New investors and finance models needed to keep US renewable energy on track

Over the past few years, the renewables sector in the United States has been a major beneficiary of public support from the American Recovery and Reinvestment Act. In all, the industry has received over $65 billion in tax credits, grants and so-called soft loans.

However, nearly all of that money has been dispensed and this week Washington lawmakers are struggling to find more than a trillion dollars in future budget cuts just to start the process of balancing the federal budget.

According to the Bloomberg New Energy Finance study – research commissioned by Reznick Group, a national accounting, tax, and business advisory firm – project development across the US will slow significantly unless the private sector steps into the breach with substantial new investment.

“The results of the study are clear – optionality is necessary for the wind power industry to attract more tax equity into the marketplace,” said Tim Kemper, Renewable Energy Practice Leader at Reznick Group.

“It is now evident that previous assumptions about yields are not true, because not all yields are the same. There can be significant advantages in using the investment tax credit even for deals that exceed a 30 percent capacity factor. Developers will need this optionality to make sure they can maximize their returns with the right structure,” Kemper said.

With a cash-based incentive which was part of the US stimulus program due to expire at the end of 2011, tax credits are likely to again become the most important federal subsidies supporting renewable project development in the US, the report says.

These incentives propelled the sector’s growth for much of the past decade, particularly in the run-up to the financial crisis.

The report delivers two major findings about tax credits: first, that the economics of ‘tax equity’ – the part of a renewable project’s financing structure used to take advantage of tax credits – can provide attractive returns for parties involved in these transactions; but second, that the US renewable sector will require new sources of tax equity if it is to meet market demand for project finance.

More specifically, the report draws the following conclusions about US renewable financing and the use of tax equity:

• Growth in the US renewable sector has been largely driven by the availability of tax equity or its temporary substitute in the aftermath of the financial crisis, the cash grant. Since 1999, the production tax credit has been allowed to lapse by Congress on three occasions, with each lapse resulting in a precipitous drop in new wind installations. The introduction of the Treasury cash grant program as part of the American Recovery and Reinvestment Act in 2009 saved the industry from another drop, but that program is due to expire at the end of 2011.
• Alternative sources of tax equity may need to emerge to meet market demand for project finance. The total need for tax equity financing next year could be more than $7 billion. That requirement exceeds the investment appetite of established tax equity providers, according to US Partnership for Renewable Energy Finance, a clean energy trade group.
• There is a vast pool of potential incremental tax equity supply: the 500 largest public companies in the US alone paid $137 billion in taxes over the past year. The participation of even a small number of these firms in the tax equity market for renewable energy could narrow the gap between demand and supply. Examples of non-financial companies which have participated in recent tax equity deals are the technology firm, Google, and the California utility, Pacific Gas & Electric.
• Expiry of the cash grant should not be expected to result in collapse of the US renewable sector. However, significant uncertainty will remain until Congress reaches a decision about whether or not to extend the production tax credit, currently set to expire at the end of 2012.
• The three primary tax equity structures offer distinct advantages to developers and tax equity investors. With the ‘partnership flip’ structure, the investor receives most of the project benefits until a change in ownership event – a flip – occurs. Under the second structure, sale leaseback, the developer ‘leases’ the asset from the investor and so requires much less investment upfront from the developer. Finally, in an inverted lease, the investor leases the project from the developer and enjoys the benefits associated with a ‘pass-through’ tax credit.

“This analysis shows that tax equity economics can be made to work for the right projects,” says Michel Di Capua, Head of Analysis, North America, at Bloomberg New Energy Finance in New York. “There is life after expiry of the Treasury cash grant program. Financing for the US renewable sector will look quite different in 2012 compared to the past three years once the cash grant is gone, but different does not mean dead.”

For additional information:

“The return – and returns – of tax equity for US renewable projects”

Bloomberg New Energy Finance