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SUPPLY/OFFTAKE
The manure supply agreement is among the most heavily negotiated documents in a renewable natural gas project. BY CHRIS PETERSON
Although each contract related to the development of a renewable natural gas (RNG) project is critical, the terms of the manure supply agreement will make or break the profitability of a project and the risk tolerance of its investors, lenders and other key stakeholders. Additionally, having an agreement that will pass the scrutiny of the developer’s lender can be a challenge for the unwary.
Successful manure supply agreements identify the big issues in the farmer’s supply of the feedstock and clarify each party’s rights and obligations. Some of the critical terms for the parties to agree upon include
the farmer’s compensation, feedstock quality, environmental incentives and credits, ownership and disposal of digestate and the third-party rights granted to the developer’s lender.
Farmer Compensation
The farmer’s compensation can take many forms, depending on the needs and interests of the parties and their respective stakeholders. Compensation based upon the volume of feedstock delivered or upon the head count of livestock are most common. When using the latter on dairy farms, the parties may compensate the farmer using a “wet cow equivalent” metric that calculates cows based on breed (for example, Holstein vs. Jersey), heifers and wet vs. dry cows.
Compensation can also take the form of milestone bonuses, where the farmer receives a bonus payment upon the developer reaching certain milestones, such as the signing of the transaction documents, the project reaching commercial operation and the validation of Low Carbon Fuel Standard pathways. And for certain farmers willing to forgo some or all compensation through the above standard structures, a profit-sharing arrangement (either through a percentage of profits or gross revenue received by the developer) would expose the farmer to more of the risk (including a lack of payment under such arrangement for the first few years), but share in more of the upside profitability of the project down the road. In some recent transactions, the farmer or affiliates make an investment in the project company, generally on the same terms as the financial investors. This provides an alignment of interests and perhaps comfort to investors that the farmer will continue production and fulfill all the terms of the supply agreement.
Feedstock Quality
Because certain characteristics of the farmer’s manure supply will affect biogas production and the stability of the anaerobic digestion process, the parties should consider including such characteristics in the description of the manure that will be delivered pursuant to the agreement. These characteristics might include moisture content and total solid content. Additionally, it is important to agree upon those extraneous materials that should not be included in the manure. For example, significant amounts of rock, gravel and certain chemicals can adversely affect biogas production.
The parties should also agree upon the consequences of delivering unsatisfactory manure. In the event the manure contains an abundance of extraneous materials that preclude the developer from using it in the anaerobic digestion process, such unsatisfactory manure will need to be disposed of. Typically, the farmer is obligated to take this back and incur any costs associated with its return and disposal (which may at least include transportation costs).
Environmental Incentives and Credits
Federal and state credits and other incentives for RNG production are often critical to the economic viability of the project. When sold in connection with the California transportation fuel market, the RNG produced from a livestock manure project offers some of the highest LCFS credits, due to the negative carbon intensity score associated with manure feedstock. These state credits, combined with the federal credits from Renewable Fuel Standard renewable identification numbers generated from RNG, provide the incentive for developers to risk millions of dollars in initial capital expenditures. The manure supply agreement should therefore clearly state that the developer owns all rights to the environmental credits, tax credits, offsets, allowances and other private or governmental incentives related to the project. The farmer, however, keeps any environmental benefits that come from the dairy’s farming, such as carbon-reducing practices.
Disposal of Digestate
Following manure processing in the anaerobic digester, the developer and farmer must agree upon what to do with the residual manure fiber, effluent and other leftover liquids. Without specifying the parties’ rights and responsibilities with respect to the digestate, the developer may be left storing and transferring the digestate material off-site. Unclear terms with respect to this digestate may also lead to a future bottleneck in gas production, as the developer is left with no place to store or dispose of such materials.
Uses of the digestate, however, are plentiful and may have significant value to one or both of the parties, as the fiber can be used for livestock bedding and the liquids can be spread on farm fields as fertilizer and soil conditioner. If a developer has no interest in digestate, the parties often agree that the developer may return it to the farmer’s existing effluent lagoon or, in the case of fiber, returned to the farmer for use as bedding. Alternatively, the developer may wish to retain the digestate, process it into a fertilizer and sell back to the farmer or other third parties. In any event, the agreement should specify what each party’s rights and obligations are with respect to these materials.
Lender Rights
Finally, the viability of an RNG project is often contingent on receiving debt or equity financing to pay for multiple millions of dollars in capital expenditures. While lending to developers in this industry is becoming more robust, lenders will typically require certain third-party rights to cure a developer default. In practice, this is accomplished by requiring the farmer to provide written notice to the developer’s lender of a developer default, and by providing a certain period of time for the lender to cure the default before the farmer has any right to terminate the agreement.
Understanding the issues inherent in the development of an RNG project and carefully addressing these issues within the transaction documents, including the manure supply agreement, are critical. Failing to address important issues in a project’s early stages often leads to costly litigation in the future. With respect to such arrangement, the farmer and developer will both benefit from having their expectations clear and unambiguous.
Author: Chris Peterson Senior Associate, Husch Blackwell Chris.peterson@huschblackwell.com 417-268-4057
