Tax Extensions Feeding Vibrant, Expanding Renewable Market
Industry Leaders Discuss Renewable Energy Market Trends Following IRS Tax Extensions
On June 21 and 22 representatives from technology companies, engineering, consulting and law firms, major banks and governmental agencies gathered in New York City for the 13th Annual Renewable Energy Finance Forum: Wall Street (REFF), hosted by ACORE and Euromoney Seminars.
The convention revealed how dramatically the renewable energy market has grown in recent years, largely thanks to supportive public policy from the US Treasury Department and IRS. Coloring the convention was the updated IRS construction start guidelines for wind, hydropower, geothermal, and biomass and trash facilities. The updated guidelines (Notice 2016-31) were released on May 5.
The notice extended the required start date for renewable energy projects to receive production tax credits (PTCs). Under the new rules, if construction starts before 2017 projects can receive full credit or reduced credit if construction starts before 2020. The update guidelines also contain a “continuous work” requirement. The continuous work requirement has been present in previous notices, however the 2016 version contains minor, though important, changes.
Tests for Determining "Continuous Work"
Previous notices determined continuous work using the “five percent safe harbor” and “significant physical work” tests. The five percent safe harbor test is met when at least five percent of the total cost of the facility is incurred before the construction start date and construction is continuous. Projects can meet the physical work test if physical work of a significant nature began before the construction start date and the construction is continuous.
Notice 2016-31 expands the five percent safe harbor test by stating a project fulfills continuity requirements if the project is placed in service by December 31 of the year that includes the fourth anniversary of the date of the start of construction.
REFF Session on Trends in Financing Renewable Energy Projects
There was a panel at the convention exclusively for discussing trends in the financing of renewable energy facilities following the tax credit extensions. Keith Martin, a partner at Chadbourne & Parke LLP and lobbyist on renewable energy policy, moderated the panel of 5 key-players in renewable energy markets. The panel included John Eber of J.P. Morgan, Adam Altenhofen of US Bank, Pooja Goyal of Goldman Sachs, Hannah Hawkins from the Treasury Department and Jonathan Stark of GE Energy Financial Services. The panel members offered a range of perspectives, coming both the public and private sectors.
The panel was in agreement that the tweaked continuous work requirements may bring up logistical questions in the future, however as of now such questions remain purely theoretical. In general, the tax extensions were welcomed, as the renewable energy market today is being driven by tax benefits rather than cash.
Today, typically 75+% of the capitol for a wind project comes from tax equity, in comparison with 40 to 50% just a couple years ago. This trend is largely due to more efficient wind turbines, which have increased production and reduced costs. Further, efficient wind turbines are bringing down electricity rates for the public. According to the American Wind Energy Association, the U.S. wind industry has recruited nearly $90 billion of private investment into new energy infrastructure over the past 5 years.
What is Tax Equity?
Renewable energy projects receive federal production tax credits (PTCs). However, the project developers generally do not use the majority of their tax benefits. A tax equity investment is when a financial institution or other entity invests in a renewable energy in exchange for the tax credits.
Tax equity investors invest towards the end of the construction of a project. Pooja Goyal of Goldman Sachs explained during the session that the most common mistake by renewable energy projects she sees is that they reach out to investors prematurely. Tax equity investors, such as Ms. Goyal, assess projects during the late stages of development, when sufficient detail is available for the project. The deal is closed when the project construction ends and operations begin. In summary, Ms. Goyal described tax equity investment as requiring a breadh of diligence.
Power Purchase Agreements
Additionally, the panel noted that corporate Power Purchase Agreements (PPAs) in wind have also been increasing. A PPA is a contract in which a developer designs, finances, installs and owns a renewable energy system on the property of a host. The developer sells the power generated at the customer’s site to the host at a lower rate than typical utility costs. If the host’s electricity costs exceed that produced by the renewable energy system, they purchase electricity from the utility. In turn, the utility will buy any unused electricity produced by the renewable energy source and tax credits from the developer. Financing counterparties, which include investment banks such as Goldman, JP Morgan and US Bank, will help finance the developers’ installation of the system. Developers typically offer their financers mainly tax credits in return. The profits from selling electricity and tax credits make up for the developer’s investment in installing and maintaining the renewable energy system. Customers include private homeowners, communities, businesses of all sizes, and governmental agencies.
PPAs are attractive to customers as they shift risk to developers and their sponsors. Ms. Goyal from Goldman said during the session, in reference to corporate PPAs, “it makes sense why corporates are entering the renewable energy market.”
While corporate PPAs present certain challenges to investment banks, namely they are relatively short-term and allow for the possibility of credit issues with utilities and corporations, the banks are willing to help finance the deals given the appropriate circumstance. John Eber from JP Morgan stated during the session that “we are happy to do deals with corporate off takers.”
New Solar Guidelines Coming
The updated tax extensions do not address investment tax credits (ITCs) for solar energy facilities. However, Hannah Hawkins from the Treasury Department implied that new guidelines are to be expected in the fall to winter of 2016.
The panel acknowledged that solar tax equity investments were slower in Q1 and Q2 of 2016 than expected. Yet, Jonathan Stark of GE Energy Financial Services remained optimistic for the coming quarters. He said, “We’re seeing a lot of solar right now and we expect to see more solar later this year.”
Notably, in 2016 solar tax equity investments surpassed wind for the first time. Of the approximately 13 billion in tax equity investments in 2015, 6.8 billion were from solar and 6.4 were from wind.
Renewables Go Mainstream
The panel closed with a positive tone, acknowledging that renewables are becoming more mainstream. Consequently, they are becoming a well-known and favorable investment. Adam Altenhofen of US Bank added, “we are bringing more investors into renewable energy this year.” This growth is not without the help of public policy, especially because current deals are defined by less cash and more tax benefits. Thus, the IRS’ extended start dates for renewable energy projects seeking tax credits are particularly important for the continued upward trend in the market.