sources of debt than agricultural banks and B loan providers. The sponsor also accessed tax-exempt financing, which can offer advantages of tenor, and also gains the support of local officials.

However, this still left Panda with a substantial gap in its funding requirements. The total cost of the project is roughly $269 million, and it could support $158 million in senior debt. So Panda, which normally leverages its project at much higher levels, also brought in a subordinated loan of $30 million from Balkan Ventures, a Connecticut-based hedge fund. It has raised additional equity through a reverse merger with Cirracor, a listed shell company.

Panda mandated Societe Generale as lead arranger of debt, on the back of its project finance background, a familiarity with commodity markets, and its previous work for the developer on power projects. SG underwrote a $103.1 million term loan maturing in 2013 and priced at 375bp over Libor, stepping down to 350bp after construction, and a $5 million working capital facility maturing 2011. It also provided a letter of credit to support the issuance of 20-year tax-exempt bonds due 2026. The issuer of these bonds is the Red River Authority of Texas, which ordinarily is responsible for the region's water resources. According to Trentel, the coupon of the bonds, as well as SG's letter of credit fee, bring pricing roughly into line with the senior bank debt.

Nevertheless, coordinating the respective security and intercreditor documentation, and ensuring the separate elements closed in the correct order was an exacting and sometimes frustrating task. This sometimes stemmed from the different backgrounds of the lenders and, notes Trentel "it took time to get our ducks in a row and reach a closing on the debt that was roughly contemporaneous." The debt financing closed on 28 July and the municipal bond issue on 31 July. Participants in the bank debt were Highland Capital, BBVA, KfW, Bank of America, CAM, American Money Management, Oak Hill and Greenstone Farm Credit Services.

Despite the time taken to reassure senior lenders that the capital structure was sustainable, lenders could take some comfort in the economics of the project, particularly the low fuel costs, abundance of manure on Texas' feedlots, and the ready market for wet distiller's grains, which command a good price. Panda does not have to ship these far, and does not have to dry them, as those further afield do.

Moreover, while Hereford is not the ideal location for procuring supplies of corn (although it is close enough to growing areas), it compensates for this in its nearness to refiners. Panda originally chose the West Texas site because it offered convenient access to the refining market in California, since this state was a leader in banning MTBE, the alternative fuel additive to ethanol. The 2005 EPAct, which further pressured users of MTBE, made Panda's product attractive even in Texas, traditionally an MTBE stronghold. Aventine Renewable Energy, which currently controls 825 million gallons in annual capacity, will provide marketing services to the project, if it comes online in the fourth quarter of 2007* as planned.

Panda Ethanol was not the largest, the first, the cheapest, or the mostly cleanly executed deal in its class in 2006. But in marrying such leading-edge technology to such a blend of financing techniques, and achieving acceptable pricing for Panda, which is relatively thinly capitalized, it may prove to be a more influential structure as the biofuels market enters maturity. Biodiesel projects, which face similar issues in convincing banks of the merits of less proven technology have an adaptable, if not off the shelf, template. Moreover, Panda has four more plants under development, using much the same technology, of which two already have air permits.

Panda Ethanol Hereford LP
Status: Closed 31 July 2006
Size: $269 million
Location: Hereford, Texas
Description: Biomass-fuelled ethanol plant with a 100 million gallons per year capacity
Sponsor: Panda Energy
Senior debt: $158.1 million
Bank debt underwriter: Societe Generale
Bond underwriter: Thornton Farish
Subdebt provider: Balkan Ventures
Legal counsel to the sponsor: Chadbourne & Parke
Legal counsel to the bank lenders: Baker & MacKenzie
Legal counsel to the subdebt provider: Reed Smith
Issuer bond counsel: McCall Parkhurst & Horton
Sponsor bond counsel: Haynes & Boone
Independent engineer: RW Beck
Marketing consultant: SJH
Gasifier technology provider: Energy Products of Idaho
EPC contractor: Lurgi PSI
Insurance consultant: Aon

*Correction: This sentence originally included a reference to a January 2007 start date. This date came from a 2005 prediction from the developer. A more current prediction, and the one in use at the time the article was written, is for the fourth quarter of 2007.