IG: DOE MANAGING HECA AT ‘INCREASED RISK LEVEL’

Tamar Hallerman
GHG Monitor
6/14/13

A report released by the Department of Energy’s Inspector General this week says that SCS Energy’s Hydrogen Energy California (HECA) project is “progressing,” but concludes that DOE is managing the large-scale carbon capture and storage project “at an increased risk level.” In an audit report released June 12, the internal watchdog says that DOE officials overseeing a modified $408 million cooperative agreement for the 390 MW integrated gasification combined cycle facility have undertaken a “substantial increase in upfront risk” by allowing project developers to “substantially decrease” their cost-share responsibility for the early stages of the southern California project. “As such, the Department is at risk of expending $133 million for its share of project costs in the first phase without it being completed if the recipient is unable to obtain funding for the next project phase,” the report says.

The audit brings increased scrutiny to the new-build, pre-combustion CCS project, which has undergone a significant structural transformation in recent years. DOE initially signed a $308 million cooperative agreement with HECA’s original developers, BP and Rio Tinto, in 2009 with money from the stimulus bill. Back then, the IGCC project was slated to produce hydrogen and utilize the facility’s captured CO2 for nearby enhanced oil recovery operations, with an estimated price tag of about $2.8 billion. But by spring 2011, after DOE and project partners spent roughly $75 million laying the groundwork for HECA, BP and Rio Tinto decided to abandon the project after they determined it was no longer economically viable. The Massachusetts-based developer SCS Energy then took over the project later that year and subsequently enacted several major changes to its design, adding a poly-generation component by incorporating urea fertilizer production in addition to the hydrogen, electricity and CO2. SCS also decided to pursue a ‘dispatchability’ component for HECA, which allows a portion of the electricity produced at the plant to be ramped up or down as needed in order to meet seasonal electricity demand. Those changes subsequently boosted the project’s price tag to nearly $4 billion. DOE later accepted the changes to HECA’s cooperative agreement, upping the government’s cost-share commitment to $408 million.

Key Updates Missing, IG Says

In its examination of the Department’s rules for forging cooperative agreements, the IG concluded that while DOE has policies in place for managing the approval of initial cost-share contracts, there was little guidance in place governing procedures for reviewing significantly modified contracts. In a memo to acting Deputy Assistant Secretary for Clean Coal Darren Mollot, Director of the Western Audits Division for the IG David Sedillo said DOE officials did not obtain and review the proper documentation for HECA’s modified design needed to substantiate the underlying principles in the project’s financial model, the formula used for determining a project’s financial viability. “In the case of the subsequent change of ownership, the Department did not require the new owners to provide supporting documentation for financial projections even though comparable information was available from other Departmental reports and projects at the time of the modification,” the IG said, adding that officials failed to reconcile new projections for factors like interest rates, operations and maintenance costs and property taxes for the retooled project, even though many of those factors had changed substantially since the original HECA design was pitched in 2009.

The audit notes that SCS provided DOE with seven updates for the financial model since HECA’s ownership changes were finalized, adjusting projections for factors like engineering and insurance costs, maintenance and property taxes. “Department officials told us that they reviewed the updates for reasonableness, but had not required any supporting documentation and could not explain changes made in the updates,” according to the IG. A HECA spokeswoman said the project had “no comment on the report at this time.”

The watchdog said DOE officials told them that they had tested the basic functionality of the financial model underlying HECA’s updated cooperative agreement and that they were going to validate the assumptions in greater detail before recommending whether the project could move into the construction phase. “However, in our view, the recent significant projected increase in the total project cost and potential adverse impact on the debt to equity ratio that has occurred since the change of ownership, as previously noted, increased the Department’s risk and demonstrated the need for the Department to obtain and review supporting documentation for key projections made in financial models in modifying future cooperative agreements,” the IG concluded. DOE did not respond to a request for comment as of press time.

More Thorough Reviews Needed

In order to improve DOE’s management of cooperative agreements, the IG suggested that the director for Policy, Office of Acquisition and Project Management develop policies and procedures that provide guidance for ownership changes in financial assistance awards. It also recommended that the official closely review changes to financial projections and cost-share contributions to assess their impact on projects. In terms of HECA specifically, the IG said the Deputy Assistant Secretary for Clean Coal should ensure that officials complete thorough reviews of the project’s underlying financial assumptions.

The watchdog said DOE officials did not agree with some their concerns, particularly related to the IG’s claim of the absence of supporting documentation for the modified financial projections. According to the IG, the DOE officials said the “level of financial review conducted at the ownership change was likely equivalent to or better than the level performed for the original award.” But the IG said more explicit requirements and documentation are needed. “Although the Department required supporting documentation for financial projections in the original award, the merit review was critical of the lack of supporting documentation for financial projections,” the IG said. “Although it recognized the very preliminary nature of financial projections provided by HECA, the Department did not require periodic updates or a detailed analysis of the financial projections in the modification agreement.”

Project Officials Aim for Q4 Financial Close

The IG report comes as company officials are aiming for a fourth quarter financial close date for HECA. In an interview with GHG Monitor earlier this year, SCS Energy CEO Jim Croyle said the development company is hoping to begin construction on the IGCC facility in early 2014 despite the fact that the company must still receive permission to construct from the state, a record of decision from DOE, negotiate a power purchase agreement and secure financing for the project. “All the things that need to happen are happening,” Croyle said at the time. In the months since, HECA’s project timeline has slipped slightly as SCS waits for the California Energy Commission to issue its permitting decision, but project officials said they still hope to make a final investment decision announcement by the end of the year.