FAQ: Why Does Cleantech Need Loan Guarantees?

Yeah, I know, loan guarantees aren’t the most scintillating topic around, but stay with me. They’re a big deal when it comes to financing big clean energy projects and not really that difficult to understand. Essentially a loan guarantee is a promise by the government to back a loan if the company can’t pay it, and the loan goes into default.

Earlier this week the Department of Energy said it would provide a total of $38.5 billion in loan guarantees spread out across several industries, with $10 billion allocated to renewable energy and electric vehicles, $20.5 billion for nuclear projects and $8 billion for “advanced fossil energy projects.”

This is great for cleantech startups because the federal government has a lot of money and banks consider it to be a reliable borrower. Cleantech startups generally operate at a loss and are considered high-risk borrowers by banks. For any high-risk borrowers (like Uncle Lennie, who has no job and $40,000 in credit-card debt) banks will demand a lot of money up front and a high interest rate before lending money to them. With plants for solar cells or facilities for solar thermal electricity generation ranging in costs from millions to billions, it’s pretty challenging to raise that kind of capital.

And even if the company can scrounge together hedge funds or venture funds to provide the down payment for plants, high interest rates still translate into higher costs, which is then passed on to the consumer of renewable electricity.

Let’s do the math: Say to build a plant a startup has raised $500 million, which is 80 percent of the down payment. It still needs to borrow $100 million that needs to be paid back over the next 10 years. If the startup is charged a high interest rate — let’s say 12 percent — the monthly payments on that loan are $1.4 million. With a loan guarantee it has a chance of getting a more reasonable interest rate, of let’s say 6 percent, which brings the monthly payments to $1.1 million. Over the life of the loan those 6 percentage points cost the company about $39 million. This kind of math works for consumers, too.

So federal loan guarantees, which only cost taxpayers if the startup can’t pay its debt, are a nice way of offsetting risk without having to create a direct subsidy. Of course, the government is on the hook if the startup fails (and some of them will), but by lowering borrowing costs the government is helping the clean energy industry get over some of the humps associated with building a capital-intensive industry from the ground up.