A Chicken in Every Pot? Is there Enough Tax Equity to Sustain the RE Market?

Michael Mendelsohn's picture

The 1603 Treasury Grant (TG) program was created by the federal government in 2009 as part of the American Recovery and Reinvestment Act (ARRA) in response to the negative impact that the financial crisis has had on the tax equity market.[1]   Since its inception, the TG program has been the source of significant sustenance to the renewable energy (RE) industry, awarding $5.37 billion as of October 18, 2010.

However, the TG program only reduces the need for tax equity investment; it doesn’t eliminate it.  Why?  Three reasons:

First, because TG awards—equal to 30% of a project’s installed cost—are made 60 days after a RE project becomes operational, developers still need bridge financing to get through the project construction phase.  This bridge financiVintage photo of couples dancing.ng is often furnished by equity investors until the TG award comes through, at which time the investor is generally repaid and no longer part of the project structure.

Second, tax equity is still needed to “monetize” the Modified Accelerated Cost Reduction System (MACRS) depreciation benefits, a key factor to the economic feasibility of many RE projects.  According to Keith Martin of Chadbourne & Parke, LLC, project cash flows associated with a typical RE project are not sufficient to fully utilize MACRS benefits.2]  The MACRS benefit is equal to approximately 26% of a project’s upfront capital costs (depending on the tax rate of the investor).3]  Without sufficient cashflows, taking advantage of MACRS requires a tax equity investment.  

Third, the economics of some projects favor traditional production tax credits (PTC) or investment tax credits (ITC) over election of the TG.  For example, high capacity factor wind projects can produce a better return to their investors by electing to take the PTC over the TG.4]  But again, because project cash flows are not sufficient to take full advantage of the tax credits, tax equity is needed to monetize the benefits. 

So, the TG program helps?  Yes, because “TG bridge equity” is necessary to finance construction prior to the TG award and is less expensive and more available than what I phrase as “true tax equity.”  According to Martin, the cost of TG bridge equity is roughly 8.25%.  True tax equity associated with ITC or PTC recovery requires an additional yield of 100 and 125 basis points (1.0% -1.25%), respectively.  If there is debt at the project level, the yield is an additional 300 basis points (3.0%) higher.  Moreover, as TG bridge equity is not associated with tax credits at all, it’s reduced complexity and risk attracts a broader base of investors.  Martin indicated the overall tax equity investor pool has increased to 14, close to the high-water mark of 18 reached in 2007, but most of the investment made here is of the lower-risk bridge variety, not the more complex true tax equity.

Nonetheless, according to a wide variety of sources, TG tax equity and its traditional tax equity cousin are still in short supply.  One tax equity investor – Marshal Salant of Citigroup – projected the demand to reach $10 billion in 2010 with only $5 billion in supply.5] 

Is the $10 billion of tax equity in 2010 a reasonable number?  I did a back-of-the-envelope calculation to check.  Looking at electric-only projects (i.e., excluding solar hot water systems, in particular), roughly 11,400 MW of RE was installed in the United States in 2009.

RE Technologies 
2009 Installed Capacity (MW
Installed Cost ($/kW)
Total Invested ($ billions)
Value of Federal Government Benefits
Potential Tax Equity Required
Wind                        10,010                  1,906                    $19.08                                     56%                          $10.68

Solar (elec. only)

                           491                  6,332                      $3.05                                     56%                           $1.71
Biomass*                            739                  1,860                      $1.37                                     56%                           $0.77

Geothermal

                           175

                 4,501

                     $0.71

                                    56%

                          $0.40

Total

                       11,405

 

                   $24.21

 

                         $13.56


*The installed capacity for biomass was based on a 2007 estimate.

The installed cost of each technology was based on a recent Lawrence Berkeley National Lab evaluation of the TG program.7]  The value of government benefits represents the sum of the combined 30% ITC and 26% MACRS depreciation.  Survey says: If we combine the investment needed to monetize the tax credit (either as ITC or PTC) with the MACRS depreciation benefits, the United States will need more than $13 billion in required tax equity, even more than estimated by Citigroup’s Salant.  And that’s just to maintain 2009 levels.  What if we need to grow the investment in order to, say, fulfill quickly-growing state renewable portfolio standards (RPS) or meet a hypothetical federal RPS?  Seems like the RE industry is going to need some more sustenance.

Photo Source: Wikicommons


[1] Although it’s known as a “grant” program in the industry, the incentive is essentially a cash payment, not a grant.

[2] Martin, K. Phone conversation. Chadbourne & Parke, LLC, June 2010. 

[3] Financing Non-Residential Photovoltaic Projects: Options and Implications, Mark Bolinger, Lawrence Berkeley National Laboratory, January 2009  

[4] See “PTC, ITC, or Cash Grant?” by LBNL and NREL, http://www.nrel.gov/analysis/pdfs/45359.pdf.

[5] See “Update: Tax Equity Market” on p. 8 of Chadbourne & Parke’s Project Finance Newswire, April 2010. 

[6] The installed capacity for biomass was based on a 2007 estimate. 

[7] See “Preliminary Evaluation of the Impact of the Section 1603 Treasury Grant Program on Renewable Energy Deployment in 2009” at http://eetd.lbl.gov/EA/EMP/reports/lbnl-3188e.pdf.

 

 

 

 

Yes TG program

Yes TG program only reduces the need for tax equity investment it doesn't eliminate it because of all these reasons. Good post as it provides good information.