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Synfuel 101 Section 29 Tax Credit Opportunities for Coal

1/2/2020 11:54:35 AM. CONFIDENTIAL. Synfuel 101 Section 29 Tax Credit Opportunities for Coal. ENRON GLOBAL MARKETS. Discussion document. July 31, 2000. REGULATORY BACKGROUND. Section 29 Credit for producing fuel from a nonconventional source.

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Synfuel 101 Section 29 Tax Credit Opportunities for Coal

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  1. 1/2/2020 11:54:35 AM CONFIDENTIAL Synfuel 101Section 29 Tax Credit Opportunities for Coal ENRON GLOBAL MARKETS Discussion document July 31, 2000

  2. REGULATORY BACKGROUND Section 29 Credit for producing fuel from a nonconventional source. • Based on energy independence legislation passed during 70’s oil crisis • Definition of Qualified Fuel IRC §29 (c)(1)(C) “solid synthetic fuels produced from coal (including lignite), including such fuels when used as feedstocks” • Value of tax credit is adjusted annually based on GNP and inflation. Current tax credit is $6 per barrel of oil equivalent or $1.035 per MMBtu. • 12,500 Btu coal produces over $25 of tax credits Synfuel Facility Qualifying Criteria • Coal synfuel machine must produce a significant chemical change on the feedstock coal • The synfuel machine must have been constructed pursuant to a binding contract signed prior to December 31, 1996 • The synfuel machine must have been in commercial operation prior to June 30, 1998

  3. SYNFUEL FACILITIES • Machines were originally developed to use low Btu waste coal and pond fines as feedstock and process it into a useable pelletized form. • Typical synfuel technologies employ a binding agent, mixing process, and pelletizer to produce the necessary chemical change and transform the fines to a product that can be used by electric utilities. • Major synfuel technologies include those developed by Covol, Startec, Earthco and Carbontronics. • An estimated 55 distinct synfuel facilities can be identified in the US today. Of these, maybe a dozen are “clean” with respect to their tax qualification (i.e., documented qualifying history, operating under PLRs).

  4. EVOLUTION OF THE SYNFUEL MARKET • Initially, generators rejected pelletized synfuel product due to handling concerns, general distrust. EFC transformed industry by processing run-of-mine coal feedstock with tacit IRS approval at its facilities on the Big Sandy River. • Utilities have begun to embrace synfuel for power generation availing themselves of a solid fuel composed almost entirely of coal at a substantial discount to market coal. • By processing run-of-mine coal, synfuel operators have been able to achieve higher production levels, more valuable tax credits, and a more marketable product that can be sold at a discount to coal. • Operators have begun to optimize the operations by increasing the capacity of various components and bypassing nonessential equipment such as the pelletizers and dryers. • Developers of the machines with limited tax liabilities have begun to sell the machines to buyers with large tax liabilities which serve as a further incentive for increased production levels. • RDI estimated synfuel production (MMTPY): 1999 4 • 2000 12 • 2001 28 • 2002 35 • 2003 43

  5. SYNFUEL PRODUCTION ROLES Monetizer Operator Coal Supply Synfuel Offtake Synfuel Facility LLC Site Provider

  6. OPPORTUNITIES FOR ENRON • Commodity Supply & Offtake • Enron contracts with a machine owner to provide a site with adequate coal feedstock supply and synfuel demand such as a mine, plant, or loading facility. Enron sells the coal feedstock into the machine and markets the synfuel offtake for a fixed fee. Enron benefits from the synfuel / feedstock spread as the synfuel and coal market prices converge. • Potential Transactions: • -Sempra • -AIG • Asset Purchase • Enron purchases synfuel machines, relocates the machines to a site with adequate coal feedstock supply and synfuel demand, and sells the machines to a monetizer. The machines are sold to the monetizer for a price based on the value of the tax credits and the NOL’s generated by the machines. As part of the sales agreement, Enron continues to sell feedstock into the machine, market the synfuel offtake, and potentially operate the machines. Enron benefits from sale of the synfuel machines to the monetizer above cost and from the synfuel / feedstock spread as the synfuel and coal market prices converge. • Potential Transactions: • -Pacificorp • -Earthco

  7. CATEGORIES OF RISK • O&M Relocation/Technology Machine works; is moved and reassembled successfully • Chemical Change Product meets definition of chemical change • Minimum Production Levels Machine achieves throughput levels • Operating Costs Pro-forma based on forecasted O&M costs • Suboperator Default Enron at risk for performance of sub • MARKETING Sales Tax credit not generated until product is sold • Force Majeure Customer force majeure does not relieve sales burden • Ratable Sales Monetizer needs to forcast annual sales for tax planning • Site Selection Credit of site provider, availability of permits, transportation access

  8. CATEGORIES OF RISK (cont.) • COMMODITY Market Spread Risk Enron enters into fixed for floating swap on coal-synfuel spread -- exposed to market risk • COAL SUPPLY Security of Coal Supply Enron is required to provide coal feedstock for continuous operation • REGULATORY Section 29 is repealed Enron loses MTM on spread, monetizer loses future cash flow • Machine Qualification Synfuel facility meets IRS placed in service requireements • Tax Credit Validity IRS audit challenges fuel and/or process qualification • SYNDICATION Ability to Monetize Credits Enron cannot use credits, asset purchases assume selling interest at market rate; will Enron have to indemnify tax risk?

  9. 1/2/2020 11:54:35 AM CONFIDENTIAL Pacificorp Transaction Summary ENRON GLOBAL MARKETS Discussion document August 02, 2000

  10. PACIFICORP DEAL SUMMARY • Enron proposes to purchases four synfuel machines located in Alabama from Pacificorp for a price of $100 million dollars and a contingent payment of $10.50 per ton on the first 1.5 MM tons produced from each machine . The machines will be relocated to acceptable sites such a mines, tramsloading facilities, or power plants. • Once the machines are sited and operating, We will sell our interest in the machines to a monetizer. We expect to receive $0.90 on the dollar for the tax credits and $0.80 on the dollar for the tax shield generated by the NOL’s. This price will be paid in an initial up front payment of $108 million with contingent payments throughout the term. • As part of the purchase agreement, Enron will continue to sell coal feedstock into the machine, operate the machine, and market the synfuel offtake.

  11. PACIFICORP TRANSACTION OBJECTIVES • Increase the value of the synfuel machines by moving them to a site that allows the generation of more Section 29 credits by supplying large volumes of coal and higher Btu coal • Monetize the Section 29 credits and the tax shield resulting from the NOL’s by selling the assets to a financial player • Recognize $62 MM NPV income from equity position • Go short the synfuel / coal spread on 6 MM tons at $2.00 per ton for 7 years • Recognize $60 MM NPV income from commodity position

  12. SYNFUEL LLC ASSETS MONETIZER PACIFICORP TRANSACTION STRUCTURE COVOL PACIFICORP 80% Tax Shield NOL & Credits 95% Tax Credits Contingent Payment Royalty Coal Synfuel ENA SYNFUEL SPV UTILITY SYNFUEL MARKET O&M Coal-Synfuel Swap Market Synfuel Price Remainder of 95% Tax Credits & 80% Tax Shield Operating Agreement SITE OWNER/ OPERATOR

  13. PACIFICORP SWAP AGREEMENT DETAIL (SYNFUEL-COAL SPREAD PRICE RISK) COAL PRODUCER ENA SYNFUEL LLC UTILITY SYNFUEL MARKET Synfuel Coal Market Synfuel Price Market Coal Price Floating (Market) Coal - Synfuel Spread Fixed Coal - Synfuel Spread ($5.50 per ton) Monetizer SYNFUEL LLC Financial Swap

  14. PACIFICORP COST BREAKDOWN ($/TON) $35.56 $35.56 $10.46 $4.60 Monetizer Tax Shield (NOL) $4.81 Enron $15.64 $25.10 Operating Cost Monetizer Payment Section 29 Tax Credit $10.50 Contingent Payment to Pacificorp Breakdown Tax Benefits

  15. PACIFICORP RISK ANALYSIS Risk Probability Potential Impact Risk Description Risk Mitigation Strategy High Low Risk that facilities will not continue to qualify for tax credits PLR’s have already been granted on the operations of XX of the machines. PLR’s have also been granted on the modifications of XX of the machines. • Tax Risk ENA attempting to identify monetizer prior to closing, establishing critical terms of transaction with several potential buyers such as Deutsche Bank High Risk that a monetizer will not step up to buy the facility. Med • Monetization Risk High Risk that facilities will not operate at pro-forma levels, also that costs will exceed pro-forma. Low Machines have operated at levels of 1 MM tpy in the past. ENA will seek warrants from Pacificorp to both machine operating costs and production levels. • Performance • Risk / O&M Price Risk Risk that ENA is unable to place four synfuel facilities High ENA already has developed a list of multiple suitable sites Low • Siting Risk

  16. PACIFICORP RISK ANALYSIS Risk Probability Potential Impact Risk Description Risk Mitigation Strategy Risk that spread blows out beyond $5.00 per ton High Low ENA takes short position on synfuel market spread, which has compressed to $1.50per on the Ohio River. Term forward sales to utilities • Coal-Synfuel • Price Spread High Low Risk that ENA can not source 6 MM tons per year of 12,500 btu coal Desk will take this risk • Coal Supply High Desk will take this risk Low Risk that ENA can not sell 12 MM tons per year of synfuel • Synfuel Offtake High risk premium • Credit Risk High Low ENA is guaranteeing coal supplier, operator, and consumer credit

  17. PACIFICORP RISK ANALYSIS Pacificorp Proforma ($/ton) Cost Description $2.65 Binder and Conditioner • Binder $0.70 Labor (sals, wages and benes), temporary labor and outside professionals • Labor Safety, small tools,fuel, lubricants, repair, maintenance and parts $0.94 • Safety, Maintenance and Repairs • Outside Testing Testing of coal and synfuel $0.17 Electricity, gas, water, telephone, and other plant expenses • Utilities $0.17 Siting fee $1.00 • Siting Total $5.63

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