Federal energy financing, financial and budgetary implications of Government guarantees

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Federal energy financing, financial and budgetary implications of Government guarantees staff report on the Task Force on Energy of the Committee on the Budget, United States Senate
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x, 34 p. : ; 24 cm.
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English
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United States -- Congress. -- Senate. -- Committee on the Budget. -- Task Force on Energy
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Energy policy -- United States   ( lcsh )
Power resources -- Finance -- United States   ( lcsh )
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General Note:
At head of title: 94th Congress, 2d session. Committee print.

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Table of Contents
    Front Cover
        Page i
        Page ii
    Letter of transmittal
        Page iii
        Page iv
    Table of Contents
        Page v
        Page vi
    Summary
        Page vii
        Page viii
        Page ix
        Page x
    Chapter I. Introduction
        Page 1
        Page 2
    Chapter II. Financing energy development
        Page 3
        Page 4
        Page 5
        Page 6
    Chapter III. Federal guarantee mechanisms as incentives
        Page 7
        Page 8
        Page 9
        Page 10
    Chapter IV. Loan guarantees: A special problem
        Page 11
        Page 12
        Page 13
        Page 14
        Page 15
        Page 16
        Page 17
        Page 18
    Chapter V. Two major energy financing proposals
        Page 19
        Page 20
        Page 21
        Page 22
        Page 23
        Page 24
        Page 25
        Page 26
    Chapter VI. Budgetary treatment of guarantee mechanisms
        Page 27
        Page 28
        Page 29
        Page 30
    Chapter VII. The second concurrent resolution
        Page 31
        Page 32
        Page 33
        Page 34
Full Text



S94th Congress COMMITTEE PRINT
2d Session J





FEDERAL ENERGY FINANCING

Financial and Budgetary Implications of
Government Guarantees





STAFF REPORT

OF THE


TASK FORCE


ON ENERGY


OF TLHE


COMMITTEE ON THE BUDGET
UNITED STATES
$oilo^


^I


Dv


AUGUST 30, 1976


Printed for the use of the Committee on the Budget

U.S. GOVERNMENT PRINTING OFFICE
WASHINGTON : 1976


76-048





























COMMITTEE ON THE BUDGET
EDMUND S. MUSKIE, Maine, Chairmanii


WA R R EN G. MAGNUSON, Washington
FRANK E. MOSS. Utah
WALTER F. MONDALE, Minnesota
I-:ERNEST F. HOLLINGS, South Carolina
ALAN CRANSTON. California
LAWTON CHILES, Florida
JAMES ABOUREZK, South Dakota
JOSEPH R. BIDEN, JR., Delaware
SAM N U NN, Georgia


HENRY BELLMON, Oklahoma
ROBERT DOLE. Kansas
J. GLENN BEALL, JR., Maryland
JAMES L. BUCKLEY, New York
JAMES A. McCLULRE, Idaho
PETE V. DOMENICI, N>w Mexico


DOUGLAS J. BENNET, Jr., Staff Director
JOHN T. McEvoY, Chief Counsel
ROBERT S. BOYD, Minority Staff Director
W. THOMAS FOXWELL, Director of Publications


TASK FORCE ON ENERGY
FRANK E. MOSS, Utah, Chairman


ERNEST F. HOLLINGS, South Carolina
JOSEPH R. BIDEN, JR., Delaware
SAM NUNN, Ge,.riia


J. GLENN BEALL. JR., Maryland
JAMES A. McCLI'RE, Idaho
PETE V. DOMENICI, New Mexico


LEWIS J. ASHLEY, Task Force Coordinator
(II)







LETTER OF TRANSMITTAL


UNITED STATES SENATE,
TASKi FORCE ON ENERGY.
(COMMITTEE ON THE BUDGET.
1'f.sh./untoo., D.('. Aagqu.' 30. 197G.
lion. EDIMUND S. MUSKIE,
Chairman, Comm.rtt(,(C on the Jad((!lct, U.>. Senatee.
DEAR SENATOR 1nMUSKIE: The President's budge(lt for fi-r.al year
1977 included propol als for "off-budget'" energy fundin- that far
exceeded those on-budg'et propo-als of the Administration. The
Budget Committee did not have adequate information on the ap-
propriate budgetary treatment of the-i "off--budg'et" proposals and
their relationship to other enero'y spending at tlhe time the First Con-
ullrrent Resolution was bteino developed last spring. Accordinglyv. tlhe
Resolution the Committee recommended and the Congress approved
in Miay accorded a higlh priority to o(l-buid'et ener.ry propo-ds with
thle understanding g that the "offi-bld!)et" l)propo-als would be reviewed
i liht of the Budget Resolution and later information.
Major energy leislatiion now before the (Coniress is designed to
assist in financing energy production and developing new energy tellch-
ologies. Two key bills under consi(lderation col'ern uranium enrichment
and synthetic fiwuels. Tlhe Fedleral finacialictv iet ut included i1 these
propo':;ils are baical(lv (Govenm0,eit oiaraitees to help private ven-
tures borrow in capital markets by sAiarinr with tle private sector the
risk of project failure. The'i:e i Icent iives which incflutde loan. price,, and
project guarante('e- constitute coltitlucnt liabilities of the Federal
(G'overnment that iniln-4t be lmonoredl. IHowever. tlhe Adini]str:,tion pro-
poses that they appeal i only partial v ou-lbudtet or not at all.
Such contingent liabilities telid to reorder priorities, may have an
impact on ouPr ecooiivy and maV re* qlire consl lerable future expendi-
ture of the publlic's mjoinev. Thus. it is important to muderstand the
financial commitilelnts that will we rev(-tllired to ca-riv out such pro-
grams if the ('onress decides to approve them. Toward this end. tlisi
staff report, prepared at tlhe request of the Committee's Eneroy Task
Force and :t-i-ed in part upon the Task Force learing"s on Financ-
in Iner2v 1)-,evelopm ent held on Ji ul v 26 and 27. examines tlhe above
mentioned Federal fin.amcial ilcentives, reviews tlieir financial a'nd
10d(1etary implications, adl preenits o01)tons to sorve as a l':i' for
thle Bu(ldet Committee's actions in develop)inij ile Second Coniiiielct
Resolution which the Con'2 1..; mst adopt in Septellmber.
Alonmj with thanking" the Task Forc'e. I a1.-o want to express -,pecial
appreciation to: Terence Finn. Arnold Packer. Dan Twoiev. )onald
(C:nmpbdl!. Charles MhcQuillen. and IHeIather Ros of thle Bllud!et Coi1-
mittee staff: and to Ni\colai Timenes. ID)avid Montgomery and Richaird
ID)owd of the C(onr-essional Biud'et Office without whose efforts thin
report would not have been po.-ible.
Nothing in this study should be interpreted as representing tle
views or recommendations of the B1!ud(,et Committee or any individual
member thereof.
Sincerely. n \
Sincere FRANK E. Moss. Chairman.
(IT)



















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CONTENTS

PB
Letter of transmittal---------------------------------------------- III
S 11n l: ry -- ---------------------------------------------------------- vII
Chapter:
I. Introduction -------------------------------------------1---
II. Financing energy development----------------------- 3
III. Federal guarantee mechanisms as incentives----------------- 7
IV. Loan guarantees: A special problem------------------------- 1i
V. Two major energy finaningi proposals------------------------ 19
VI. Budgetary treatment of guarantee mechanisms------------ 27
VII. Thp Second Concurrent Res,,lution------------------- -------- 31
i(V)















SUMMARY


Increasingly, the Federal Government is being asked to assist in tihe
financing of energy development projects. This assistance is rendered
l)rim arily through various guarantee mechanisms. most notably loan
guarantees, price guarantees, and project guarantees.
The Budget Commnittee is concerned with the growing use of these
guarantees for energy and other activities. While Federal guarantees
appear to be cost free, they in fact can be costly tools of public policy.
(Gilarantees may reallocate capital from one economic sectorr to an-
other and in turnii drive interest rates up in sectors which lose capital.
Should defaults occur, they can have a major iml)pact on budget totals.
InI addition, loan, price, and project guarantees can affect national
priorities by influencing the allocation of investment funds.
The Budget Committee is also concerned with the budgetary treat-
Iment of tlIe-: guarantee programs. How these programs are scored-
there seems to be no uniform pattern-can affect not only the budg-
etary totals but also the decision to establish such guarantees.

FINAN('ING ENERGY DEVELOPMENT
Underlying the increasing use of guarantees in the energy area is
the need to finance new sources of energy. So far, the private sector
has for the most part been hesitant to develop new energy sources
suich as synthetic fuels, the sun. and geothermal heat. The obstacles
to private investment are the sale of the capital required, the un-
certainty of future prices for petroleum energy, technological uncer-
tainty. and regulatory policy. By making use of guarantee mechan-
isms, the Government enters the private financial market in such a
way as to reduce or remove the risks associated with these obstacles
tlhereblv allowing the private sector to proceed with the capital
investmIent.
When the Government uses such guarantees. private participants in
a selected venture are protected from some or all of the effect of its
economic failure. By emplovino such guarantees direct Federal ex-
penditures appear to be avoided and a major private role is assured.
At the same time, the Government, assumes most of the risks associated
with the. enterprise. Tnh.se risks must b)e considerable because the
investment community has chosen not to provide the capital.

FEDERAL GUARANTEE 31ECIIANISNMS AS INCENTIVES
Although the Budget Committee's Energy Task Force has focu.--d
on guarantees proposed to finance energy development, guarantees
were also considered in t'eneral as tools to carry out public policy.
The private market allocates resources aocordinoif to calulIations of
tlhe risks and the potential returns attriluited to alternative project.
(VIiT)





VIII


Because tlese calculations focus on the flow of funds to private in-
v,.stors, outcomes of nmiarket decisions may not conform with percep-
tions of the national interest. Public policy often promotes the alloca-
tion of resources 1a:ed on calculations of costs and benefits to the
economy as a whole. Private investors evaluate a project more nar-
rowly than would be appropriate for Government. Projects that are in
the national intere-t but have an unfavorable risk/return ratio are
not ordinarily undertaken by private ind ist ry.
If Government is effectively to stimulate private investment in a
desired project the Government must first analyze the role expected
profits and risks have played in hindering that investment. Govern-
ment action to reduce uncertainty will not stimulate investment if
a project is unattractive primarily because its expected profits are too
low. On the other hand Government action which increases a project's
expectedd profits may still not make it attractive to investors if the risks
of failure are too great.
Unlike tax incentives, for example, which are available to all in-
vestments that satisfy stated criteria, these guarantees are made avail-
able only to selected projects. Thus, they are appropriate to remedy
specific obstacles to investment, rather than obstacles arising from
general economic conditions.

LOAN GUARANTEES: A SPECIAL PROBLEM
Because loan guarantees are a mnechanism that is increasingly pop-
ular-net new loans guaranteed now average $48 billion each year-
and because new proposals are believed to have a different impact on
the budget and on the economy than earlier guarantee programs, they
deserve special consideration. From the perspective of their budgetary
impact, there are three types of loan guarantees, those designated to:
(1) Cor'(rt Imperfei'ctio in the Capital Markets.-The earliest
guarantee programs were created because lenders were un-
able to estimate the risks attached to important types of
relatively small loans.
(2) Allocate Cr,'d;t to Ola.,x.- of Jlary bi "1 Borrowers.-Federal
guarantees have also been used to help extend credit to
small borrowers who are demonstrably greater than ordi-
nary risks.
(3) Fntiice D,.,.cft-e Ventlr,.s. by Allocating Crcdit.-More re-
cent programs have made use of loan guarantees in order
to allocate private credit to specific projects favored by
public pol icvy.
In type 3 loan guarantees the loans are often large loans to one
or a few borrowers who may face common risks. This category includes
the loan guarantees for energy development. For this type of guaran-
tee it niay be iimpo-:ile to anticipate the ma nitude and timing of
outlays. Moreover, deciding the proper budgetary treatment of these
guarantees is especially difficult. Many of the rea.-ons for concern in-
herent in type 3 loan glia 'raitees are found as well in project guar-
antoes such as those, proposed in the Nuclear Fuel Assurance Act, an
$8 billion nmca-ure that has passed the House and is pend(ling before
the Senate.






Federal loan guarli-itees do more tihan ilp)lyI change calculations
of risk. By assuring investors that the full faith and credit of the
Government stands behind a loaii, gua rantees tend to we;ake:n the
process by which proposed activity is elevated. Loan guarantees, and
for that matter, price and project ('m'aantee.. (d litt le to ensure tliat
tlie disciplines of tihe private market w-ill coite to bear on :.-elected
project s.
FEDERAL FINANCING BANNK
Guaranteed obligations may be purclhased by the Federal Financing
Bank (FFB) which was created in 1971 to coordinate the impact of
Federal agency debt issues on thle capital markets. The FFB is now
the primary investor in guar: iteed loan-. By using the FFB a Fed-
eral agency can finance large loans more cheaply and easily than if
funds had come from private lenders. When the Federal Financing
Bank purchase. a guaranteed obligation the Government is no longer
ju st a guarantor but the direct lender. The FFB can buy all of an obli-
gation which may only be guaranteed in part. Since the FFB finances
its investments by issuing obligations to the Treasury, Treasury bor-
rowing increases by the full amount of the loan. This undercuts the
argument that partial guarantees force the private sector to bear some
risks inherent in a proposed project.
Loan ua.rantees have consequences for both Governimient decision
making and the private sector. Such guarantees may result in Federal
outlays although neither the timing" nor the magnitude of these outlays
can be forecast. Another Gover-nmeiital consequence, steaming from
the mistaken belief that loan guaranteess do not have an impact on the
budget, is that a proposal may get inadequate review with resulting
distortions in the allocation of pu)lblic resources. (Conisequences for tlhe
private sector may include increasing tlhe prolal)ility of default and of
p'vmature shutdowns and higher interest rates for borrowers who do
not benefit from the guarantees.

MAJOR ENERGY FINANCING iR O'1LPOSALS
Two major energy financing proposals may soon be before the Sen-
ate. They are the Nuclear Fuel Assurance Act (H.R. 8401) and the
Synthetic Fuels Commercialization Program (H.R. 12112). These
bills provide for loan guarantees and project guarantees. Many ob-
servers believe that the latter bill will require price guarantees as well.
Because of the legislation's impact on national priorities and on the
budget, as well as the issues they raise regarding budgetary treatment,
the Energy Task Force believes that the bills require the Senate's
careful consideration.

BUDGETARY TREATMENT OF GUARANTEE MIECIIHANISMS
Because the budget is a decisionmaking tool. it is important that the
full scope of Federal activity be reflected, including the nature and
extent of the Government's liabilities.
Loan !iarantees are specifically excluded from tte definition of
'i)udget authority" provided in Section 401 (-) (2) (C) of the Con-
gressi(onal Budget Act of 1974. This "off-budget" characteristic of


76-048-76--2







l,;in guainrantees has inmeait that guarantee programs tend not to co:-
pete with regular spending programs for o:airce Federal dollars. This
li;,- contributed to the growth in number of guarantee programs, a
21owth which Tamies L. Mitchell. an Associate Dire'-tor of OMB,
terned "a astonishing "
Now that net new loiians giuaraniteed annually average $48 billion,
a problem is how best to include potential cost to the taxpayers in
1)budg(et de(,--ions. Placing loan guarantee- "on budget" facilitates the
control of public policy through the budgi t but provides a seriously
exae--,,rated picture of the size of the budget.
An alternative for treating loan guarantee! in the budget is to eti-
mate ,ach year the amount of Federal payments likely to result from
loan guarantees and have that estimated amount appear in.the budget
as budget authority, accompanied by the associated estimate of out-
lays. The full exposure of the guarantees would not be reflected in the
budget, only the amount of expected expenditures. This is the treat-
minent being accorded the proposed synthetic fuels bill. For 1977, HI.R.
12112 (as reported by the Committee on Science and Technology), if
enacted, would show on-budget $515 million in budget, authority and
815 million in outlays for a $2 billion exposure through guarantees
of Federal funds in the first year.
Prie guarantves do not pose too great a problem in terms of
budgetary treatment. Authority to implement a price arantee pro-
gram is requested through the normal authorization and appropria-
tions process. funds from which would appear in the budgetary totals.
The difficulty with price guarantees is not budgetary treatment but
rather budgetary control. Price guarantees are entitlement program ms.
Once in plaC'e they can make demands upon the budget that must be
honored.

BUDGETARY TREATMENT OF PROJECT GUARANTEES
The budgetary treatment of project guarantees can best be dis-
cussed in terms of specific proposals. The .1, billion in project guaran-
tees contemplated by the Nuclear Fuel Assurance Act could be treated
in several ways. One option would be to score the full $8 billion as
biidget authority, an approach akin to scoring the full exposure of
a loan guarantee program. Another option would be to score the full
value of ea,'h project as- the guarantee is ratified. Still another option
would be to sore partial amounts, representing the actual Govern-
ment liability year-by-year, as the liability grows. A different way of
treating the bill would be to score some fraction of the $8 billion as
budget awithority based( upon an estimated rate of default greater than
zero. A fiinal option would be to score nothing at all because the liabili-
ties extended by the Nuclear Fuel Assu ran ce Act are con.ftigent liabili-
ties. This final option is the one the Administration believes is appro-
priate. All the other options, of course, would affect the budget totals.
Thus, if the bill were enacted and the Administration's position re-
jected, budget authority would be created and reflected in budget
totals.










Chapter I. INTRODUCTION


iicireasinigly, the Federal G(vernilmelit is being g asked to assist in tlhe
finan c(ins of ienergv developielnt t)rjects. lThis assistance is renldered(l
pr'imharily througiI various u1't 1I'aa1ntee mec(hanislms, most notably loan
guarantees. price guaranitees, and project mguarantees. Congro-s. for
exai i)le, rel.ently enacted a '2 illioi ( l),ian guar antee 1olograI 1o
filianlce energy c(lservatiolln projects. Tle A d(lm ilnistration is pIroposinf
an 1S l)ilion ura liulli enicm'lienit proo()oram that contemplates specific
project guarantees. and somIe o0,-crvelrs 1)elieve that the plopo-'(ld
synilthetic fuels (commllercialization pPr0 rail will not be viable wit houtl
price guarantees.
lie lBulg,,t (Coi ll]ittee is concerned with thle increasing us.e of tli.:-
gmuarantee meclihanisms. Loan guarantees, price guarantees, and project
rual'antees are tools of Federal policymvaking that at first ,rlaince ap-
p)ear to be cost free. Wh1en a 2iiuaraintee is extended, the Goverinment
n('urs no0 immediate expenditures anid tle possible future spe)(ndin"
is not inclcHided in thle budget totals. Moiveover. unlike typical sp)end(lilyg
and t ax proposals. guarantee mieclanisilis are neither displayed inll oie1
)place i ior( reviewe(l in the co('ntext of competing, )ro'ramlls. Even reg-
ulatolr proposals are typically scrutinized by affected interest g2rolups
wit li a view to illuminating costs. But tle costs of uarantee m-echan-
isms are not readily apparent.

COSTLY POLICY TOOLS
In fact. loan guarantees, price ,"uarantees, and project grlalailtees
(canll be costly policy tools. Thev 1mav reallocate (capital. and (drive ulp
interest rates in sectors which receive less capital. Some other proj-
ects-po1)ssibly worthwhile projects-mayv l)e unable to secure tilanlc-
iig'. They thus have an overall impact oi tlite economy that should not
1be itnored. They also (can have a major impact onil budget totals, should
a (lefault occur or )price sulpp)orit become ne'cs-:a rv.
Certainly no economic activity of the Federal Government should
g,'o unchallenged nor should the potential for spending be free of
c'-itical examination. In fulfilling its resp)onsibl)ilities under tlhe Con-
2rTessiolal Budget and Inpouindment controll Act of 1974 the (Com-
mittee on the Budget calln provide some of the necessary v focus an(l
review.
TIljis responsibility extends also to questions of national spend(linl(g
priorities. The task mad(lated bv) Sectioi 301 (a) of tlhe new Bud]et
Act to set forth in the Coniurrent Resolution an estimate of budIet
outlays and an appropriate level of new budget authority by the fuinc-
tional categories of the bud,,eti is in effect a setting of national priori-
ties. This allocation of fil-al resources alonsl functional lines allows
the Senate and House to debate sucl) priorities. The amounts contem-
plated for energy expenditures and the urgency underlyvinc the devel-







opment of energy supplies make Federal spending for energy-actual
and potent ia direct and indirect, current and future-a priority item
to be considered in formulating the functional targets of the Budget
f'-61olution.

TECHNICAL NATURE OF GUARANTEE MI1CHIANISMS
The re-ponsibility of the Budget Committee also extends to the more
techlmic;:l issues of budgetary treatment. How various forms of Federal
spending such as guarantee mechanisms are scored in the budget can
Ibe a complex subject requiring knowledge of budget concepts and past
budgetary procedures. For example, the most appropriate means
to account in the budget for the $ billion in project guarantees
authorized under the pending Nuclear Fuel Assiurance Act
(I.R. 8401) is particularly complicated. Unfortunately, past prac-
tices offer no clear guide on how bet to treat guarantee mechanisms.
There is no traditional way" to account for loan. price, and project
guarantees in the budget totals. Yet how these guarantees are scored
can influence not only budget totals but also the decision whether to
e-tablish such guarantees. The technical nature of guarantee mecha-
nisms for financing energy and the importance of their budgetary
treatment thus requires the Committee on the Budget to review tlhe
various mechanisms that are under consideration.

PURPOSE AND ORGANIZATION OF REPORT
This ctaff paper reviews the budgetary impact of these mechanisms
and examines their financial implications. The paper is intended to
serve as background for the Senate Budget Committee's markup of
the Fiscal Year 1977 Second Concurrent Re;olution. It contains no
recommendations but does present options that the Committee may
wish to consider in developing the Resolution. The paper also is
intended to contribute to the Committee's major study on the use of
Federal financial guarantees. Such guarantees are by no means limited
to the area of energy. They are an increasingly important element of
public policymaking that deserves far more attention than is possible
in this paper. By reviewing the impact on the economy and the effect
on national priorities of these financial guarantees, the Committee's
major study can focus on a dimension of public policy that hlas by and
1 arre escaped comprehensive public scrutiny.
The orga nization of this staff report is relatively simple. Chapter I
has noted that guarantee mechanisms are increasingly being used to
a:sst in the financing of energy development projects and that the
Committee on the Budget has a responsibility to consider this activity.
Chapter II discusses the reasons why these guarantee mechanisms are
deemed necessary and lists several recent examples of Federal guar-
antees. Chapter III discusses how guarantee mechanisms serve as in-
centives for private investment. Because loan guarantees are a preval-
ent form of Federal truarantees. Chapter IV reviews how these guar-
antees operate and what different types of loan guarantees there are.
Chapter V discusses two major energy financing proposIals, synthetic
fuels and the Nuclear Fuel Assurance Act, that may soon be before
the Senate for consideration. Chapter VI reviews the budzetary treat-
ment of giiarantee ine.h:niirm= while Cha)ter VII, the final chapter,
relates this tri-itment to the 1977 Second Concurrent Resolution.









Chapter II. FINANCING ENERGY
DEVELOPMENT

Underlying the increasing use of guarantee mechanisms to assist in
financing energy development is a desire to develop new sources of
energy. These sources include synthetic fuels, the sun and geothermal
heat. Together with an expansion of present nonpetroleum bja-ed en-
ergy sources such as nuclear power and coal, they can-if new tech-
nologies are developed and adequate funding is forthcoming--reduce
our vulnerability to the petroleuin exporting nations while providing
increased domestic energy at reasonable cost to the Americanl con-
sumer.
The task of developing these energy sources will require considerable
financial resources. Investments from both the private sector and the
public sectors are necessary. Exactly where and how the two sectors
interface is not yet clear. What is cloar is that both must focus their
attention and direct their resources to the common task of assuring
that our energy needs will be met.

Obstacles to Private Investments
So far the private sector has been unwilling to finance many of the
projects which seek to develop these new energy sources. Several ob-
stacles to investment have emerged.

CAPITAL REQU IIEMF ENTS
The first obstacle is the scale of the capital required. The cost of
commercially developing synthetic fuels, geothermal heat, nuclear
power, coal and the almost limitless energy of the sun is substantial.
The Congressional Budget Office estiiiiates that the total investment
in energy production needed to keep petroleum imports in 1985 at cur-
rent levels is $560 billion. Individual projects are also costly. A single
high Btu synthetic ga- plant will cost approximately $1.0 billion.
A single gas centrifuge plant to enrich uranium will cost over $3.0 bil-
lion. To place such costs in context, we must remember that in 1975 only
160 U.S. corporations had total assets in excess of $1.0 billion. While
private industry has financed extremely large projects-the Trans-
Alaskan pipeline was financed without Federal assistance at a cost
of $7.7 billion-the scale of financing energy development will test
the resources of America's capital markets.

PRICE UNCERTAINTY
A second ob.-tarle to the private sector in financino- thle development
of new energy sources is the uncertainty in the future price of petro-
lemni energy. The semi-controlled nature of domestic oil and gas price-s
plus the leverage of OPEC in establishing the price of world oil creoatc-
a climate that hinders energy investment. Prudence requires that a
(3)







re;isn ,ible rate of return on investment plus the amortization of debt
1)e a-.-ured before committing risk capital. Investors will be reltuctant
to risk capital in new energy projects if external price. policies canl
iunder'iit their economic, vialb)ilitv. For example. as long as OPEC can
suddenly drop petroleum prices below what synthetic fuel plants mi:zt
charge, the capital to finance these plants will not be forthcoming. ThiL
risk of failure is simply too great.

TECHNOLOGY UX .TA I NTY
The third olb)stacle is technological uncertainty. The technologies to
d(lerive sufficient energy at reasonable costs from synthetic flels, geo-
thermal Ieat, the sun and even some forms of nuclear r power do not yet
fully exist. While we can be confident that our research, developmentt
and demonstration programs will ultimately be succes4sful, tile outcome
is not preordained. Advances in technology do not occur simply from
spending money. Ingenuity, perseverance and luck are also necessary,
and even then we may not achieve our goals. Moreover, the advances
in energy technology that we need are slub)stantial. In some instances.
like synthetic fuels, quantum steps are necessary. Investors understand
that risks are associated with technological advances. In the energy
field tlhey perceive these risks as another reason to exercise caution in
exposing capital.
REGULATORY POLICY
Another obstacle to financing energy -development is regulatory pol-
icy. Like other areas of public policy, energy is beset by a wide array of
regulatory agencies whose rules and regulations can mean the differ-
e+ce bttweln failure and success. The Federal Energy Administra-
tion. the Environmental Protection Agency, the Federal Power Corn-
mission. the Nulear Reiulatorv Commission, the Interst4ate Commerce
(Commission. the Occup national Health and Safety Administration and
the Department of Justice are all Federal agencies whose responsi-
bilities encompass the energy field. Their rules and regulations are
supplemented by those of State and local agencies whose responsibili-
ties are similar. These agencies generally perform a useful task in our
society, bult a side effect of this regulatory environment is a web of
ohst:iles that hinders development. This web acts :is an impediment
to fi aliicin energy projects. Potential investors are aware of the
mainy opportunities for delay. They are aware also that a seemingly
arbitrarv decision on the part of a regulatory agency can curtail a
project, well after capital has 1,eeni invested.

Government Action to Assure Future Energy Supplies
Taken together these oibt4acles have inil ibited the priv ate sector from
invet ilila in the development of new energy sources. Given the priority
t!i;it such energy development constitutes, the public -ector-primarily
the Fedleral Government-believes it must act to a--sre that fit'iure
(,erg. supplies are sufficient. One course of action would be for the
Government to make the nece-sa irv investmnepts directly. This presum-
ably would ensure that energy development would occur but would
severely tax the fiscal re-soutrces of thle Federal Government. It might
also unalterably revise the boundaries in this country between the pri-
vate and public sectors.




5

A\notther course of actionll w<,uld be for tlie (G over1nmiiunt to m.,1a1ke 11-c
of available mechanisms that enable thle private sector to overlcomte ilie
o(tIstaacles to investment. The GoverniCent would enter ilit() thle private
financial market in such (a way as to r'eduIce or reIliove the risks to
liiiancino energy development. This would allow the private sect ro to
proceed with tlhe rnece-ary capital invest I Ie it.
Some financial mechanisms that allow the (GovernImeit to so act are
loan guarantees, price guarantees anld project guarantees. By usil"ng
such guarantees, the Government assures tlie ultimate inaiwial via-
l)ility of the particular enterpri.-e to whichh the guarantee is exted(led.
Moreover, by employing such guarantees, direct Federal expenllditulres
appear to be avoided and a major private role is assured. At the sane
time, the Government assumes most of the risks associated with tlhe
enterprise. These risks must be considerable because thle investmiieit
community has chosen not to provide tlie capital. (Were no risks
involved, guarantees would not be needed.) If the enterprise does not
succeed, the guarantees are invoked and tlhe Government must absom)
soiiie of the loss. With energy development projects, these losses could
entail sub4t a ntial budgetary expenditures.

Increased Use of Federal Guarantees
Energy legislation utilizing til, :- guarantee mechanisms is appear-
ill' wit incr .asing frequency. In 19.75) (Cono-ress enacted the Energy
Policy and Conservation Act. Section 102 of this act established a $75)
million loan guarantee program to develop new underground coal
miines. The year before. (Congress enacted tlie Geothermal Energy Re-
(search. Development and Demonstration Act which established a 1man
guiarantee pr'ogr: m for developing geotliernmal resoumrces. This act
placed no limit upon the extent of liabilities.
This year (Congrn'.s- has enacted the Energvy Conservation a!nd Pro-
duction Act. This law, which extended the Federal Enlergy Adninis-
tration until I)ecember 31, 1977. also established a "2 billion loan gzma r-
a'itee progr;!'! for investments in energy coi i-rvat ion. CurrentlV pend-
ir" before (Con.i ,s, is a version of Administ4ratioi's proposal for a
Synthetic Fuels Commlmercial D)emnonstr:ation PIovrlam (I.R. 12112).
'lh is program conteimplates a -2 billioH loan guarantee progIram as
we ll as a program of lprice g'uaraiitees. Indeed. manv ol)servers ) Ibelieve
tilat the price giuarantees zl'e essential to tle program's sue5,-s. Also)
pendinfZ is thie Nuclear Fuel Assiiraince Act (I1I.1. S401). a version of
the Admiinistrationis proposal to extend SS 1)illion in project guar-
antees to private uranium enrichlinment plants. Tils act lhs lpssd(l tle
! lfhi.se and is now before the Senate.













Chapter III. FEDERAL GUARANTEE
MECHANISMS AS INCENTIVES

Although the Task Force attention focused on propo-als included
in pending energy legislation, guarantees were also considered in gen-
eral as tools to carry out public policy.
The private market alloates resources, according to calculations
of the risks and the potential returns attributed to alternative projects.
Because these calculations focus on the flow of funds to private in-
vestors, outcomes of market decisions may not conform with percep-
tions of the national interest. Public policy often promotes the alloca-
tion of resources based on calculations of costs and benefits to the
economy as a whole. Private investors evaluate a project more narrowly
than would be apl)propriate for G'overnment. Projects that are in the
national interest but have an unfavorable risk/return ratio are not
ordinarily undertaken by private industry. Three factors can lead to
the private allocation of resources in a way which is not optimal for
society as a whole:
1. A private investor cannot capture enough of the economic
benefits associated with a project.
2. A project can have non-economic benefits accruing to the
public.
3. Private firms may perceive risks differently than the Govern-
ment such as the risk of adverse regulatory decisions.
By altering private risks and returns in specific projects the Gov-
ernment can play a powerful role in altering the outcomes of private
market decisions. However, for public action effectively to stimulate
private investment in a deird proje,-t. the Government must first
analyze the role expected profits and risks have played in hinderingr
that inv,-4t;ient. Government action to reduce uncertainty will not
stimulate investment if a project is unattractive primarily because,
its expected profits are too low. On the other hand, Government action
which increases a project's expected profits may still not make it at-
tractive to investors if the risks of failure are too areat.
INCENTIVES FOR SPECIFIC VENTUrRI'.S
Three mechanisms are now being proposed to provide incentives
for invest, ient in energy development: loan guarantees, price guar-
antees, and project guarantees. By their nature, the guarantees con-
sidered in this report are specific to an individual project or a class of
projects. Unlike tax incentives, for example, which are available to
all investments that satisfy stated criteria, these guarantees a iv, made
available only to selected projects. Thus, they are appropriate to
remedy specific obstacles to investment, rather than obstacles arising
from general economic conditions.


(7)


76-048-76-3






Loan Guarantees
The Federal Government can increase the attractiveness of an invest-
ment to a lender by removing or reducing his risk of default with a
guarantee that principal and interest will be paid. The attractiveness
of an enterprise can be greatly increased also for stockholders or other
owners by making use of "non-recourse" loan guarantees which pro-
vide that, in the event of default, the Federal Government will only be
able to require payment from the assets of the guaranteed project
itself and not from the general assets of the participating firms. The
extent to which risks to stockholders are reduced depends on the frac-
tion of total project investment eligible for loan guarantees.
If investors are confident of prompt payment in the event of a
default, they will view guaranteed loans as near equivalents to obliga-
tions of the U.S. Government. Guaranteed loans, therefore, usually
have interest rates lower than those normally required even of the
highest quality private borrowings of comparable maturity and terms.
Recipients of loan guarantees may be required to pay a fee to the
Government for the risk it has assumed. Unless that fee is large enough
to cover the expected cost of defaults, a loan guarantee constitutes a
subsidy to the borrower.

OBSTACLES IN THIE FINANCIAL MARKETS
Although loan guarantees can alter the perception of risk and re-
turn by both borrowers and lenders, they are most appropriately used
when factors in the financial markets are the major obstacle to a de-
sired investment.
H.R. 12112, now pending in the House would authorize loan guaran-
tees for synthetic fuel production.
Price Guarantees
In general, these guarantees replace an uncertain future in which a
product must be sold at prices set by changing market forces and sub-
stitute a certain future in which the product can be sold at or above
a price established before a project is undertaken. They can be used
(1) to subsidize production when market prices are expected to be too
low to cover costs plus an adequate profit; and (2) to shift the risks of
change. in ma ;-1',t prices from the private producer to the Government.
Depending on its design, a price guarantee can have various effects on
invest client decisions and Government cost.. For example, a guarantee
may specify the price that a producer would receive, with the Govern-
ment paying the difference if the market price is below the guarantee
price and collecting the difference if the market price exceeds the
guaranteed price. On the other hand, the guarantee may place a floor
on prices, with the Government making up the difference if market
price falls below the floor but the private producer retaining all profits
if market prices exceed the floor.
The price guarantee also contains an element of subsidy unless two
conditions are met:







1. The guaranteed price must equal or be less than the expected
market price.
2. The Government must share in profits when unexpectedly
high prices prevail to the same extent that it shares losses whlen
low prices prevail. This could be done, for example, if the Govern-
ment purchases the product in all events at the guaranteed price
and resells it at market price.

OBSTACLES IX TIlE SALES MAI:::-S
Price guarantees at an appropriate level can b)e effective if a major
hind ran iice to private investment is either uncertainty about tihe market
in which products must be sold or certainty that market prices would
be too low. Price guarantees (do nothing to red(tce iuncertainty associ-
ated within the co:-t of production unless thlie guaranteed price is set on a
cost-plus basi< .If the guaranteed price is set by a formula that excludes
costs of production, private investors bear all risks inherent in com-
pleting a plant that can achieve planned output on schedule and under
budget.
Two versions of HI.R. 12112 authorize price guaraniitees to synthetic
fuel producers.
Project Guarantees
The Government (can a I.-) provide a broad ".-, fety net" under all of
the private participants in a desired project. Unl(der a project guiarantee,
the Government commits itself to step in whlien (continuation of a proj-
ect becomes undesir.ible for private participii uis, to assume the obliga-
tions incurred in the operation of the project, to repay lenders, and, if
certain cond(litions are met. to co()pei,,sate inveUtrs. TIese, of course,
are very broad forms of guarantee which significantly reduce or re-
move thie private parties' exposure to risks inherent in future market
prices, and in product and process technology. They share many of the
budget problems of loant guarantees which are discussed in the n.-xt
chapter.
Such incentives are contemplated by thle Niclear Fuel Assurance
Act (11.R. 8401).














Chapter IV. LOAN GUARANTEES: A SPECIAL
PROBLEM

Although loan guarantees have long been used to encourage private
lenders to invest in accordance with Federal objectiv. -. they have
characteristics which can create significant problems for public policy.
These guarantees deserve special consideration. One reason is that the
use of l,.,i guarantees has increa:--d rapidly in recent years. Net mnew
loanii guaranteed now average -4S billionii each year. 1)v the end of
FY 77, guaranteed and insured loans outstanding-for all purposes-
are expected to total $235.1 billion. Guaranteed loans outside the
budget in FY 1977 are estimated at $174.6 billion. Outlays for exist-
ing "off-budget" programs are e-ti1iated at $11.1 billion for the
same period. Another reason is that some of the r,'cent guarantee
programs and proposals have. or are likely to have, a very different
impact on the Federal budget and on the economy from tliat of earlier
guarantee program n-.
POWERFUL POLICY TOOL
As it reviewed ways to budget Fedei.l incentives for energy devel-
opment, the Task Force had to consider loan guarnalitees carefully.
It b)ecanme clear that loan .iarnt'es are a po-werful p ihcy tool a,-d
their use imay have unfoeseeab-)le fiscal consequences. Ce,-rtain charac-
teristics of l(.:n o'uarantees call for carfn vw o t vrawtees,
when inappropriate., are not used to achieve (1Airlble endsb.
nihis ch' 1 fa r of thle sta, rep-' rt v. il lihliii t reveall f' ,!tlres of
lua":,:'Vtedd le:isI. It 1com14i f-. f he three tvl:- of ]on cja e
andt second, the operation of loan gu,'aratis. Th, ( Coe 1r),n a1l
Pudget Acts exclusion of lc, ', ::,' t. s from the defiition of
'budYet4 authority" is an important fea f :a.'i that will be treated in a
later chapter.

Types of Lo'?n Gu..rantee Pi'ogr'vi :
I:ii] g./''...nite prnopo-als have creatlv canned in pur'",, and de-
QL07 since the 1932(''s when thyv were i-t i- xtensively. P : -s
usin the mechanism vary widely froni one ,otil r I, e v-a
( -le'ned to fit the carct tics of a paicular credit
the politics of a S,,cific tilie. Their treated t in tihoe 1Ud( Ve 1 eon
u'ied 1v0 no cov.:si ;te-"t theory. y-,ever. fro,. ti ,e d1 ti. of t', 01
budetary iLact there an t i"' types.

TYPE 1 CORRECTING TI-PERFECTION INT T-rE CAPITA ARKET
The earliest guarantee programs were c'.t.," 1 ':u Ie. r' ders were
unable to estimate the risks attached to i)ortant ty, 's of Iep(ti'.
For example, during the dep: --ion wides).. 'd ( "o: ',lo-n and
ba iiruptcies were triggered because homes tended to be c'.:aed with
(11)







short-term loans. Federal policymakers were convinced that, if home-
ownership were to be possible for most families, general acceptance
had to be created for the self-amortizing long-term residential mort-
gage covering 80 percent of a property's value. Bankers, however, had
no ex.N)erience with that form of lending and were reluctant to offer
ac01,ptable interest rates. So. FHA mortgage, guarantees were insti-
tuted in 1934 in the conviction that the actual risk involved in the new
form of mortgage was significantly less than mortgage lenders were
estimating. By as.-uning risks which otherwise would be borne by
lenders, the Government reduced the cost of borrowing for consumers
and rental investors and provided the private market with information
on the risks involved in this federally preferred form of lending. The
strategy was i,,inensely successful. Lenders were encouraged to adopt.
the new mortgage instrument, eventually even without Federal
guara ltos.
The budgetary impact of these guarantees has been negligible. The
programs involved many small loans with liens on property and were
designed to be actuarilv sound. Defaults in FHA's basic single family
insurance fund have been about 5 percent of total guarantees-so
low that fees and premiums have more than covered the fund's losses
and other expevns!-(. Tiece. programs thus involve neither Federal
budget authority nor outlays.

TYPE 2: ALLOCATING CREDIT TO CLASSES OF MAMIINAI, BORrOWERS
Federal guarantees have also been used to help extend credit to
borrowers who were demonstrably gr a ter than ordinary risks. IIigl er
risks resulted from a greater than normal probalbility of default, or
from the lack of a,.rptable collateral. So. Federal agencies assumlled
ri-k- which private insurers were unwilling to accept at -ocially toler-
able rates of intciv -t. For example, loans in urban renewal areas were
guaranteed to lelp coori in-,te private investment with public efforts.
Residents of t1n -, :'v :u typically had not established a record of credit
worthiness ,-il the future value of properties in these areas was too
uncertain. These guarantees were not a simple extension of prior FHA
activity. In fact, they caused con-idlerable tension between the older
"I IA pers ,.--committeed to actuarially sound guarantee pro-
yr1i ,<--n'd the newer ul,0n r,.newal staffs committed to the attain-
ment of social ,: l".
Loans gQl:,,;! ,d. d under these programs usually are numerous and
relatively -II!:1L. It is thu, po:-ible to accumul:'te experience. upon
which to e-tiii;te andl thus provide a serve for defaults. These pro-
grains typically involve s:,cial objectives which hinder their operating
on an actuarill.y S mund I-'.... The guarantee also is often combined
with intere'-St .-l,'-idies. openrtin-" sulsidies or other incentives. These
pr >_,a ii :., therefore, do l( ad to Federal outlay..

1i,'llr T" I'. POOL RI.K-
Beauie Type 1 guarantees require sharply different treatment in
the budget from those in Type 2, the distinction is an important one to
,in-.;o. However. th,-.e two typ'.s of guarantee progIrans share impor-
t:iit characteristics. They have usually involved large iunmibers of rela-
tively small lo;nil. Withi the marai ntees. the Government pools risks
across many t ran-:ct ions. If the risk of default is randomly distributed







among individual transact ions, the statistically expected cost of de-
faults can approximate the actual costs. Government pooling of risks
may be especially appropriate when defaults are not random but are
heavily influenced by regional economic shifts or by cyclical swings in
the economy. For such cases the lessons of experience come more slowly
and less clearly than in the case of risks that are fairly uniform nation-
ally or over long periods of time. Tlw.c. characteristics of pooled-risk
from the third.

TYPE 3: FINANCING DISCRETE VENTCUTFS BY ALLOCATING CI:II IT'
Other programs have made use of loan guarantees in order to finance
specific public programs by allocating private credit rather than by
on-budget spending. The loans being guaranteed are often very large
loans to one or a very few borrowers who may face common risks.
This of course is the category in which the loan guarantees for energy
development fall. Many of the reasons for concern inherijit in Type 3
loan gu;ir;aitees are found as well in broader project gui'aiitees such
as are proposed in the Nuclear Fuel Assurance Act.

TIMING OF OUTLAYS
For this type of guarantee it may be impc.-be to anticipate the
magnitu(le and timing of outlays. When guaranteed loans are for single
pIurpo.- plants the Fed(eral guarantor agency may be unable to recoup
a large proportion of the (uaranteled payments by re-illing assets after
a d(lefault. ()Outlays :.'y a:-' be driven above g:tee amounts by the
need to manage a troubled project o which a major Federal comnmit-
ment has been made. Finally, the timing of major outlays-a central
issue for Federal fi-.al policy-a;,ii rarely be estimatedd when such a
guarantee program is being considerr. d.
In the case of Type 3 guarantees, deciding the proper tre.:ment
of budget authority is especially troublesome. If every loan guarantee
pro.,:,in weere euired to establish through appropriation a .,-,ve
for (defaults equal to the 1)est estimates of its expected outlays, one could
argue that tle probal e budg, imp.,ilt of all loan guarantee pro2, ':!.,,1
as a group would best be rei'ieted. But, rather than being a solution,
this would bring great pru. : ,e on progr. ,Advocates to p;:e a low
estimaie on the probability of (1dfaults. If deflts ef ts occurred, the ex-
istenice of a .'-,.rve coveroin onlv a fhaio of ifvle(needed outlays wouldl
s-olve Tew probleIs: on the other hard, if the prog-i ,n succeeded, none
of the bud,-t authority would be used.

Operation of Loa n Guarantees

SOURCES OF FINANCING
When the use of lean guarantees is being advo'-ate(, it is often
claimed that they provide a relatively mild form of Federal interven-
tion in a basically private t ran action. It is implied that the sounmi(:, -
of a proposed venture is a.-',ed because a participating' )private bor-
rower will have to deal with private lenders. This sI'ir-ts that the
Government guarantee merely changes calculations of risk in a ti';i, -
action similar to most others in thle private -c..tor. This argument i-







based on the premise that private lenders will be motivated to evaluate
the prudence and strength of the project being financed. That premise
may not be valid. Even when banks or other lending institutions play
an active role in loan guarantee programs, they tend to be more con-
cerned about evaluating the terms of the Government guarantee than
evaluating the merits of the activity. For example, private institutions
play an active, role in loan guarantee programs which require the
origination and servicing of large numbers of small loans. However,
even in these cases private lenders may take no role in weeding out
ill-conceived ventures. The involvement of private lenders in the Sec-
tion 235 Homeownership Assistance Program did not prevent wide-
spread defaults resulting from questionable loans.

SIMILAR TO FEDEPRAL AGENCY DEBT
Private lenders may be even less interested in evaluating a venture
which involves a Type-3 loan guarantee. Programs guaranteeing large
corporate borrowing have typically involved Federil guaranteed cor-
porate bonds sold in t ,e securities market. In the past, these guaranteed
loans were often so designed that investors treated them as if they were
not the debt of a private borrower, but rather the debt of a Federal
agency. For example, announcements of the debt issue prominently dis-
played information about the Federal agency which gave the guar-
antee-the identity of the private firm receiving the proceeds of the
debt issue was of little interest to the investors. Once the trust worthi-
ness of the guarantee mechanism assured investors that the full faith
and creilit of the Federal Government stood behind the loan, the na-
ture of the project being financed was almost of no concern. Thus, loan
gua rantee- may have little value as a way to insure that the disciplines
of the private market will come to bear on the operations of selected
projects. Understanding the role of the Federal Financing Bank may
nmak this even clearer.
FE!)FnP.\ FINANCING BANK
The Federal Financin Bank (FFB) was created in 1974 in or.ler to
coordinate the impact of Federal agency debt issues on the capital mar-
kets. Because many gi,1aaranteed loans differed only technically from
Fed:iral agency obligations, the FFB was authorized to purchase any
ohlli-at ion guaranteed in whole or in part by an a zency of the Federal
Government. The FFB has now become the primary investor in guar-
anteed loans. and is expecl ed. to acquire e 63 percent of the net lo ns .:iuar-
antced by Federal agencies in fiscal yenir 1976. The Federal Financing
Bank char,:es interest which is only I/ of 1 percent above the yield of
comparable Treaniirv securities. Therefore. by using FFB. a Federal
arency can finance a vorv large guaranteed lean much more chlieaply
and "a, lv than if funds had come from private lenders.
When the FFB purchases a guaranteed obligation, the Fe,,Ilonm Gov-
ernment, of course, is no longer just a guarantor, it becomes the direct
lender. Note that the FFB buvys al of an oh ration which may only I
guaranteed in part. For example, a private borrower cn sell the FFB,
eOt' say. $100 million in bonds of which only $80 million may be guar-
,.ntoed by sonim Federaln nency. Since tl-he FFB finance its investments
1) issuiina oblifgationz to the Trea..ury, Treasury borrowing would in-
crease by the full $100 million and not just by the $80 million covered







by the Federal guarantee. This undercuts the argument that partial
guarantees force the private sector to bear soniw risks inherent in a
proposed project and therefore to carry out its own evaluation of the
project's merits.
As will be divcuss!ed in a later chapter, loan guarantees can be used
as a way to provide a project with Federal financing which does not
appear in the Federal budget.
USEFUL ROLE OF FFB
It would be misleading to imply that the FFB purchase increases
the impact of a guaranteed loan on the capital markets. The guar-
anteed borrowing, without FFB, could come to the private markets
but at higher cost. This FFB role is useful in coordinating the imppact
of guaranteed borrowing on the capital markets. Understanding tihe
FFB actively should highlight the need for careful Government
scrutiny of new guarantee programs.
CONSEQUENCES FOIR GOVElRN 7!!-.NT DECISIONMAKING
UNCONTROLLABLE OUTLAYS
A loan guarantee is a contingent liability of tlie Government that
must be hlonoied. A guarantee for a loan that defaults results in
Federal outlays. Therefore, the budget will rise automatically unmkle:-.,
an appropriate contingency arrang'eonent is made to cover such an
eventuality. However. neither the timing nor the m.i tude of result-
ing outlays can ordinarily be forecast when a guarantee program
vv*ceixes legislative approval. Once a ii' ,nitee is give, ihe timing of
any outlays is largely out of (Governmeni t control. A.s ,Ta ,es Mitcliell,
an Associate Director of 0MB. mentioned in his testimoily to the
Committee's Ener'y Task Force, with loan uarantees thlie problem of
"trying to estimate a cash disbur;e:eint in the furtre is a very. very
tough question."
DANGER OF INADPVUATE REVIEW
By using loan guara ntees. Government act l s;iplants tle risk and
return c:' luilat ions tl!rou :1,wich tle pri)vate, economy eva!iites. ,
proposed project and therefore the Goverunment stimulates the flow of
credit into a favored project. As we have noted. there are many in-
stances in which the decision of the private market shoUld be over-
ridden because it does not conform with the public inter.-t. When this
intervention is made, however, the Government must su -'itute its
own evaluative processes for thor, of the private market. No major
economic activity of the Governmnent should o'o on umchlallenged by
anybody as if it were a free good. as if there were no opportunity
costs', as if it were not drawing resources away from other priorities.
As Dr. Barry Bosworth testified:
You mn st. realize t!at v,',on vn extc '' .... , ...ra',i'
program1,1 tle Gove1 10 ,c1t 11st replace tr ma (I v,, Tli Tov-
e I -_,,1, le1 t he Gor ,, S. S, .. ..d:,
ernmeit. l'7st se. in d do itS 0 ; va ( io of ; u: 1
before it extends the lonI ,:1'vl p. ora. In h os-
tion a ,-'. of whether or ro n ve-ry ": siw:ations it 7s tr1e
that the Federal Govermuen- kows sonethin:r'() thFt t,'c 1-
va-te market doesn't know. P ,-' tlie Governmentit .''.-ow that
the.s, are really good projects, but for so-: .,- ;-son flio pr'ivate
market is foolish. Although it wants to earn a profit, it simply
cannot realize that thli-e are r.-ally profitable undertakina12s.





18

When decisionnmakers think that loan guarantees do not have an im-
pact on the budget, a proposal may get inadequate public review, and
serious distortions in the allocation of public resources may result.
There, are, of course, many ways in which the Government can affect
the distribution of resources in the economy without the activity ap-
pearing in the budget. Taxation and regulatory powers are obvious
examples. Most proposals affecting these, however, are subject to re-
view in adversary proceedings, such as congressional hearings and
the courts.
HIGH POLITICAL COSTS
Once a project is in operation the existence of a loan guarantee may
significantly alter the bargaining position of the Federal guarantor
agency. A major default would usually bring hicrh political costs, even
when a project was originally undertaken with broad public recogni-
tion that the Government was being exposed to significant risks. When
such a default looms, a guarantor agency may be very reluctant to
undergo the intense, scrutiny of a congressional and media investiga-
tion. By quietly threatening default, the sponsor of a project could
put great pressure on the Federal officials to develop a rationale for
additional subsidies and other incentives in order to avoid the cost and
embna rrassment of a full Government bailout. Additional problems for
the Government might also be created if important sectors of the
economy have become dependent upon the output of the project. Even
if the economics of the project were so unfavorable as to force a de-
fault, the Government may be politically unable to terminate the
project.
CONVSEQr-ENCES FOR TIHE PRIVATE SECTOR
ENCOURAGES DEFAULT
Loan guarantees also have a significant impact on the operating
de(.isions of a participating private firm. As Dr. Bosmworth pointed out
in his tv.stimony, "Although loan guarantees may encourage the inita-
tion of a desired project, they also tend to increase the probability of
default and premnit'iro project shutdown." This is especially t,:ie for
firms with larfre net worth. The standard criterion for deciding to
abandon a project once it, is operative is whether or not thlie project's
r'evpnlIes cover its variable co-ts (that i. 'the total cst lea sch fixed
charges as interest and amortization of debt). An operating project
would ordinarily be continued as long .as its revenues cover r.,riTh,
o.?fs and nl:e "', cont- ibNtion to payment of fixed charges. The
only exception is if the entire corporation would be. l bnkripted by the
fixed chrares. However, with a loan guarantee, it might be profitable
to nabndon the project wl.en it br,',ni'O, apparent flthat revenues will
not cover to',il ,)'... that is variable c.. tz plus fixed chari-os. It is im-
porftant. tlierofore. that tlip gua rant,, i V',r,' (,ent be de(si ,ned carefully
so) that it motivates the private p)articil)ants in the project not to de-
f:;. lt precipitately.
WHO PAYS FOR PROJECT?
The Government's choice of a melhanismn to stimulate invefntmont
in a particular project largely determines who pays for it. In anny year,
the level of the Federal deficit or surplus results from major political






decisions which are reached independently of decisions onil individual
programs. For fiscal year 1977, as an example, the President with his
January Budget Mes:,age announced a projected deficit of $413 billion
and the Congress, in its First Budget Resolution, established a tart'"t
deficit of $50.8 billion. Both figures had gri:.t symbolic importance as
summary statements of Federal fiscal policy. Each figure cont m :iii(ed
the budget requests of executive depi,,rtments or the actions of (con-
gressional committees. So when a major new activity is fiiianced with
on-budget expenditures-if the deficit remains tlie s;1le-it will be
"paid for" by diverting resources from competing governmental ac-
tivities through spending cuts. or bv diverting resources from private
current consumption through incre aed taxes. Advocates of other pri-
orities, therefore, will give the new proposal careful review.
When financing for a new project is obtained with lo;ii guarantees,
it is "paid for" by drawing resources out of the capital mnlarkets. Tifis
is true whether or not the guaranteed loan is purchased by the Federal
Financing Bank. With the guarantee, a borrower becomes a price com-
petitor for available credit. Unfortunately, this does not mean the re-
sourcvs are diverted from activities which from the perspective of the
Government are of lower priority. The increased demand tends to drive
up intere.-t rates in -,etors which lose capital. The operation of the
private market decides which activities will now not get credit. Tra-
ditionally, the weakest competitors in periods of high interest rates
have been those demanders of credit most dependent on long-term
financing: housing and the capital needs of State and municipal
government.
LIMITED 1; :I:OURCE
As is the case with Federal revenues, private credit is a limited re-
source. The wide-spread use of loan guarantees may largely convert a
visible competition among Federal progr i ,is for fiscal resources into
an invisible competition of Federal pr,<'grams for private credit. The
Federal use of loan guarantees, therefore, must be systematically
evaluated by policymakers determining thlie impact of Federal (Gov-
ermnent on the economy. Each new loa propo-:il-especially if it is
a Type-3 guarantee-should receive especially careful scrutiny.














Chapter V. TWO MAJOR ENERGY FINANCING
PROPOSALS


Two major proposals to finance enego-v development may soon Ibe
before tlie Senate. They are the Nuelear Fuel Assurance Act (11..
S401) and the Synthetic Fuels Commercialization Program. (Ii.K.
12112). These bills provide for loan guarantees and project guarantees.
M[any observers believe that the latter bill will require price guarantees
as well.
This chapter discuss-:es these two major energy financing propo-.,.l- in
order to provide background and specificity for the previous discus-
sion of guarantee mechanisms. Chapter VII of this report will review
the budgetary treatment of these two bills as it relates to the forth-
coming Second Concurrent Resolution.

Uranium Enrichment
Uranium must be enriched before it can fuel nuclear power plants.
Three U.S. uranium enrichment facilities now exist, all owned and
managed by the U.S. Government but operated by private industry
under contract.
Currently planned expansion of existing Government-owned en-
richment facilities will increase U.S. capacity but ERIDA indicates
that this entire capacity has already been committed to customers-
the equivalent of 208 domestic power plants and 121 foreign plants.

TWO EXNICIIMENT TECIINOLOGIES
Two principal enrichment technologies have been developed: diffiu-
sion and centrifuge. To date, the gaseous diffusion process developed
during World War II has provided all U.S. capacity. It is a mature.
reliable process that has been used on a lar,-,e scale for :30 years. The
newer centrifuge process is anticipated to have several ad vant i es over
the diffusion method, and is generally considered to be tlhe enrichment
technology of the future. Nevertheless, because the centrifuge lias not
vet been commercially proven, the older diffusion process is expected to
be used in the next enrichment facility constructed.

NEED FOR ENRICHIMENT CAPACITY
With continued growth in electricity generated by nuclear fi-sion,
the eventual need for new enrichment capacity is clear, bt the timinin
and magnitude of that need are not. Htow much additional enrichment
capacity we need, and when we must have it depends on projections
of nuclear power growth which can be either optimistic or pessimistic
and on assumptions about the foreign markets to be served. Analvsi-
by the Congressional Budget Office, however, suggests that the four
private enrichment plants contemplated under IH.P. 8401 will produce
(19)







iiore .. 'lear fuel than will be immediately needed but that this sur-
pi lls will be ii-td during the 1990's.

NlUCLEAR FUEL ASSURAN.\CE ACT
Inactment of the pending Nuclear Fuel Ass-iirance Act (H.R. 8401),
would permit private financing, construction. owner.slip, and opera-
tion of new uranium enrichment plants subject to action by the Ap-
)rol)priations Committee and to approval by Congres. ; of each of the
individual project guarantees. The bill would authorize ERDA to pro-
vide private industry with classified uranium enrichment technology,
for which users would pay royalties. Private developers cold( pur-
chase .ertiin unique materials, services, and equipment from the Gov-
ernment on a "full-cost recovery" basis (i.e.. ERDA would be reim-
bur-,', for all costs except certain R. & D. expenses recoverable
through royalties). The Government would warrant that the eln-
richment technology would perform to specification. H.R. -401 as
amended on the House Floor. says that any future liabilities for
which the Government would not be fully reimbursed shall be limited
to the isslir:mnce that the technology will work. To ease start-up of the
new private facilities, the Government could provide access to its en-
riched uranium stockpile, either purchasing production overruns if
private customers were not ready to take delivery or providing stock-
piled enriched uranium to customers at cost if initial private proIduc-
tion were insufficient.

GOVERNMENT liESPONSIBILITY IN TIHE EVENT OF DEFAULT
To implement the warranties and to protect private lenders, ERDA
would ,, authorized-if a particular private project faltered-to
take over the plants, assume domestic assets and liabilities including
project debt. and-depending on the reasons for failure-to compen-
sate (Pi,--tic equity investors. These warranties and conditions would
)e sp,.ed out in cooperative agreements entered into by the private
companies and ERDA and approved by Congress under tlie terms of
thlie Niiuc(l:;i Fuel Assurance Act.
Thlie bill also directs ERDA to berinl the work necessary to build an
add-on diffusion plant at the existing Portsmouth, Ohio, facility, in
addition to any private cooperative agreements and plants that may
be approved.
GU-ARANTEES TO OVERCOME OBSTACLES
T'e gLuarantcrs authorized bv the bill are (lesigneed to overcome
tli,., major obstacles to )private development: classified te,'mnology.
siz:.e of initial investment, and potential rl-ks to investment. Warran-
ties of Governmnent technology would eliminate uncertainty about the
l)erforiin licee of classified technologies. The other obstacles would be
removed by the Government's agreement. to take over a project and
coip)e sai te investors, if nllecessary.
An 'reet'lient that the Government would, if necessary, assume the
lo:in obligatioii- of a project would remove thlie risks facing lenders
and. -iimultaneowisly, enable the project to raise a large portion of in-
vested a)apital through borrowing. That ability reduces problems aris-
ing from the size of the investment required.







The ability of a p)roj,('ct to1) raise a larre portion of its financilln"
through del;t tlhat is unsec(ured Ib. the general assets of the equlty
investors also reduces the risk faced by equity investors (stockhold-
ers). Wihen fit-n contracts with customerss ensullre a steady streaii of
revenues upon project completion. the mlailn risk 1 )to e(qlulty investors
would be the possibility of losing u their initial 'capital investment. A
high (debt/e(q1tity ratio liale po-1Ssi)ble b)y guarantees wNould limit tllis
risk be ul use the maximum that equity ii vestors could los, would be the
relatively v small equity investment.

INVESTMENT TAX (CRIED1)IT
The investment tax credit acts. in addition to the ciiar'antees, to
reduce even further the capital investment t actually contributed by
equity investors. Ilnder some circumstances, tax benefits ac(cruing to
equity investors could exceed their investment in tlie project.
ERDA has received four pr1)oplosals to construct uranium enrich-
mnient plants from firms anticipating utilization of tlhe a'-si-tance that
would be provided by the Nuclear Fuel Assurance Act. The existence
of these proposals indicates that the incentives proposed in I.I. 8401
would le sufficient to stimulate private investo:!ent.

Wlio SIOULI) OWN TIlE ENI'lii-I :NT PLANTS?
Underlying tlhe issue of whether to enact tlie Nuclear Fuel A-.-ur-
ance Act is the broad question of who should construct and operate
future enrichment facilities. Several options exist. They are Gov-
ernment ownership, cooperative arrangements with indu-ti- y (which
H.R. 8401 propo:e.-)), and mixed (Govefrlnent-)rivate owvne4ship. In
addition, the existing enrichment plants could be sold to private in-
terests or the question itself could be l)postp)oned beyond fiscal year 1977.

CASE F(OR GOVERNMENT OWNERSHIP
The c ,-e for Government ownership rests, to a consider';tdle extent,
on tlhe belief that the degree of competition required to realize tile
potential benefits of private ownership is unlikely to develop and thait.
despite the large initial outlays, additional Fedleral enrichment ac-
tivities would ultimately return la -r' revenues to the (Gove0rnmtnlt.
Another formn of Government ownership would be to create a Gov-
ernment-owned corporation to enrich uranium. The case for tilis subl)-
option rests on the desiral)ilitv of retaininir Government ownershipv
of a Government-developed technolo-v and revenues from it, while
avoiding large direct Federal budget ii impacts and realizin7 son ie of the
efficiencies as-ociated with corporate (versus Government) business
practices.
If the Government were to own all new capacity (here ;i--umed t
6 plants by yv;eair 2000). substantial annual outlays. according to (BO.
would be required to finance construction. The annual outlays will ri:,.
to a peak of approximately $2.7 billion by 1984 and diminish thereafter.
Annual revenues from sae, would also increase but would not exceed
annual outlays until 1988. Cumulative revenues would exceed cumula-
tive outlays, including assumed interest in 1983.







CASE FOR PRIVATE OWNERISiIIl'
The case for private ownership r.sts generally on the presumption
that bro( ad efficiencies characterize private undertakings, and onl the
philosophicaLl belief that production of materials is an activity best
suited in our society to the private sector.
If private industry were to own all new capacity, no Federal out-
lays beyond tho( e currently planned would be required-assuming
contingencies would not occur-and no revemnle- from new sales would
1-e re.eived. However, the Government would receive royalties for the
1use of Government-owned technology. If, for example, a royalty rate
were, negotiated at 3 percent of gross revenues for 17 years, each large
private facility could pay the Government more than $400 million in
cumulative, royalties during those years, and annual revenues from
six plants could reach $150 million by the early 1990's.
However, in order to encourage private sector ownership the Feder'al
Government could be at risk for amounts ranging up to $8 billion ($1.4
billion for the diffusion plant, $1 billion for each smaller centrifuge
plant, plus contingencies and an inflation factor) from initiation of
construction to sometime after the date of full commercial operation.
While ERDA believes default is very unlikely it is a possibility and
hence a risk.
)MIXT-RE OF PRIVATE/GOVERNMENT OWNERSHIP
The case for a mixture of private and Government-ownership rests
on the belief that the need for the first new increment of capacity in the
mid-1980's is such that planning and construction should begin in the
very near future and that Government, with its experience in building
and managing three existing facilities using a proven technology, is in
the best position to own this next facility, which is likely to be the last
one using this older technology. Private industry would then assume
responsibility for providing other future additions to capacity using
new technologies. This option would be provided by the Nuclear Fuel
Assunmce Act which directs ERDA to construct another enrichment
plant in addition to any private facilities.
If ownership were mixed, with the Government owning the next
facility and the private sector owning further additions, the Govern-
me:it would receive both royalities and enrichment revenues. Royalties
would reach about $125 million annually by the early 1990's. Initial
Government outlays would reach a maximum of $0.9 billion in 1983,
with the cumulative debt (including assumed interest) repaid by 1993,
and cumulative net revenues reaching over $4 billion in year 2000.
An additional option would be to delay any decision on future en-
richment facilities for at lea.t 1 year. Since the Government-owned
additional: plant las been authorized independently of H.R. 8401 the
next (liffisimoi plant would proceed even if the action on the bill were
to 1)e delayed. Thus, the primary effect on enrichment development
might be to delay initial work on centrifuge facilities.
A final additional option would be to sell existing plants to private
corporations. If this alternative were considered in lieu of the Nuclear
Fuel Assurance Act, it would clearly settle the issue of whether
uranium enriclhment facilities should be private. It would require the
Federal Government to forego revenues from the existing plants
which, from 1976 through 1990, could total $9.2 billion. In place of
this revenue source would be the value of the plants to be sold.







Thiis alternative alone, however, would not addn-., the issue of pro-
viding for future iwi 'I5-ses in1 enriclmenit (;i pac-ity.

Synthetic Fuels
Synthetic fuels are usually considered Ito include ,,as and oil mnade
fiolit such sources as coal, oil sihale, or u1rl);'11 or oler waIste, but not
gas~~ ma s-V II e"g
gas made from oil. Production of such >synt hetic fuels would be eligi-
ble for support under I I.1. 12112 which is now being considered in the
IIoii.-,. of Repreenitatives.

PRESENT TECIINOLOG Y
Several proce:-.-.s for producing synthletic fuels have been developed.
Some of the older pl'rocess'es have bOeen demonstrated to -work, ad ll have
been put to use in foreign countries. However, much of tihatt produc-
tion is subsidized, and the scale of production is considerably smaller
than that envisioned for programs proposed in tlihe United '4tatcs.
ERDA conducts an extensive re.-arch program aimed at developing
second-generation' processes for producing synfuels that promise to
be more economically attractive, efficient in use of resom, es, and envi-
ronmentally acceptable. Nevertheless, such technologies are not .e
available, and economics of existing processes have not, inll the past,
been sufficient to induce indlstrv to produce synthetic fuels corn-
mercially in the United States.

COSTS OF PRODI)UCING SYNTHETIC FUELS
Current cstimates of the cost of producing synthetic fuels exc cded
1by a considerable margin the price, at which competing fuels c.;il now
l)e purclhased. For example, Dr. Willianm McCormick, Director of
ERDA's Office of Commercialization, testified at thle hearings of the
Energy Task Force that while high-BItu pipeline gas might cost .5.2
to $:.5( per million Btu, the highest price at which natural gas now
sells (in intrastate markets) is under $2 per million Btu. Mr. Fraln.:
Cannon of the Koppers (Conpany agreed, stating t ,at for 4 years
Koppers which has 17 plants overseas has tried to market its g:tsifica-
tion process in the U1nited States without success, because thlie cost of
producing gas with that process was too high for potential U.S.
customers at current prices.

RELEVANCE OF FUTURE PRICE//COST TO PROFITABILITY
HIowever, as Dr. McCormick remarked in his testimony, the relevant
comparison is between future energy prices and future costs of svn-
thetic fuels. If energy prices were to increase rapidly, sy ithetic Tel
production could 1be,)come a profitable e enterprise. Studies performed
for ERDA have indicated tliat it is unlikely that energy prices will
rise rapidly enough to make synthetic fuel production 1)pirofitable Ie-
fore 1985, but that such market forces probably would create a, private
synthetic fuel industry after 1985.

GOALS (OF A SYNTHETIC FUI:LL PROGRAM
In proposinig a synthetic fuels commercialization proerTram, tie Ad-
ministration specified three roals for 1985: (1) development of teclI-





24


nical, en\ ironnlental, and ec'iionoic inforiiiat ioii oni synfuel production
p)roces -!css; (2) accumulation of experience with synfuel production in
American industry: and (3) production of significant quantities of
synthetic oil and gas. To achieve thliese goals, the President i; itially
pr'Op)osed price guarantees. loan guarantees, and construction grallts
designed to achieve an interim synthetic fuel production ta rget equiva-
lent to 350.000 barrels of oil per day. with an option of expandiiir the
program to 1 million barrels per day by 1985. The first part of the
Administration's program, i; billion in loan guarantees. \vas defeated
in the Hoiuse of Representatives last year. This year the Adininistra-
tion is requesting a smaller ?2 billion program of loan guaranlitees.
The relative importance given to the production and tlie inforina-
tion goals call influence the desirable size of a :v-nthetic fuel program.
The information objective might be achieved, according to CBO. with
a prograin too small to increase dolme-tie, energy production signifi-
antl.y. That objective could be piir,-ied effectively if a target produc-
tion of 350,000 barrels per day by 1985 were chosen, but substantial in-
formation might also be generated by a smaller program. One with a
target of 125.000 barrels per day would allow construction of one plant
to produce each type of fuel included in the larger program i ii. To achieve
a 125,000 barrel per day target might require $1.5 billion in loan guar-
antee authority. $1.7 billion in price guarantee authority, and '30 mil-
lion in construction grants. Such a program might support construe-
tion of five plants.

DIF'I:I-TIENT VII,.-TONS OF SYNFIUELS BILL
Congress is considering a variety of options for assistance to syn-
thetic fuel production. The version of It.R. 12112 reported by tlie
Committee on Science and Technology of the I.S. House of Repr sent-
ativp- would provide only loan guarantees as an incentive. The Houtse
Banking Committee and the House Commerce Committee reported
amendments to H.R. 12112 that would add authorization of price
guarantees. The Commerce Committee amendments also altered the
scope of assistance by excluding all fuiel produced from coal from re-
ceiving guaranteed and by allowing synthetic gas at prices higher than
tlhosr allowed by t'he Federal Power Commission if customers can be
found.
DIRECT GOVERNMENT OWNERSHIP
If a derision were made to restrict the scale of svnfuel production
while ursnuing the information roal vigorously, direct Gore,,ment
o0ii'',./,1'ep of a small number of plants constricted and operated bv
private contractors (much like present uranium enrichment plants)
might be desirable. Such an approach appears well-suited to dealing
with environmental and socioeconomic consequences and to acquiring
publicc knowledge of svnfuel tenlmologv and economics. On the other
hand, it would not foster creation of a private svnfuels industry,
ibut would put the Governme),nt in the oil and gas business (directly
comn)etiwir with private industry) if high production targets were
c.hose. (l
A Itei rn at lvel v. the Govermnent could construct synthetic fuel pl1 ants
aind then sell or lease them to private industry, as s.i.Lrested b Se.nator
Bellmnon. Such an approach would remove the "front-end" risks of





25

constructing synthetic fuel l)plalits, because plants woulld not be trans-
ferred to the private sector until they were colipl)eted amd licel-k-ed
successfully. However. if the costs of producing synthetic fuels were to
prove to be higher than the selling price of alternative fuels, tlie (Gov-
eminent would be unable to recover its entire cost through sale or
lease to private investors. Rc,-ale "at a discount" would then provide a
mechanism through which tlie (overiment would provide a, adequate
subsidy to induce the private sector to produce syilthetic fi .ls.
Government cost-sharin'g with private industry could si-:ilarly
reduce the initial cost borne by private enterprise, and this redce t lie
price private industry would have to charge to recover its 1iv"-, inet
and earn an adequate profit.
According to CBO. to construct the same plants included in the pr)-
gram budget provided by ERDA in te-tiniovV oil the oan c -ig'unIalitees
of H.R 12112 would cost abl)out S5.9 billion : those outlays would occur
between 1977 and 1985. If current projections of prices and c' 1,s are
correct, revenues would not be sufficient to repay thtis iivestl 'zon v-Itll
interest: the shortfall would probably be on the order of 1 ii on over
the life of the plants.

DEVELOPMENT OF NEW TECIINOL(OGIES
ERDA is developing several advanced svnfuiiels processes i _:. could
improve the economics, reliability, and environmental impact o" svln-
fuel proPss.s. Pilot plants for several seco< d-ogenerationI proesse; are
under construction or operalting, and a req(iest for proposal hi been
issued for a deinonstration->,rle plaint to produce sytet:' )oilelr
fuels from coal.
In many casvs adequate private investment in research is not f)rth-
coming without Government sl)pport since the enterlprise which ears
the costs and risks of research cannot shave in its full social I c, cfits.
In the commercialization stage the rewards to private eterptis may
more closely approximate the social benefits. If these considrratiotm-
alpply in the case of synthetic fuels. (C'ongress may find it appro'Vi~ite to
emphasize Federal involvement in support of reI. arch while givimn
responsibility for commercialization to private eteprir.-e.

DEMONSTRATION PLANTS
Tie President's budget for 1977 propo-td authorization of three
new demonstration plants: one designed to convert higlh-suifur coal
to clean boiler fuel, one to convert coal to a "'high-Btui" goas of qualityy
sufficient to ship by pipeline, and one to convert coal to a "1. w-Itu"
fuel gas for electric utilities and larger industrial users.
These demonstrations could require up to a 1otal of '400 million inll
outlays by the late 1980's. Such projects would not be completed b before
1985. Consequently, the new technologies probably would not be avail-
able for inclusion in synthetic fuel plants constructed l)efore 1 9.'.)
By the yeai r 2000. ERD)A anticipates that advanced tecl.hnolo lead to production of 2 million barrels per day of oil from coaIl ald
possibly 10 quads (5 million barrels per day equivalent) of .s from
coal.
Further research and development into new techno-ii1oe-' '" syn-
thetic fuel production would provide a better technical basis f' r -tab-
lishment of a commercial synthetic fuels industry.







If it is decided that a commercial synthetic fuels industry should
be established immediately, a choice must be made among Govern-
ment-ownership, provision of loanl guarantees alone, or provision of
loa i i and price g-ua rantees.

OPTIONS TO REDUCE RISKS
Lowei guarantees can reduce "front-end" risks, especially those due
to iunicertainty about the cost or performance of new technologies.
Government construction of a synthetic fuel plant, with later sale to a
private firm, can perform a smiliar service. If concern about the mar-
ket on which synthetic fuels would be sold is an obstacle to private
development, such devices may be insufficient. Price guarantees, set
at an appropriate level, could be effective in removing such an obstacle.
Government construction of a plant then leased to the private sector
could, depending on lease terms, reduce both regulatory and market
risks.












Chapter VI. BUDGETARY TREATMENT OF
GUARANTEE MECHANISMS

The Budget
As noted by the 1967 report of the President's (Commissioil onl Budg-
et Concepts the budget presents the financial plan of the Federal Gov-
ernment. This plan includes appropriations, receipts, expenditures,
net lending, the means to finance a budget deficit (or the way to use
a budget surplus) and information about governmentt borrowing and
loan programs.
The budget is a "road map" of where we are going. It is both a state-
ment of national priorities and an instrument which can be used to
reorder those priorities. The budget is also an element of economic
policy and a tool to shape that policy. Finally, the budget of the
United States Government tends to reflect boundaries of activity be-
tween the private and Government sectors and between the States and
the National Government.
The budget should reflect the full scope of Federal activity. Action
by the private s-ector ought not to appear in the budget, but tlie various
financial transactions of the Government. including its liabilities.
should be reflected in some way. Otherwise. policy makers in both the
Executive and the Legislative Brianches Imay be unable to ;I::,rs the
full impact of their decisions.

CRITERIA FOR A BUDGET
It is important that the budget fully disclose the nature and extent
of tile Government's liabilities. This includes contingent liabilities
as these may have a significant budgetary inlpact. Moreover. it would
be useful to know the beneficiaries of the resulting alsistace or ssub-
sidies. Certain types of financial incentives will assist tlbe (olsumer.
some are designed to assist industryv. and some would shift costs to
one or the other.
In addition to reflecting the full scope of Federal activity, tlheo
lidget should be precise in terms of amounts and clear in terms of
concepts. Distinctions between budget authority and outlay:, between
contract authority and borrowing authority, between potential liali i-
ties and actual expenditures ouQht to he recognized. "Federal spend-
ing" takes many shapes and to lump them all together at times ignores
the complexity of budgetary concepts which themselves sck oly to
reflect the complex reality of public policymaking.
At the same time the budget should be understandabl)le. With knowl-
edge of a few basics, policymakers ou'rlit to be able to interpret the
budget. The vast sums and thle technical :om)lexities must iot ol)bscure
the fact that the b]ud'et is a tool for deeisionmakers. It is il-o n in-
strument by which the general 1)pulb)li can become informed as to tle
(27)







scope aid direction of public policy. Unless the budget is understaniid-
able it (.., not serve this important function.

EFFI'ECTS OF GUARANTEE
Thie various mechanisms to finance energy development all have
atn ililpact on the budget. Loan guarantees, price guarantees, and
project guarantees are integral pirts of the Government's financial
plan. How the budget accounts for all guarantees will affect the
amounts in the F1,ral Year 1977 Second Concurrent Resolution and
future years, and may in the long run, affect the nature of the con-
ir,--ional budgetary process itself.

Loan Guarantees
"The authority to insure or guarantee the indebtedness incurred by
allother person or government" is specifically excluded from the
definition of 'budget authority" provided in section 401(c) (2) of
the Co('irr.-ssional Budget Act of 1974. Loan guarantees, therefore,
have an "otf-budget" characteristic which distinguishes them from
most alternative methods of financing public objectives. Prior to pas-
sage of the Congressional Budget Act. many programs had been
designed with "backdoor" spending mechanisms that provided budget
authority without advance action by appropriations committees. In his
testimony before the Committee's Energy Task Force, James L. Mitch-
ell. an Associate Director of 0MB, noted that in recent years there
have been an "astonishing" number of loan guarantee proposals. "We
have moved," Mr. Mitchell said, "from the old backdoor on appropria-
tions into the guarantee techniquee"

OUTSIDE BUD;IFT TOTYrALS
The President's ( commissionn on Budget Concepts report, which rec-
omllmnended1 that loan guarantees be reflected outside budget total.-.
stated t lat tlie.,e guarantees were likely to become increasingly impor-
tant. Thlie (Commission recommended that loan guarantees be sul,-
narized4 as a note in the budget and that serious consideration 4'e given
to "new forms of c('oordinated surveillance" of such guarantees. As
stated in thle report:
(O)therwise, an appropriate choice in terms of effective re-
source allocation may be difficult to achieve and the inclusion
of direct loans in thl(e budget may encourage an undue expan-
>'n of guaranteed and insured loans to avoid being counted
i1 thie budget.

BUD(;GIE' TREATMENT OF LOAN GUARANTEES
A.t i:'e Ta>k Force hearings Stanley Lewaiidl, a vice president of
Cl(-ia1, Manhiattan Iank,. noted that (Govermnent support of private
venItu'-.- suchl as loan guarantees "is not withliout cost to the taxpayers
wh(o 8 ,- U'ie all or part of the hue-ite: risk in lieu of the venture's beie-
ficiar,.'-." Now that "total primary guaranteed loans (adjusted)" out-
sid(e fl, I) budget total $174.6 billion a major prolbleii is how best to in-
clude that c,)t to the taxpayers in budget decisions. The Task Force
hearing brought to light a conflict between the needs of budgetary con-
trol a':d the neeld-, of economic analysis. Unless the cost of a program





29


appears onl the budget so that the p)rogram111 colipetes against other
claims upon the Governument's financial i)riorities, or the programll is
subject to some other adversary proceeding, it may es,'ipe adequate
congressional review. Loani guarantees are therefore of concern to
those interested in control. Philip S. IuNohes, Assistant Comptrol-
ler at the General Accounting Office stated (GA('Ys position "that
there should be full disclosure of the blmudget impact of all exist-
ing and proposed Federal credit anmid credit support programs.
Only by full disclosure can the full impact of such programs
and the trade-offtis with other Federal programs be evaluatedd" (O)n tlhe
other hand. I)r. Arnold Packer, the Budget (C'ommittee's (C'hief Ecoi-
omist. -f.ited that economists ordimNarily exclude Government, lendtinr
from the-, activities which should appear in thle Feederal budget.
Treatig' lo:lii guarantees as a Federal outlayv. hlie felt. would provide
a seriously exaggr'erated picture of tlhe size of thle Federal sector in the
economy. -' would think that it would be (distorting from a lacro-
economic point of view to put the lending in the budget," s;:id IDr.
Packer "Now if the Federal Government is g()oing to operate a syn-
thetic fuels plant or a nuclear enrichmn)enit plant, then it is a FederalI
activity an(ld it ) belongs there, but not if it is the guarantee area or even
in the lending area.
Another way to treat loan guarantees in tlie mudgret wold lhe to est i-
mate each vear the amount of Federal payient.s likely to result fromu
lo:III guaranItee defaults and have that estimated amount appe:I r in the
budget as budget authority, accompanied by the associated estimate of
outlays. The full exposullre of the guarantitees would not be reflected in
the budget. Only the amount of expenditures that we anticipate. will be
needed would appear. For example, if a 42 1)illion solar energy loan
guarantee program were established and were expected to have a 10-
percent. rate of default, the budget would show m"" million. The ad-
vantage of this approach is precision. Only thle amnounit that is esti-
mated to be necessary and that in all likelihood will Ixbe spent appears
in the budget totals. The disadvantage is that tlie extent of the Federal
liability is not shown nor is the economic impact of the guarantee upol
the private -ector. The Government might have to spend far mIore than
thle amount estimated to cover defaults than is shown in the. budget.
The budget thus would not reflect the complete potential for Federal
spending.
This approach is how some (but not all) loan guarantee programs
have been treated(l in the bmdgret. In the case of the '2 billion synthetic'
fuels program, the Admin istration lias esti mated a default rate of .2
percent aniid is requesting budget authority of m00 million that woubtld
apl)peair i the budget to co)v-r anticipated spending.

TREATMENT OF ASSUME!) I)'rBT
If a default were to occur when CFedleral IloaI gI uarani es' III it :' Ve I ee
extended, the (Governmnent might well take over operate ion of the fac'il-
ity and a-Isuie its assets -i(nd liabilities. Threese liailities will prol)lyV
include d(,1bt. whether this deo)t. when it is eld )v the Gove1nment,
becomes part of the Federal debt suilject to limitation that is reft...t(
in the b udget and shown in the concurrent resol utions of thle Congrs,-
sional budret is uncertain. The Task Force lopes tliat tll iste ':, 1CM
reviewed in thie ('o01111 1ittee's major study of Federal financial rarguamn-
tees.







Price Guarantees
Price guarantees do not pose too great a problem in terms of budget-
a r v treatment. Authority to implement a price guarantee program is
r iuest ed through the normal authorization and appropriations proc-
,-. If approved, an estimate is made of the program's costs, and the
anticipated amount of budget authority is then provided through
appropriations. This budget authority appears in the budget totals.
One issue that does arise with such programs is in what year the
budliget authority should be carried? Should it be carried in the year
the program is enacted? Or should it be carried in the year that the
price support payments are required? The principle that budgetary
costs should be acknowledged when the decision to establish a program
is made argues in favor of showing the budget authority up front.
Outlays of course would appear in the year they occurred. But the
difficultyy with estimating accurately what level of price supports might
be required several years hence argues in favor of carrying the budget
authority in the year for which it is necessary.

BUDGETARY TREATMENT VS. BUDGETARY CONTROL
The difficulty with programs that support prices is not budgetary
treatment but rather budgetary control. Price guarantees can be en-
titlement programs. Once in place they can make demands upon the
budget that must be honored. Given the unstable nature. of prices,
particularly in the energy area, these demands can be considerable.

Project Guarantees
Project guarantees are intended to protect participants. in a venture
from the failure of a particular project. Guarantees are extended not
to the financial institutions lending capital to the ventures but to the
project itself. Much of the analysis in this staff report on the affect of
];nc guarantees applies equally well to project guarantees. But the
liabilities incurred by project guarantees-unlike those of loan guar-
,ntes--are not specifically excluded by law from the budget totals.
Be.aiuse project guarantees are relatively rare, a discussion of their
budgetary treatment can best occur in reference to a specific guarantee.
The next chapter of this paper in part will discuss the budl'etary
treatment of the guarantees contemplated by the proposed Nuclear
Fuiel Assurance Act.






Chapter VII. THE SECOND CONCURRENT
RESOLUTION


In the. First Concuirv eint Re.-oluition tlie Committfe assumed $5.1
billion in budget authority and 4.2 billion in out lays for energy.
Thel-.c amniounts were considerably above what tihe President had re-
quested and reflected the Comilit tee s view that energy, ought to rank
as an important budgetary. priority. However, no provision "was made
in the Resolution for funding off-budget energy proposals. This ex-
clusion was not mieant to prejudice Senate action. The "Committee
sinpiy believed that sufficient information was not then available to
review these proposals. As stated in the report :
by not including ainy funds in the First Concurrent
Resolution for the President'lts ofl'-)ud(et pro)'Pos )als, the Com-
mittee does not ) preclude any action oni tlhe specific propo-:ls.
if they are broug ht to the Senate Floor. Both the of'-t)udgIet
issue and the sp)ecilfic procgramin proposals themselves could
then be reviewed in light of tlie First (Conmirrent Resolution
and any availabl)le information. If significant on-budget ex-
penditures were deemed appropriate by the Congress, an
adjustment could be made by the Second Concurrent
Re.-olution.
Since pas-.a.. Ie of the First (Coicurrent R, -olution. legislation re-
lating to both uranium enrichlnent and synthetic fuels haw moved for-
ward. The (Coimnittee nmust now determine in the Second Concurrent
Resolution whether or not to adjust Function 300 targets to aeom)-
i lod(late such legislation and, if tlio,-e targets are to be adjusted, what
budgetary treatment oif budget authority and outlays is appropriate.

AVAILABLE OPTIONS
A number of options for treating the Nuclear Fuel Assurance Act
and the synthetic fuels commercial demonstration program--if the v
are enacted-are available to the Committee. Each of these options is
defensible from a technical viewpoint and yet each one has a very dif-
ferent effect on functional totals. In addition, the selection of (one or
another of tlhe available options may establish a precedent.

Uranium Enrichment Scoring Options 1
The $8S billion in guarantees contemplated in IT.R. 8401 could be
treated in a number of ways. Thle Commnittee could choose to:
-Score the full $8 billion as budget authority at the time of tile
appropriation. This approach is akin to scoring the full ex-
posure of a loan guarantee program.
This section deals exclusively with the $8 billion in contract authority
authlirized in HI.R. 8401 in as much as the $255 million authorized in section 4
of the bill for a new Federal enrichment plant is a traditional type of authoriza-
tion. If the bill were enacted and funds were appropriated, the amount provided
would aliiea r on budget. as budget authority with resulting outlays.
(31)







-Score the full value of each contract with a private venture at
the time of rat ificat ion of each individual contract.
-Score partial amounts, representing the actual Governmient
liability year-by-year, as the liability grows. For example, if
all the contracts are approved, the first year of liability would
be approximately $300 million.
-Score some fraction of the $8 billion as budget authority based
upon an estimated rate of default greater than zero. This is
the procedure presently contemplated by the Ad;ministration
and the House Budget Committee for treating the synthetic
fuels bill.
-Score nothing at all because the liabilities are contingent.
SCORE NOTICING AT ALL
The position of the Administration is that no budget authority
should appear since budget authority as defined in the Budget Act is
authority to enter into obligations which will result in future outlays.
If this approach is followed, Function 300 targets for fiscal year 1977
would require no adjustment. In the event the default occurred in
some future year, that year's budget authority and outlay would have
to be adjusted to reflect the actual level of Federal liability. It should
be noted that this off-budget treatment is, in the view of the General
Accounting Office, permissible but undesirable. In an opinion re-
que-ted by SBC staff, the GAO stated that while the authority author-
ized in H.R. 8401 did not establish "budget authority" within the
meaning of the Budget Act, the authority should be reflected in the
budgetary totals if Congress is to achieve the maximum effectiveness
of the new budget process.

SCORE SOME FRACTION
The c.-:e for scoring some fraction of the project guarantees is pred-
icated on the assumption that some defaults will occur and future
outlays will be required. In this instance, the Committee's final action
could reflect the probability of failure associated with each of the
component elements of the package. The components include tlhe coin-
struction of one new gaseous diffusion plant and three centrifuge
plants. It appears unlikely that the gaseous diffusion plant will fail
for technological reasons. Therefore, a case can be made for not scor-
ing the $1.4 billion of liability associated with its construction in the
SCR. In the ca -e of the three centrifuge process plants, however, some
technological risk does exist since the process, at the commercial scale,
proposed is new. If the Committee wished to show in the budget the
amount of liability under H.R. 8401 associated with the gas centri-
fuge teclmnology, $3 billion would be added to the budget totals.
Centrifuge plants are constructed as a series of "caqscades". When
the first such "cascade'" is complete, the technological risk will have
been resolved. At this time, success or failure is evident. Additional
"casads'" need not be constructed. In the event that the process is not
sulc5'essful, constri action could be suspended and the project guarantees
paid out. The amount of Federal exposure under H.R. 8401 necessary
to support the development of the first "cascade" is estimated to be
approximately $400 million per centrifuge facility. If, as is planned
three facilities, are extended guarahtees and all three centrifuge plants




33


fail, the Federal liability would total $1.2 billion. The Co:-ii',ittee
could, if it wished show this amount in the budget totals.
SCORE PARTIAL AM( OU NT
Another option for the Committee would be to score a partly aliolilut
of the $8 billion in project guarantees contelmp)lated by the Nuclear
Fuel Assurance Act representing the actual liability on a ve.i .-bv-vear
basis. Because the $8 billion constitutes the total liability over a period
of several years, reflecting the $8 billion in the budget for any one yeair
might distort the budget totals and exaggerate the liabilities. Tlhe
amount of the Federal liability for the one year in question coui(ld be
shown instead. If all the contracts anticipated under II.R. 8401 were
reflected in the budget in this way, the liabilities for fiscal year 1977
would total approximately $300 million.
SCORE FULL VALVE OF EACH[ CONTRACT
Another budgetary treatment option for the Committee would be
to score the full value of each contract within a private ventul'. at the
time of each individual contract. The $8 l)illion authorized i II.R.
8401 is the upper level of contingent liability that the Goven(,mewnt
could conceivably assume with regard to tlhe four private enrichment
plants expected to request project guarantees. Of the $S billion. $1.4
billion is attributed to the one gaseous diffusion plant being planned,
:3.0 billion is attributed to three centrifuge projects, and $.f is at-
tributed to continigencies and inflation. The budget could reflect tlie
liability of the Governmient assumed through the project guarantees
for each of the four enrichment projects or as many as are approved
by Congress.
SCORE FULL A .MO UNT-$8 BILLI()N
Another option would be for the Committee to score on buidglt the
full amount of thie liabilities contemplate(l by the propo:-ed NuIclear
Fuel Assurance Act. Thus $8 billion in budget authority-the upper
level of liability-would be added to the budget totals at the time of
the Second Concurrent Resolution. Thle Administration b)elieves this
option to b)e unwise because it artificially inflates budgetary totals
while distorting the macroeconomic impact on the budget. As noted
above, the Administration also believes thliat this option is unncess: rv
given the specific definition of budget authority in the BudNet Act.
Nevertlmeless the Committee might want to exercise this option I, .use
the $8 billion is the amount that the Federal Governient is oiit,(ed
to pay if a series of events concluding in the default of all the pD',j *'ct
guarantees were to occur.
When to Score Uranium Enrichment Options
In addition to the problem of what or how much to co.re ii order
to accommodate legislation such as II.I. 8401. the Budget (C.'ol.mittee
must determine when to score the required l)u(lget authority if at all.
In the event that budget authority is required, should that bd'et
authority be available at the time the Appropriations Committee takv-
action or at the time the contract is signed an(l tlhe liability tvcrted ?
Or should budget authority be scored only when an actual Fed(eral
payment is required? It may well be most appropriate to score tlhe
budget authority at the time the resolution approving the individual




UNIVERSITY OF FLORIDA
III~~111 IIlIllJ IlII IIr III 11111 I~lIl
3 1262 09112 5145

rcont,:i.t i :;t--ed for it is ;It tlii- tine that the liability, however con-
< *iT, is ,-taldi-- 1. In any event. ac.ominnodating current legisla-
t ,i* tii mu v ith utiiiiu ricnI, eiilc ent poses the qpe:tions of what to
-,~* lrr :l (dI %% iI" to .-., re.
Synthetic Fuels Scoring Options
M:iiiv ,C tl probl'mins reIl:iting to how much and when to score
1!-,1 aul ?ii iut f,,r iiriiiiuln enricMment are not present in the legis-
li';.,t relating to Fiec-ral ,tiarantees for the development of a conm-
,...i, ,1 it,,.ftic ful.1- industry. IJ.R. 12112 provides for loan guar-
M itNci II 1t niionlot of S4 billion and allocates that amount equally
in i;,a I rs 1977 and 197>. S. 2-t,4, a version of the bill that. passed
t -Sc1.lte 1,14t veir-, p1rovid,.- for s-; billion in guarantees allocated
; il it !- *al v, :i u "1977. For the lo:aii guarantees in the House bill. it has
en '" -te(ld thaIt *:,) million in 1977 budget authority be included
in t le bul,.1- t. UIy totall- subject to action by the Appropriations Conm-
itiit,.,. TV,;- :mnonnt rprc.n-set- a default reserve of 25 percent based
1q,,i1 a .:2 billion hlo;iI girantee progriain. This treatment of loan
guar:i.t-t-.- as budget authority, which the Administration accepts,
would aIpl,:!'v to be consistent with the Budget Act although guaran-
ti' have at ti ,i 1elen treated differently in tile pa-t. In marking up
t,- Fir-4 (moicuirrenrt Resolution the Ho)sc Budx.t Committee also ac-
ce)teid tlI- budgetary treatment of loan guarantee.; and assumed .500
ilcliM I in b!;'1"et authority for a synthetic fuels commercialization
1)11 5 't' LI.
PRI'ICE GUARANTEES
ProIblems i,''uliar to synthetic fuels development and the legisla-
ti\e i!!iti:!tiv.- which -Illpport it are related to price guarantees. 'Ihis
is -o w\Viet,(r or not the price guarantees are specifically
conteit)lated in syntlhetic fuels legislation. Legislation reported
)by both the House Banking, Currency and Housing Commit-
tee and tlie io)s-e Committfa on Interstate and Foreign Commerce
contemplates varying levels of price guarantees over the 30-year life of
tie filit. No price gua:rantees are mentioned in the Science and
Tellnoloyrv Comnittees version of tlhe bill. Yet there is little doubt
that syvntliti c fuels, in the short run, will fail to be price competitive
witb either ilt m.olviii or natural gas. Hence some. type of price guar-
a:uitec .ctI,. inherent with :v.nthetic fuels commercialization. The Ad-
mini-ti ritions, initial Sf billion synthetic fuels loan guarantee pro-
poIal reco'izdi/.. d this for it -p)ecifically conternplated(l $4.5 billion in
price -11:rante.s for which authority was to be requested later on.
The exact time at which emncruy from synthetic sources will become
prie ci ipetl itive is highly conjectural. Therefore the level and dura-
tion of the filnci;tl colIll1IitIIIents; associated with such price guaran-
tee: cannot be calculated. And their budgetary treatment thus be-
,moles (diffitlil. It may be thliat the Committee wishes to have budget au-
thorivty scored for the year ill which price payments are made, or the
C,,IIIinttee may wish to estimate the amount in the budget for the
year in which tihe synthetic fuels program was established. In either
,c.as, 1mlemIdbers of tlie Committee and of the full Senate as well will
want to realize that some form of price assistance may be necessary
for tlie proposed syntlhetic fuels programs.
0