The Implications of Plant Optimization Activities

By John Eustermann and Randy Shefman | September 08, 2008
As crush margins shrink, owners of existing ethanol facilities are under significant pressure to reduce costs and boost revenues. Further, new market participants implementing second-generation technologies with the backing of the latest incentives have changed the competitive landscape for the early industry movers. These dynamics require plant managers to investigate incorporating new technologies and equipment into existing facilities to optimize yields and, in some instances, create additional revenue streams from new coproducts. Management should consider the impact such optimization activities have on operational documents such as previously executed financing or development agreements, technology licenses or permits.

The following are some common project-related documents that should be examined when investigating optimization activities or technological modifications to the plant.

Technology licenses: As part of the initial construction and development, a technology license agreement is often a key document included in the overall construction or document package. It includes language governing a plant's use of the initial process technology, including certain duties and obligations related to technological modifications. A close examination of the license agreement and the licensor's intellectual property rights is warranted in the face of optimization strategies that involve technological modifications.

Financing documents: Any modifications should be investigated with the active participation of the company's lender. For those companies still subject to a term loan, several restrictions require lender review of and consent to any significant changes to the plant. A review of all financial and operational bank covenants is warranted, as a number of provisions might be triggered by such proposed investments in optimizing a facility.

For example, how will such activities affect current debt/leverage ratios, new debt restrictions, capital expenditure limits, cash flow sweeps and/or other use restrictions on cash flows from earnings? Additionally, in most instances, before approving new capital investment, lenders will need to review revenue enhancing and payback projections to ensure such figures are based on sound and reasonable assumptions. Also, the lender likely has a blanket lien on all existing and future acquired assets. This is key to the extent management is seeking to finance plant modifications from a source other than its current lender. In such instances, each lender will likely need to agree to appropriate subordination and intercreditor arrangements.

Finally, if financing optimization activities, the lender will likely require collateral assignment of relevant project agreements and warranties, such as any technology license agreement, operational agreement or equipment warranties.

Off-take agreements:
As the primary documents governing the generation of revenue for the biofuel plant, management is wise to give the off-take agreements a thorough review in the face of any plant optimization activities. The issues to consider in such instances range from the potential for any slowdown or shutdown in production that may be necessary in any plant upgrade to the effect such technology changes may have on the quality of the fuel produced. A production delay or the failure of such production to meet applicable specifications or ASTM standards as negotiated in the off-take agreement can have a direct negative effect on the cash flow of the facility.

Permits and site control issues: The effect that any proposed optimization projects may have on a facility's environmental controls cannot be overlooked. With regard to both air and water, such activities can trigger management's need to obtain new or revised permits. Physical changes or changes in the method of operation that may result in increased or modified air emissions or changes to water appropriation and/or water discharges at the plant require regulatory review to determine if additional permitting is required. It is important to note that such regulatory review is required even if the increased air emissions or changes to water appropriation and/or water discharges will meet existing permit limits.

John Eustermann is an attorney with Stoel Rives LLC. Reach him at jmeustermann@stoel.com or (208) 387-4218. Randy Shefman is an attorney with Hogan & Hartson LLP. Reach him at rshefman@hhlaw.com or (303) 899-7338.