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Renewed Concerns about Renewables

Key tax credits for investments in renewable-energy projects could soon begin to expire.
Kathleen Hoffelder, CFO Magazine
August 1, 2012

If long-standing renewable-energy credits expire as scheduled starting this year, companies that have taken advantage of those hefty tax breaks for wind and solar financing will have to consider new alternatives.

Wind-project developers or solar-facility owners typically have tax-equity partnerships with large-company investors such as Google or Chevron, where both sides benefit: the developers get necessary capital and the investors get big tax write-offs. Corporate investors in wind, geothermal, and bioenergy projects are currently eligible for the production tax credit (PTC), which provides an income-tax credit of 2.2 cents per kilowatt hour for up to the first 10 years a facility is open. They can also take the investment tax credit (ITC), a one-time tax break of 30% on their investments, or an equivalent cash payment from the U.S. Treasury Department.

But sooner or later, that could all change. The PTC for wind projects, which companies can exchange for a cash grant, is set to expire at the end of this year, while the geothermal and other bioenergy PTCs expire at the end of 2013. Treasury's 1603 grant, which provides cash payments worth 30% of the total cost of a renewable project, is also phasing out. Named after Section 1603 of the American Recovery and Reinvestment Act of 2009, the grant is now available only to projects that began construction in 2011. Solar ITCs, meanwhile, are set to expire in 2016.

Financing shortfall

The uncertainty surrounding the renewable-project market is already slowing project development. Some participants are hopeful that Congress will extend the credits at the 11th hour, but typically, when lawmakers do renew these credits, they tend to extend them for no more than a year or two.

Demand for tax-equity financing already exceeds the supply of funds available. Only $3.6 billion in tax-equity funds will be available for renewable-energy projects in 2012, but the demand for renewable-project financing in 2011 was $7.5 billion, according to an American Council on Renewable Energy survey last year. "That source of capital that is helping the industry grow is going to slow down if those incentives are not there," says Brent Stahl, principal and partner at law firm Stahl, Bernal & Davies. In fact, that's already happening, as only those wind projects already under way are still receiving the tax credits.

Investors have been lured to the projects in the past few years, when the tax savings increased dramatically. "The cash-on-cash return that a firm is paying a tax-equity investor may be 3%, but in substance the tax-equity investor is earning a very high return because it's using these tax attributes to shelter or reduce the tax burden on [its] other income," says Mark Regante, a partner at law firm Milbank, Tweed, Hadley & McCloy. "In the case of accelerated-depreciation deductions, the benefit is like an interest-free loan from the government."

Before the recession, investors in solar facilities were earning a 6% to 8% aftertax internal rate of return; now they can reap an IRR of more than 10% on the renewable deals. If the tax credits expire, however, other alternatives for investing in renewable projects could become more popular. For example, market participants have started to discuss a master limited partnership as a financing vehicle, similar to the model for pipeline businesses, says Stahl. The concept would be a first for the renewables sector.

Already-existing tax-equity structures could also draw new interest. Sale-leaseback structures, where a developer sells a project to an investor, could prove useful for investors with short-term horizons. And inverted-lease structures that let an investor lease a project directly from a developer could also become more popular, say market participants. Similarly, accelerated-depreciation federal-tax incentives, including credits for solar-project investments that extend over a five-year period, are not expiring yet and could be more appealing with the traditional credits going away, Stahl says. So far, relatively few companies have taken advantage of these incentives.

Interest in these alternatives varies by market. The wind sector may need more investor support, but the solar industry is better equipped to stand on its own because of its retail appeal, says Milbank's Regante. There are more tax-equity investors in the solar market now than a year ago, he says, and developers are finding ways to get their projects financed.




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