Brazil’s Banco Nacional de Desenvolvimento Econômico e Social and an affiliate of ERB – Energias Renováveis do Brasil, a Brazilian biomass-to-energy start-up, closed the R210.7 million ($103.8 million) project financing for the the Aratinga wood-to-energy greenfield project on 28 June 2012, two years after starting work on structuring the deal. BNDES, Brazil’s main long-term infrastructure lender, had never financed a wood-to-energy project before, which contributed to the lengthy financing process. The R265.4 million ($130.7 million) Aratinga cogeneration project will also be ERB’s first wood-to-energy plant.

The Aratinga project will replace the natural gas-fired steam supply at Dow Chemical`s petrochemical site in Candeias, in the state of Bahia. To this end, ERB is building a dedicated cogeneration unit and planting 10,000 hectares (24,700 acres) of eucalyptus-wood biomass to fuel it. This will produce up to 150 tonnes of steam per hour and fulfil an 18-year steam purchase agreement that serves the site’s chloralkali and chlorohydrin production processes. As a by-product, ERB is also generating 11MW of excess power to dispatch to the grid.

This is believed to be the first case in the world of a petrochemical site being fed by steam produced from biomass. Dow Chemical benefits from a lower cost for its steam supply, estimated by ERB to be around 24%. The project is expected to start operations in August 2013.

While all the funding ultimately comes from BNDES, the debt contract was signed between ERB and three Brazilian banks. These banks acted as lenders, taking all the credit risk of the project as well as all the project’s guarantees under a repasse arrangement. Banco Votorantim, the lead arranger, is providing 34% of the debt, while Banco Itaú BBA and Banco Bradesco are each providing 33%. Rio Bravo was the financial adviser to the project.

To structure this loan ERB had to go through seven main steps:

First step

ERB had to choose lenders. In June 2010, ERB and Rio Bravo issued a request for proposals to six of the most active banks in Brazilian project finance; ERB sought credit-approved commitments, so it allowed four months for the banks to complete due diligence and submit proposals.

Second step

In November 2010, after choosing the three banks, ERB began negotiating a term sheet before examining BNDES financing. The negotiations were tough and lasted until March 2011. Meanwhile, in December 2010, ERB signed the 18-year steam purchase agreement with Dow Chemical.

Third step

Rio Bravo and the banks applied to BNDES for financing eligibility in April 2011 by presenting Aratinga’s summarised business plan. BNDES, after two months of assessment, indicated that the project was eligible for financing.

However, BNDES assessed the eligibility of the project in completely different terms to those presented in the business plan. The project, as first presented, had a total investment amount of R220 million ($108 million) and applied for a R176 million ($87 million) in financing under one credit line: alternative energy. But the BNDES eligibility analysis suggested that the project could access only R116 million ($57 million) under two different credit lines – productive capacity and working capital. BNDES’ alternative energy department would be responsible for analysing the project.

ERB, Rio Bravo and the banks arranged a meeting with the alternative energy department to understand why the eventual financing eligibility was so different to what they had requested. BNDES’ eligibility department did not understand that this project was eligible under the alternative energy credit line, which allowed projects to raise 18-year debt for up to 90% of eligible investment amounts. Instead, the eligibility department thought that the project was eligible under the productive capacity credit line, which had shorter tenors and would only fund up to 60% of eligible investment amounts. BNDES may have come to this conclusion because the alternative energy credit line was fairly new and has usually been applied to wind projects.

Another reason for the lower eligibility amount was that part of the investment in eucalyptus plantation and maintenance relative to a period beyond the start-up of the cogeneration unit were considered not eligible for financing. Since eucalyptus for energy use takes roughly six years to reach maturity, ERB thought it made sense to include five years of investment in eucalyptus (2011-2015). But BNDES’ alternative energy department explained that it could not finance a greenfield project beyond its start-up year. ERB would have to apply in a second stage for its 2014-2015 eucalyptus investment.

At this point, with only R116 million ($57 million) in eligible financing, the alternative energy department suggested that ERB continue the process, as it could submit the project for a second round of financing eligibility analysis later on.

Fourth step

ERB had to prepare a detailed business plan for Aratinga to enable BNDES’ alternative energy department to start its final analysis, but the project was not far enough advanced in June 2011 for this analysis to start. Aratinga, at that point, lacked the following conditions defined by BNDES and the banks: the issuing of the environmental industrial installation license; the approval of the tax incentives ERB had promised to obtain in the summarised business plan; bankable technical due diligence from independent consultants; the selection of the main suppliers to the construction of the cogeneration unit (engineering, procurement and construction; boiler; and turbine); the negotiation of a final figure for industrial capital expenditure; and the creation of an operation & maintenance strategy for the cogeneration unit. Additionally, ERB and its financial adviser had to negotiate with the banks the complete terms and conditions for the loan and all of its many guarantees that were first outlined in the first term sheet of March 2011.

The structuring of all loan-related contracts was a massive challenge with five legal teams at the table: each bank`s internal legal counsel, Mayer Brown as banks’ legal counsel, and ERB’s internal legal counsellor. It was the first time any of the five legal teams dealt with a wood-to-energy project financing with no friendly ready-to-go contract templates. The negotiations started in April 2011 and finished only in December 2011 with an additional round of final negotiations in the month previous to the signing of the loan.

The environmental industrial installation license was issued in less than six months, in August 2011, a fast process by Brazilian standards.

ERB, whose adviser was Ernst & Young, planned to obtain three tax incentives: REIDI, Desenvolve and SUDENE. In August 2011, ERB Aratinga obtained the REIDI incentive and in November the Desenvolve incentive. The SUDENE incentive application process extends to the commissioning phase of the cogeneration unit, so the project will obtain this one later on.

The banks demanded six technical due diligence reports on the project from independent consultants: basic engineering project review by WBS, which was concluded in October 2011; construction supervision by WBS until start-up; agricultural assumptions review by JSR, which was concluded in September 2011; environmental compliance review, including an Equator Principles compliance action plan, which was conducted by ERM and concluded in October 2011; an insurance plan conducted by JLT, which was concluded in December 2011; and, finally, legal advice and review of the loan related contracts conducted by Mayer Brown.

Between June and August 2011, ERB sent out requests for proposals to select the main suppliers and final contract values. In December 2011, it picked as boiler manufacturer CBC Industrias Pesadas (a subsidiary of Mitsubishi Heavy Industries), a leading biomass boiler supplier in Latin America. Later that month, it chose Produman, a traditional contractor in the state of Bahia, to be engineering, procurement and construction contractor. In March 2012, it chose TGM, the number one turbine manufacturer for biomass in Brazil, as turbine supplier. The contract structure consists of a turnkey fixed-price boiler contract with CBC and a turnkey fixed price contract for everything else with Produman. The boiler supplier is so reliable that ERB did not feel that it was worth having the entire cogeneration unit guaranteed by the EPC contractor.

The operation & maintenance strategy for the cogeneration unit was to outsource it under a long term contract with a reliable and experienced supplier. ERB issued a request for proposals in September 2011, but given the relatively high costs of outsourcing this function, ERB is still considering the possibility of doing it by itself. Therefore, ERB agreed with the banks that the implementation of the strategy should be made no later than six months before start-up.

At the same time, as Aratinga project was maturing, ERB decided to increase its steam output. Given that the project’s steam supply represented only about half of Dow Chemical’s needs at its petrochemical site in Candeias, ERB negotiated with Dow Chemical an amendment to the steam purchase agreement and decided at year-end 2011 to expand the project. The boiler was upgraded from 130 to 150 tonnes per hour of steam, the excess power generation increased from 8.2MW to 11.0MW and the Eucalyptus plantation expanded from 8,261 to 10,000 hectares. Consequently, the project’s total investment amount increased from R220 million to R265.4 million.

In January 2012, after fulfilling all of BNDES’ and the banks’ conditions, ERB was finally allowed to present its detailed and updated business plan for the project, and did so at the end of January. At the same time, given the change to the project, the banks and the BNDES asked for an update to both the basic engineering project review and the agricultural assumptions review.

Fifth step

In February 2012, BNDES started its project analysis period. The alternative energy department started its analysis by visiting the project. The next two months involved almost daily questions and ERB had to constantly forward BNDES additional documents and information.

Sixth step

By the beginning of April 2012, BNDES’ alternative energy department sent the first draft of its project financing terms and conditions to ERB, Rio Bravo and the banks. The draft was based on the terms and conditions ERB and the banks had previously agreed upon, plus a few changes BNDES thought necessary based on its analysis. All parties involved had to agree to the terms and conditions of the financing to enable BNDES’ alternative energy department to submit this document to its board of directors for final approval.

At the same time, given all the changes to the Aratinga project since the banks’ first credit approval in the end of 2010, the project had to be submitted again for final credit approval to each bank. This process started in February and continued through April 2012, with the project analysis by BNDES’ alternative energy department completed in the beginning of May 2012.

Aratinga also had to go through a second round of financing eligibility analysis in order to increase the financing amount and adjust its credit lines, but this was also completed in May 2012. Subsequently, the financing terms and conditions were swiftly finalised, allowing for its submission (along with a review report of the project’s business plan) to BNDES’ board of directors.

Seventh step

The final step was to win approval at a board of directors meeting, which are typically scheduled for each Tuesday. In order for a project to be consider at a particular meeting, it has to be submitted for approval by the previous Wednesday. The alternative energy department tried to submit the project four weeks in a row. During the first three weeks, the project was not approved during internal reviews. Finally, on 13 June 2012, it was successful, allowing for consideration at the following week’s board meeting, and about a week later, the project financing debt contract was signed.

The R210.7 million financing falls under three credit lines. The main line is called alternative energy and represents 83% of the total. This line includes the acquisition and assembling of equipment, construction of the cogeneration unit, engineering, plantation and maintenance of eucalyptus and pre-operational and development expenses. The second line is called working capital and represents 16% of the total. This basically covers the acquisition of third party biomass to supply the first four years of operations while ERB’s eucalyptus forests are growing. The third line is called social and represents a little less than 1% of total funding, and will be used to develop social projects in the areas covered by the Aratinga project.

Although it was the first time that BNDES was asked to look at a wood-to-energy project, its strong cash flow generation (1.5x debt service coverage ratio) allowed it to obtain a 79/21 debt/equity ratio, pretty close to BNDES’ established ceiling of 80:20. Another reason for the high leverage was the 17.5 years tenor possible under the alternative energy and social credit lines, including a grace period of 19 months while interest accrues. The project’s debt service payment obligations will start six months after the planned start-up of the cogeneration unit in August 2013 and will last for 16 years on a linear basis. The working capital credit line has an 8-year tenor.

The pricing of the alternative energy and social credit lines is a flat 140bp over TJLP (the long-term interest rate, currently 5.5% per year) charged by BNDES plus the commercial banks’ spread for taking on the credit risk of the project. The working capital credit line has a higher BNDES rate and the same credit risk spread charged by the banks.

In terms of guarantees, the banks benefit from the following: a pledge of the cogeneration unit; a pledge of all the eucalyptus plantation; a mortgage over the project’s own agricultural lands; a mortgage over the surface rights to the industrial site provided by Dow Chemical; a pledge of all credit rights from the sale of steam and power; a pledge of the power production permit; a pledge of all ERB Aratinga’s shares; a conditional pledge of all contracts related to the project, including the agricultural ones; a corporate guarantee from ERB to ERB Aratinga, valid up to project completion; and an equity support agreement from FI-FGTS and Rioforte Investments (ERB’s main shareholders, with a 49% stake each), also valid up to completion.

On the last guarantee, FI-FGTS could not legally give a corporate guarantee for the project valid up to its completion, as desired by the banks. In exchange, ERB and Rio Bravo negotiated with the banks a R25 million ($13.3 million) equity support agreement in order to mitigate the risk of cost overruns at the cogeneration unit and the Eucalyptus plantations.

As a condition of the first draw on the loan, CBC and Produman had to provide performance bonds equivalent to at least 15% of the value of their contracts, to mitigate the risk of construction delays and construction completion. In addition, the equity portion of the financing had to be contributed upfront to ensure that there would be no funding constraints. Moreover, even though the steam cashflows represented 88% of revenues, Aratinga had to commit to sell its 11MW of excess power under a five-year power purchase agreement in order to obtain the 79/21 debt/equity ratio.

ERB had intended to sell the excess power in 2011. It tried to participate in the auction held by ANEEL (Electrical Energy National Agency) in August 2011. However, the market price had decreased substantially from around R150 per MWh ($73.89 per MWh) in 2010 to around R100 per MWh ($49.26 per MWh) in 2011. So ERB decided to wait for the market price to improve during 2012, as Aratinga would not be operational until August 2013. Given that prices in auctions held by ANEEL in 2012 are likely to be depressed, ERB is currently negotiating to sell Aratinga’s 11MW excess power in the free market.

Overall, the main challenges faced during the structuring of this loan were:

1. The fact that this was the first time BNDES and the banks financed a wood-to-energy project

2. The fact that this is a greenfield project that involves agricultural investment as well as industrial

3. That the main revenue comes from steam rather than from power

4. That the project is supplied by wood and not by sugarcane bagasse unlike most Brazilian projects

5. That this is the first project of a pre-operational sponsor founded in 2008

6. That the sponsor’s shareholders could not put a corporate guarantee in place.

The expected net present value of the Aratinga project is significantly positive and its estimated cash flow generation is very robust. As a result, this project became a living example that biomass-to-energy projects can be economically feasible in Brazil, even without any feed-in tariffs or subsidies from government.