Is RNG Right for Your Farm?

Disponible en anglais seulement.

The economics of renewable natural gas, or RNG, and the evolution of carbon markets have generated serious interest in the byproducts of animal agriculture. It's creating opportunities for livestock producers to expand their operations, diversify their revenue and improve their own carbon footprints.

The conversations around this topic, however, are complex and sometimes raise more questions than answers. I recently moderated a panel of agriculture industry and financing experts to discuss carbon markets, negotiating the deal, issues around installing digesters, and the potential impacts that RNG projects can have on a farm’s operations and finances. Joining me in the discussion were:

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  Jordan Hemaidan, Partner and Energy Group Chair at Michael Best, a Milwaukee-based law firm

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  Dan Wenzel, Founding Partner of Dairy Business Consulting

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  Aidin Sadr, Vice President of Investment Banking at BMO Capital Markets’ Energy Transition group

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  Steve Kehoe, Director of Investment Banking at BMO Capital Markets’ Energy Transition group

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  Brad Guse, Senior Vice President and Agriculture Relationship Manager, BMO Commercial Bank

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Following is a summary of the event.

One key driver of the recent activity around RNG is the ability to earn environmental credits. Credits can be generated by converting livestock manure into RNG via an anaerobic digester. Operators can then monetize those credits by selling them to a buyer. As Sadr explained, there are two key types of credits:

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  Renewable identification numbers, or RINs, which are used as currency under the Environmental Protection Agency’s Renewable Fuel Standards program.

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  California’s Low Carbon Fuel Standard, or LCFS, which is designed to decrease the carbon intensity of the state’s pool of transportation fuel. Fuels with carbon intensity scores lower than diesel generate LCFS credits.

"These programs apply to fuel importers and refiners, and they're obligated to participate in this program,” Sadr said. “Many of the largest refiners in the world are purchasing credits.”

Buyers and sellers connect through third-party intermediaries, and the EPA website provides real-time pricing information. Sadr said more markets are coming online, including Washington state and Canada’s federal system, which are expected to launch in 2023.

Like any other tradable commodity, supply and demand figures into the value of RNG credits. Right now, Kehoe said there's plenty of room for demand to catch up with supply. "If we were to capture all of the renewable natural gas we could in North America from all the sources—cattle, dairy, municipal, solid waste—it would amount to about 2 billion cubic feet [BCF] per day,” Kehoe said. "When you think that North America consumes about 115 to 120 BCF per day, it's a drop in the bucket. From the perspective of people who own these assets, dairy farmers, you've got an asset that's very limited going into a market that’s very broad.”

Given that the carbon credit market is still emerging, determining whether a farm is getting a fair deal can be difficult. Hemaidan said enlisting an engineering consultant can provide producers with a rough idea of what their farm’s carbon intensity score would be. “The value of renewable natural gas is first and foremost determined by your carbon intensity score,” he said. “So having an idea of what that score is and what the value is of how much gas you're going to produce at that score can be very powerful for a farm in terms of getting an estimate about what they hope to get paid and what they ought to get paid.”

Hemaidan also pointed out that the finance sources for RNG infrastructure are evolving. Until recently, private equity firms were driving up to 90% of the deals, he said. But that’s beginning to change. “That ratio is coming down as banks get more comfortable and more interested in this space,” Hemaidan said. “And, of course, the cost of that debt is going to be a lot lower than the cost of equity.”

Financial opportunities aside, operators will have to determine the impact an RNG project can have on their day-to-day operations. Construction tends to be a key concern, according to Wenzel.

“The timelines and deadlines of the management of the construction site are different than what the farm is used to,” Wenzel said. “The farm likes to get it done, and there's a lot more corporate bureaucracy in some of the construction, design and planning.”

Wenzel added that working with the gas company during construction can be another obstacle. “Another thing I've run into is the gas company forgetting what they agreed to,” he said. “In some cases quite a bit of time has elapsed since the agreement was signed versus the construction. So it's really important to know what you're agreeing to and have documentation.”

Wenzel gave the example of a gas company that installed pumps and pipes that were too small to get manure consistently to the digester. “You're partnering with someone that doesn't understand your business, and it just takes a little bit of time to step back and communicate to make sure that it’s a smooth process and that you have a say in the process,” he said.

Along with the logistics of installing a digester, farms may have to make significant operational adjustments. As Wenzel said, the more cows a farm has the better deal they can get. “If you're big enough that's fine,” he said. “Otherwise, I’ve had farms that have expanded to either get a digester or to get a better deal with the digester. So, first of all, they have to be in a financial position to do that. Secondly, they have to make sure they have approval from their milk plant to ship more milk.”

Partnering on an RNG project can provide an opportunity to expand, but that also requires capital investment. That’s why Guse said operators will need to answer two key questions before making a commitment.

“Number one: what does it do to my cost of production? Number two: what does it do to my balance sheet?” Guse said. "You want to make sure that you’ve got a profitable plan in place and that it has adequate cash flow to cover debt service. What does it do to the balance sheet? You want to pay close attention to working capital and also to your longer-term shock absorber, which is equity.”

After construction, Guse said a good rule of thumb to follow is to have 2.5 months of working capital available and more than 40% equity in the balance sheet.

For any farm that ultimately decides to take on an RNG project, Hemaidan noted the importance of making sure you manage your environment credits properly. “Give the developer what they're entitled to,” he said. “They're entitled to all credits and monetization of those credits that arise from their production of pipeline-grade gas from manure.”

But there are many different agricultural practices and potential practices that ought to belong to the farmer. Anytime a farmer is negotiating, don't give away all environmental credits from all activity on the farm. Give them away for the production for what the developer is doing. And make sure there's something in the agreement that reserves the rest to you.”