Financing Renewable Energy at Government Facilities

Claire Kreycik's picture

Through the Clean Renewable Energy Bonds (CREBs) program, public entities can access low-cost financing for qualifying renewable energy projects. In the latest round of the program, the Department of Treasury allocated $2.2 billion of CREBs to successful applicants.

Introduction

An alternative to other sources of municipal financing (e.g. traditional bonds), low-interest CREBs can be used by state and local governments to finance wind, closed-loop biomass, open-loop biomass, geothermal, solar energy, small irrigation power, landfill gas, trash combustion, marine, and hydrokinetic facilities.

Figure 1. Money flows under CREBs

CREBs can be issued by electric cooperatives, government entities (states, cities, counties, territories, and Indian tribal governments,) by public power providers, and by certain bond lenders. CREBs, as tax credit bonds, are designed to be interest free. The federal government extends a tax credit to investors in lieu of interest payments from the issuer. In reality, governments often must pay an interest coupon to investors or sell the bond at a discount to par, but this interest rate can be significantly lower than the interest paid on traditional tax-exempt municipal bonds.

In order to make use of the financing mechanism, a public entity must apply to the Internal Revenue Service (IRS) for an allocation when funds are available. Most recently, the program was amended and extended by the Energy Improvement and Extension Act of 2008 and the American Recovery and Reinvestment Act of 2009 and applications were due August 4th, 2009. Though the solicitation is no longer open, the most recent guidance document and application may provide insight into how to structure applications if the program is extended further.

A brief history of the CREBs allocations

2005. CREBs were created under the Energy Tax Incentives Act of 2005 (and detailed in Internal Revenue Code Section 54). The CREBs program was funded at $800 million.

2006. Legislation increased total CREBs funding to $1.2 billion.

2008. The Energy Improvement and Extension Act of 2008 (the "Energy Act") authorized $800 million of "New CREBs" funding and extended the issuance deadline for existing CREBs by one year to December 31, 2009.

2009. The American Recovery and Reinvestment Act of 2009 increased the "New CREBs" allocation by $1.6 billion, bringing the "New CREBs" total to $2.4 billion. Applications were due to the IRS on August 4th, 2009.

The tables below shows how CREBs allocations were distributed in each round.

Table 1: 2006 and 2007 Round CREBs allocations by project type and issuer
Approved Projects Round 1 Round 2
Co-ops Governments Co-ops Governments
# # # Million $ # Million $
Solar 33 401 1 $1 138 $83
Wind 13 99 14 $63 88 $107
Landfill Gas 13 23 4 $17 41 $45
Biomass 12 1 1 $30 12 $16
Hydropower 6 8 6 $30 4 $6
Trash Combustion 0 0 0 0 3 $6
Refined Coal 1 0 0 0 0 0
Geothermal 0 0 0 0 0 0
Total 78 532 26 $141 286 $264

Source: IRS 2009, NREL 2009.

Table 2: 2009 CREBs allocations by project type and issuer
Approved Projects Municipal Utilities Co-ops Governments
# Million $ # Million $ # Million $
Solar 13 $55 4 $70 694 $714
Wind 9 $395 8 $161 30 $63
Landfill Gas 0 $0 0 $0 0 $0
Biomass 1 $6 11 $204 3 $8
Hydropower 12 $345 8 $175 6 $11
Geothermal 0 $0 0 $0 3 $4
Total 22 $800 31 $609 736 $800

Source: IRS 2009, NREL 2009.

In the first round, the size of allocations ranged from $23,000 to $3.2 million for government projects (including municipal utilities), and $120,000 to $31 million for co-op projects. In the second round, approved government projects (including municipal utilities), ranged in size from $15,000 to $2.95 million; and co-op projects ranged in size from $30,000 to $30 million.

In October 2009, the Department of Treasury announcedPDF the allocation of $2.2 billion in new CREBs for 805 projects across the country. Governmental entities predominantly won awards for small solar projects, and all government projects ranged in size from around $22,000 to $2.78 million. Municipal utilities and electric cooperatives submit applications for larger projects on average. The 31 cooperative projects ranged in allocation size from $433,000 to $100 million (for a biomass project in Georgia) and the allocations awarded to municipal utilities ranged in size from $75,000 to $140 million (for a hydroelectric plant in Washington State).

San Diego's Success

Entities in San Diego County, California (including municipalities, school districts, universities, and a water district) won 192 allocations of New CREBs totaling $154 million. The county took a collaborative approach to applying for allocations; efforts were lead by the non-profit CleanTech San Diego. The public entities leveraged the work of several UCSD engineering students, who created a financial model for CREBs, and high school students who coordinated the application efforts. San Diego's strategy consisted of applying for small allocations ($1 million or less) for on-site solar projects. In direct consequence, 20 MW of new solar power will be developed in the San Diego region (San Diego News Center 2009).

Issuing CREBs

For more details about how to issuing CREBs and spending the proceeds, consult the NREL BriefPDF and the IRS Guidance DocumentPDF). Some points of emphasis are that:

  • It is recommended that the issuer consult with a tax lawyer before issuing a bond.
  • Tax credit bonds are still fairly new in the bond market- investors are still getting comfortable with the instrument. Some investors may prefer that the issuer structure the CREB as a voter-approved general obligation bond. If this is not possible, an investor may require the issuer to create a debt reserve fund (sinking fund), into which the issuer will make scheduled payments for the purpose of principal repayment at the end of the term. In certain cases, CREBs have been structured as secured lease transactions, where the actual renewable energy system is treated as collateral. (IRS 2009, NREL 2009)
  • Tax credit bond rates and permitted bond lengths are published daily on the TreasuryDirect® Web site. (An investor will receive an annual tax credit equaling 70% of the published rate). Once applicants receive their allocation, they have three years to issue the bond.

NREL Analysis

Given the average tax credit rates in 2009, investors will require issuers to pay some supplemental interest (or to issue their bonds at a discount). The table below presents a matrix comparing 16-year "new" CREBs with average tax-exempt bonds (TEB) issued the week of June 15, 2009. Though the tax credit rate is posted at 7.59%, the 70% credit reduction makes the effective rate 5.31%. At a corporate tax rate of 35%, an investor might require supplemental interest from the issuer of at least 2%, depending on the issuer's credit rating. If the municipality is single A, an investor might require as much as 3% supplemental interest. However, these interest rates are below typical tax-exempt bond interest rates. For a more in depth explanation, review the recent NREL publication on CREBsPDF.

Table 3: Comparison of bond investments for companies with a 35% tax rate
Year 1 "New" CREB "New" CREB TEB (AAA) TEB (AA) TEB (A)
Par Amount $100,000 $100,000 $100,000 $100,000 $100,000
Tax Credit Rate (70%) 5.31% 5.31% 0.00% 0.00% 0.00%
Interest Rate 2.00% 3.00% 4.85% 5.25% 5.13%
Tax Credit $5,313 $5,313      
Interest Payment $2,000 $3,000 $4,850 $5,250 $5,130
Tax on Credit $1,860 $1,860      
Tax on Interest $700 $1,050      
Net Benefit (Credit — Taxes) $4,753 $5,403 $4,850 $5,250 $5,130

* Net Benefit is the sum of tax credits plus interest payment, minus taxes (on credit and interest).
Sources: NREL 2009.

Potential challenges for state and local governments

With the new program rules, the deadline for spending CREB proceeds is tight at three years. Additionally, the window for reimbursement of project costs is only 18 months. Project developers must pay close attention to this deadline. Seeking time extensions is possible, but not necessarily straightforward or easy.

The most significant challenge with the CREBs program is that the high cost and complexity of issuing a CREB can drive up overall financing costs for a project. CREBs require considerable upfront work to apply for an allocation and to issue a bond. In previous rounds, some state and local governments have cited high transaction costs as a barrier to issuing CREBs. These costs are relatively independent of project size, and include the labor required to submit an application and issue the bond, legal fees, costs associated with voter approval (if pursuing a general obligation bond), and printing costs. In fact, a project revenue team estimated that the cost of issuing a CREB is roughly equivalent to issuing a revenue bond as much as five times its size.

One creative solution to reduce transaction costs was used by the Commonwealth of Massachusetts. The State's bonding agency, MassDevelopment, bundled 12 projects totaling 1 MW together and issued one bond. This approach reduced the cost of issuance significantly and helped attract investor interest, due to the larger bond size (Cory et al. 2008).

Case Study: Denver Water

When financial analysts at the City of Denver's water department were evaluating options for financing the capital investment in two hydroelectric projects, they chose to investigate CREBs. After applying for and receiving an allocation, Denver Water issued two CREBs in June 2008 for a total amount of $1.8 million. The bonds ($900,000 each) funded the construction of the Gross Hydro project and the expansion of the Williams Fork Small Hydro project. Denver Water approached four tax investors. With the aid of a bond counsel and financial advisor, Denver Water sold the CREBs to Bank of America with a 0.75% supplemental interest coupon over the 15-year term of the bond. It must be noted that these bonds were issued under the old CREBs rules, which were different with respect to tax credit rate, principal repayment, and use of proceeds.

The CREB covered all final-stage construction costs for the Gross Hydro project, which was less than 10% of the total project cost. The CREB also covered about 70% of the cost of modifying and expanding the Williams Fork small hydro plant. The remaining expenditures of each project were covered by revenue bonds issued in 2007.

Per the bond resolution, the investor required a reserve fund of approximately $130,000 for each CREB, which could not be funded by the CREB proceeds. This fund was a line item of the larger Water Works Fund. (Note: With the updated program rules (e.g. the exception to arbitrage restrictions and the change to bullet maturity) the debt service fund may be larger and require annual payments into the fund.

The process of issuing debt for these projects took longer than if traditional municipal bonds had been issued due to the timeline of applying, receiving the allocation, looking for investors, and then preparing all the usual documents. Otherwise, Denver Water found the process of issuing CREBs straightforward (Rettig 2009).

CREBs provide a low-cost way for state and local governments and public utilities to finance renewable energy projects in conjunction with their RE goals or requirements. In the event that the Congress extends the program, public entities may want to investigate the use of CREBs for financing their projects.

References