Grand Marais Biomass District Heating System Project Overview – Updated Feb. 2015

Grand Marais Biomass District Heating System Updated Project Overview Prepared for City of Grand Marais and Cook County Local Energy Project Submitted by

222 South Ninth St., Suite 825 Minneapolis MN, 55402 www.fvbenergy.com Phone 612-338-4489 Fax 612-338-3427 Feb. 17, 2015

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Grand Marais Biomass District Heating System Project Overview – Updated Feb. 2015

Contents Background ................................................................................................................ 3 Potential Ownership ................................................................................................... 4 Potential Customers ................................................................................................... 4 System Design ............................................................................................................ 5 District Heating System ............................................................................................................. 5 Biomass Fuel .............................................................................................................................. 7

Propane and Fuel Oil .................................................................................................. 8 Business Plan.............................................................................................................. 9 Overview.................................................................................................................................... 9 Revenue ..................................................................................................................................... 9 Costs .......................................................................................................................................... 9 Plant .................................................................................................................................. 10 Distribution ....................................................................................................................... 10 Energy Transfer Stations ................................................................................................... 10 Total Capital Costs............................................................................................................. 10 Financing ................................................................................................................................. 10

Reducing the Dollar Drain ......................................................................................... 11 Next Steps ................................................................................................................ 12

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Grand Marais Biomass District Heating System Project Overview – Updated Feb. 2015

Background The Cook County Local Energy Project (CCLEP) and its partners have sponsored studies of the feasibility of a biomass district heating system, motivated by the following goals:  Stabilize and reduce long-term energy costs;  Increase energy security by using local fuels rather than uncertain supplies transported long distance by rail, truck, barge or pipeline;  Support existing logging and/or sawmill businesses;  Improve forest management including wildfire mitigation efforts;  Retain energy dollars in the local economy, creating local jobs and spin-off economic activity;  Reduce carbon dioxide emissions and other harmful environmental effects of fossil fuel energy. In 2012, using funds provided by Cook County, CCLEP contracted with FVB Energy to conduct a two-step process to study, refine, design and develop a plan for biomass district heating in Grand Marais. The Step 1 study included a full feasibility study and additional technical studies, marketing and business planning. This step was focused heavily on assessing the heating load and marketable price for district heat (and thus the system’s revenues), and in determining the costs of converting and interconnecting numerous customer buildings. Following the completion of the Step 1 study, FVB completed a Step 2 study including system engineering and a full Business Plan. A grant from the U.S. Department of Agriculture Forest Service (USDA) provided additional funding for detailed design of the Distribution Piping System (DPS). The Step 2 report and engineering documents were finalized June 30, 2014.1 As discussed below, given lack of success in obtaining 2014 State bonding funding for the project, and unexpectedly high bids on the DPS due to a lack of competition, active project development efforts were put on hold in 2014. The City has now received foundation and State grant funding to undertake the following work: Meet with potential customers with a goal of signed contracts contingent on financing Identify and assess potential new sources of grant funding Follow up with State, regional and federal agencies regarding low-interest loans Develop revised financing plan Community stakeholder outreach and discussion Develop revised Bonding Bill request Support Bonding Bill request in communications with Governor and legislative leaders Obtain new bids for project construction

February -- May 2015 March -- April 2015 March -- April 2015 May 2015 Ongoing June 2015 July 2015 -- May 2016 June -- August 2016

This Project Overview is based on the Step 2 report, with updated information as appropriate. See the Step 2 report for detailed information including data sources.

1

For further information, see the Step 2 Study at the CCLEP website under News at the following link: http://www.cookcountylocalenergy.org/news/grandmaraisdistrictheatstepiistudy

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Grand Marais Biomass District Heating System Project Overview – Updated Feb. 2015

Potential Ownership The system would be owned by the Grand Marais Public Utilities Commission (PUC) and would be operated as a non-profit utility service. PUC ownership will provide stability, reliability and permanence, and will ensure that the economic benefits stay within the community.

Potential Customers The most feasible approach to initiating a biomass district heating system in Grand Marais was determined to start with 18 Initial Customers on N. 5th Street and downtown. The pie chart below summarizes the heating energy consumption of these proposed Initial Customers. The Initial System is designed to stabilize and reduce heating and hot water costs, with a focus on our major publicly supported buildings: hospital, clinic, YMCA, schools, churches, county and city buildings, and publically assisted apartment buildings. Over 70% of the Initial System customer load is in the public sector.

Apartments 6%

Churches 3%

Hospital 28% Hotels 23%

City Hall 2% Clinic 2% Law Community Enforcement Center 5% 3%

Courthouse 9%

YMCA 7%

Cook Co. School 12%

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Grand Marais Biomass District Heating System Project Overview – Updated Feb. 2015

System Design District Heating System The proposed biomass heating plant location (Cedar Grove Business Park) and layout of the plant facility are shown below.

Plant Site Location and Size 1. Water and Sewer Connection 2. Electricity Connection 3. DPS Connection

Plant Site Layout

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Grand Marais Biomass District Heating System Project Overview – Updated Feb. 2015 The biomass hot water district heating plant includes a 6.8 million Btu per hour (MMBtu/hr) biomass boiler and additional propane boilers for peaking and back-up. Hot water would be distributed from the plant to buildings through highly efficient pre-insulated supply and return piping. This initial distribution system, illustrated below, would be constructed with welded pre‐insulated steel piping, which minimizes heat losses and comes complete with a leak detection system. Hot water would be supplied at a temperature of 210◦F during winter and 190◦F during summer. Once the heat is extracted by the buildings, the water is returned to the plant to be re-heated. District heating service eliminates the need to operate current heating facilities, e.g. propane or fuel oil boilers and domestic hot water heaters. At each building, heat would be transferred to the building heating and domestic hot water systems through heat exchangers, which transfer the heat without mixing the district heating system water and the building system water. The Energy Transfer Station (ETS) at each building consists of a heat exchanger, control valves, isolating valves, a digital controller, and an energy meter.

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Grand Marais Biomass District Heating System Project Overview – Updated Feb. 2015 The proposed biomass boiler is far superior to those installed at the High School and elsewhere around Grand Marais in the 1970s. Computer controlled combustion temperatures and automatic feeding results in dramatically higher efficiencies and lower emissions. The proposed biomass plant has low enough emissions that an air quality permit is not required. Despite a lack of regulatory requirement, the project plan includes the additional capital cost required to fulfill European standards for emissions controls. Standard multi-cyclones as well as an electrostatic precipitator (ESP) are planned to provide low particulate matter (PM) emissions. The biomass plant PM emissions will be very small relative to the current background PM emissions in Grand Marais, which include significant current use of wood. Wood smoke is a common smell in Grand Marais during the winter, and it is being burned in inefficient, high-emission units. That is why the U.S. Environmental Protection Agency is proposing more stringent standards for new wood stoves.

Biomass Fuel Biomass district heating in Grand Marais is technically viable, with ample supplies of fuel from low-value sawmill waste material or logging slash.2,3 Using low-value by-products of existing forest harvest and processing activities greatly improves the probability of a long-term, reliable, and low-cost fuel source. The Hedstrom sawmill produces about 5,000 green tons (GT) of a low-value material composed of sawdust and hogged bark. This is truly a waste material that is currently trucked up to the Resolute Forest Products plant in Thunder Bay to be burned in boilers. Logging slash is also a viable fuel source that could be cost-effectively procured for district heating in Grand Marais. Whole-tree harvesting and other logging operations generate waste piles of tops and limbs and other non-merchantable material that can be chipped at the harvest site. Such material could be cost-effectively obtained for a total cost of about $31/green ton. This cost includes operating costs as well as all capital recovery costs (i.e., assuming the chipper is used only for producing fuel for the district heating plant). To the extent that a strong market develops for biomass fuel to feed new boilers at Resolute, it is likely that the cost of a field chipper could be amortized over a larger annual throughput, thus reducing per ton costs. Establishing a market for low-value forestry residues can bolster the local forest products industry, and (depending on fuel source used) could marginally increase the economic viability of forest management practices designed to improve forest health and mitigate risk of wildfire. The Grand Marais Biomass District Heating project is strongly supported by the U.S. Forest Service and the Minnesota Department of Natural Resources (see attached letters). It is expected that the most cost-effective fuel source will initially be the Hedstrom sawmill waste materials. The biomass boiler would have flexibility to use a range of low-value biomass materials, including logging slash or trees harvested for wildfire mitigation efforts.

2 3

Dovetail Partners, Forest Biomass District Heating and Electricity in Cook County, MN, Phase I Report, Feb. 2012. Supporting Community-Driven Sustainable Bioenergy Projects, Dovetail Partners, Inc., Final Report, Executive Summary, Review Draft 12/7/12.

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Grand Marais Biomass District Heating System Project Overview – Updated Feb. 2015 The small, community-based scale of the proposed Grand Marais system is efficient in terms of fuel transportation distances and avoids any possibility of over-harvesting the forest. The average fuel consumption will require only four truckloads of biomass per week. Existing State and Federal forest harvest regulations and guidelines are in place to protect forest ecosystems including guidelines that specify sufficient slash to be left on forest floor.

Propane and Fuel Oil The key direct benefit of biomass district heating is stabilization and long-term reduction of heating costs. The ultimate economic benefits of the system depend on future increases in fuel oil and propane prices. Accurately predicting the future is impossible. However, we do know what has happened to fuel oil and propane prices over the last 20 years. Weekly data on Minnesota fuel oil and propane prices4 are shown below. Over the last 20 years, Minnesota fuel oil and propane prices have increased at average annual rates of 7.5% and 5.6% respectively. The weighted average fossil fuel price increase for the proposed district heating customer base has been 6.2% per year over the last 20 years.5 MInnesota Propane Prices (Nominal Dollars) Jan. 1995 to Jan. 2015 $4.50

$4.00

$4.00

$3.50

$3.50

$3.00

$3.00

4

U.S. Energy Information Administration, Weekly Heating Oil and Propane Prices, Minnesota. http://www.eia.gov/dnav/pet/pet_pri_wfr_dcus_nus_w.htm

5

70% of the Initial Customer heating base requirements use propane and 30% use fuel oil.

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Jan-15

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$0.00

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$2.00

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Dollars per Gallon

$4.50

Jan-95

Dollars per Gallon

MInnesota Residential Fuel Oil Prices (Nominal Dollars) Jan. 1995 to Jan. 2015

Grand Marais Biomass District Heating System Project Overview – Updated Feb. 2015 Minnesota has been supplied with propane by the Cochin pipeline coming south from Canada, the MidAmerican pipeline flowing north from Kansas and from rail deliveries. The Cochin pipeline has historically supplied 40% of Minnesota’s propane, and has now been shut down. (The pipeline will reverse flow to carry light condensate used to dilute thick oil taken from Canadian oil sands so it can be transported.) With supplies from the Cochin pipeline cut off permanently, Minnesota will have to rely on distant pipeline shipments and/or rail or truck shipment, which is more expensive than previous pipeline transportation.

Business Plan Overview The biomass district heating system will be capital intensive but can provide long term energy price, economic development and environmental advantages. Once established it should be able to grow to serve other customers, thereby improving economic performance. The challenge is in the initial financing, specifically in striking a feasible balance between two conflicting criteria: offering a district heating rate that is attractive enough to induce customers to sign long-term contracts; and meeting bond underwriting criteria and cash flow requirements.

Revenue Capital and operating costs would be supported completely by project revenues and anticipated capital grant funding. Financing must be secured with long-term contracts with customers consistent with the financing term. Proposed financing and contracts are for 25-year terms. In order to successfully bring Initial Customers on board, we anticipate that the first year cost of biomass district heating would have to be comparable the avoided costs of self-generation. There would be no upfront cost for the Initial Customers, with the system providing the funding for the service line to the building as well as the installation of the Energy Transfer Station(s) inside the building. There would be two types of district heating rates:  A capacity charge to cover the fixed costs associated with financing and operating the system (debt service, operating staff, maintenance) and to build up a repair and replacement reserve; and  An energy charge to cover the variable costs of running the system (primarily fuel and a little bit of electricity). The energy charge would be a pass-through, i.e., these charges would reflect the actual variable costs incurred. The capacity charge would be set at an initial rate and would be escalated up to a contractually set limit. If and when the system grows and new customers are added, the system’s fixed costs will be spread over a wider base, allowing escalation of the capacity charge to be limited. In March 2014, District Heating Service Proposals were developed and conveyed to key potential Initial Customers which collectively represent over 94% of the total Initial Customer load. The proposals included a full proposed Thermal Energy Service Agreement.

Costs The operating costs of the system (biomass fuel, peaking/backup fuel, electricity, maintenance, ash disposal, administration and labor) are estimated to be $509,000 in the first year of operation. In the

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Grand Marais Biomass District Heating System Project Overview – Updated Feb. 2015 Step 2 study the first year of operation was assumed to start in fall 2015. In updated proposals to be provided to prospective customers in 2015, the first year of operation will be assumed to start in fall 2017. All elements of the district heating system -- plant, distribution, and building interconnection (Energy Transfer Stations) -- went out for tender during the Step 2 study.

Plant The plant was tendered in a Design-Build (DB) approach, in which the design requirements and performance criteria are set out in an Owners Requirements Document, and the bidders must propose a price to perform additional detailed design, procure all equipment and materials and construct the facility. Two plant proposals were received, but neither was fully compliant with the Request For Proposals (RFP); both addressed only the biomass boiler and not the balance of the plant.

Distribution For the Distribution Piping System (DPS) a detailed design was prepared and put out for bid under Design-Bid-Build (DBB) procurement. In DBB, the design is detailed, with comprehensive drawings and specifications, and the contractor must propose a price to procure all equipment and materials and construct the system. The procurement for the pre-insulated piping and other DPS components was put out under a separate bidding process, so the bidders for the DPS construction did not have to determine a price for that major equipment requirement. Two DPS proposals were received, but the prices bid for the excavation portions of the proposals were extremely high due to a lack of competition, high demand for excavation services at that time, and the fact that funding for the project was not secured. A competitively priced excavation subcontract bid is expected to be significantly less costly than the bids received to date.

Energy Transfer Stations ETSs were also tendered through a DB approach, with a separate procurement process for packaged Two bids were received on the packaged ETS equipment, but no bids were received on the installation of the equipment and other required work in the Initial Customer buildings.

Total Capital Costs Competitive bids on all system elements are expected to result in capital costs between $12.3 and $14.5 million.

Financing The goal is to finance the system with Revenue Bonds, in which the loan security relies on project revenues rather than the credit of the sponsoring agency (e.g. the Grand Marais PUC). Lower interest rates could be obtained if the City of Grand Marais or Cook County issued General Obligation (GO) bonds which they would back with their full faith and credit. Although GO bonds would significantly reduce the interest rate, both the City and the County have indicated an unwillingness to pursue this approach.

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Grand Marais Biomass District Heating System Project Overview – Updated Feb. 2015 In the Step 1 financial analysis it became clear that Revenue Bond financing of the entire project is not viable, and that the project will need credit enhancement or other means to bring down the interest rate; partial subordinated and/or forgivable debt; and/or grants. During the Step 1 and Step 2 studies, representatives of CCLEP, the City and FVB engaged with a wide range of agencies to explore the potential for funding assistance. The City of Grand Marais requested partial funding for the project in the 2014 Bonding Bill. This request was strongly endorsed by the Minnesota Department of Commerce and the Minnesota Department of Natural Resources. The project has also been strongly supported by the U.S. Forest Service. Unfortunately, the project was not included in the Governor’s bonding proposal. The City’s financial advisor, Ehlers & Associates, conducted an evaluation of debt financing options for the district heating system. Their report indicated that the project could be funded with Revenue Bonds or GO bonds, with a likely range of 5.5-6.5% interest for Revenue Bonds, and 3.5-4.0% interest for GO bonds. FVB developed a proforma financial projection under a range of financing approaches. Based on the analysis, it is clear that the project must rely on significant grant funding and/or low-interest loans, e.g.:  State bonding funds or other sources of grant funding must be in the range of $4.7-5.6 million if the balance of funds are to be borrowed through Revenue Bonds.  The amount of grant funding could be reduced to $3.2 million if the City or County was willing and able to finance the balance with General Obligation bonds at the high end of the estimated interest rate range for GO (4.0%).  If $0.5 million in grant funding was obtained for working capital, the balance could be financed with debt if ultra-low cost debt (2.0% interest) was obtained. No specific source of such lowcost loan funding has been identified. Since the Step 2 financial analysis was prepared, long term tax exempt interest rates have dropped.

Reducing the Dollar Drain Biomass district heating in Grand Marais can significantly reduce the energy “dollar drain” from the local economy.  As illustrated in the graph below, projected direct cumulative dollars retained in the local community over 25 years would be: o Over $18 million if fossil fuel prices continue to increase at the average rate over the last 20 years o Over $35 million if fossil fuel prices continue to increase at the average rate over the last 10 years  Of the total direct economic benefits, about 67% would accrue to the public sector (largely Cook County).  Beyond reductions in direct energy expenditures, additional benefits would results from indirect and induced spin-off benefits, which would be expected to more than double the impact.

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Grand Marais Biomass District Heating System Project Overview – Updated Feb. 2015

Cumulative Customer Savings ($ million)

$40 $35 $30 $25

4.0% escalation

$20

6.0% escalation

$15 8.0% escalation $10 $5 $0 1

3

5

7

9

11 13 15 17 Operating Year

19

21

23

25

Next Steps As discussed above under “Background”, a number of steps will be undertaken in 2015, with the following goals:  Signed agreements with Initial Customers (contingent on financing);  Identification and evaluation of sources of grants and/or low-interest loans; and  Preparation of a request to the Governor and Legislative for Bonding Bill funding in 2016. The project has to date attracted $425,000 of State, Federal, and private funding for feasibility study and project development costs. This demonstrates a strong regional and national interest in supporting community-based thermal biomass energy projects. Prospects for State, Federal, and private grants and low-interest loans are good because those entities recognize the environmental and economic benefits of clean, local, renewable energy development and are interested in funding regionally significant pilot projects. The project is supported by the City of Grand Marais, the U.S. Forest Service, the Minnesota Department of Commerce and the Minnesota Department of Natural Resources, as indicated in the attached letters.

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USDA ~

United States Department of Agriculture

Forest Service

2020 w. Highway 61 Grand Marais, MN 55604 Phone: (218) 387-1750 Fax: (218) 387-3246

Superior National Forest Gunflint Ranger District

File Code: Date:

2700 February 6, 2013

c

George Wilkes, President Cook County Local Energy Project P.O. Box 973 Grand Marais, MN 55604

Dear George: This is a letter of support for the Cook County Biomass project that seeks to use forest biomass as an energy source. Biomass as a fuel source has been and will continue to be generated from fogging activities on the Superior National Forest. Treatment of suitable sites would contribute to implementation of the Superior National Forest Land and Resource Management Plan by helping achieve vegetation objectives, retaining and restoring healthy Forest conditions, and reducing fuel loading at critical locations around vulnerable communities. We are glad to be part of this effort and look forward to continuing this work. Please continue to keep Patricia J. Johnson as the contact for the Gunflint Ranger District, Superior National Forest, [email protected], 218-387-3230. l

Sincerely,

!l~;6 NANCY S. LARSON District Ranger

cc: pjjohnson, cmcquiston

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Caring for the Land and Serving People

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