Tax Equity Financing For Utilities: Another Helping Of Renewable Energy, But Hold The Tax Credits

Many consumers want more of their electricity to come from clean energy sour1ces like wind and solar. And many regulated utilities have responded, adding a record number of renewable energy projects to their portfolios, relying, in part, on federal tax credits and advanced technology to reduce the cost of those projects.

The recently enacted Tax Cuts and Jobs Act, however, has threatened to turn the clean energy boom into a fizzle. The Act reduced corporate taxes – and thus utilities’ appetite for tax credits – across the board.

Fortunately, there may be a new solution emerging for regulated utilities: tax equity financing.

Federal Production Tax Credits

In late 2015, Congress enacted the Protecting Americans Against Tax Hikes Act, which extended the eligibility of wind and other renewable projects for federal Production Tax Credits (PTCs). The PTCs are now scheduled to phase out by 2020.

Qualifying renewable energy projects like wind earn PTCs based on the amount of electricity the project generates. This is calculated on a megawatt-hour basis (MWh) for the first ten years after the project is placed into service.

The PTCs represent real dollars. For perspective, a 200 MW wind farm, operating about 50% of the hours in a given year will generate about 876,000 MWh. With a full (100%) PTC value of $24/MWh, that’s about $21 million per year, or more than $200 million over the ten-year period.

In total, PTCs can represent as much as 60% (or possibly more) of the project’s total cost. And accounting for the project’s energy revenue (remember, the wind that spins the turbines is free), in many cases a project that uses PTCs can easily pay for itself – and then some – over its useful life.

But Corporate Tax Reform Made the PTCs Less Useful

In late 2017, Congress enacted the Tax Cuts and Jobs Act, which decreased the federal corporate income tax rate from 35% to 21%. That lower tax rate has, in general, reduced tax liabilities for all companies and thus the appetite for tax credits has subsided. While PTCs remain an important part of the economic viability of wind projects, regulated utilities are beginning to consider creative ways to reduce the costs of wind projects by trading the value of the PTCs for capital.

Enter: Tax Equity Financing

Tax equity deals for renewable energy projects are common among private energy developers looking to stretch their capital and financial institutions eager for credits to reduce their tax liability.

Under this structure, a developer and tax investor form a holding company that owns the project’s assets (e.g., the real property, the interconnection rights, wind turbine equipment, etc.). The financial institution contributes capital and, in exchange, receives the tax benefits (PTCs and depreciation) and cash distributions during the first ten years the project operates, allowing the investor to recover and earn on its investment. When the tax equity partner has recovered its investment and captured the tax credits, the ownership structure flips. The developer becomes the majority owner and usually has the right to buy out the tax equity investor’s remaining fractional stake. In this way, a developer has built a wind project for a fraction of the installed cost in exchange for handing over the tax credits and cash distributions to the investor.

Given that utilities have a lower tax appetite now, some have begun to look for creative ways to use tax equity financing to build their projects. But regulated utilities are just that – regulated under a set of laws typically designed to ensure safe and reliable service at a fair price. The details of these utility laws vary across jurisdictions, and it is unclear whether or how they may apply to regulated utility tax equity deals, if they apply at all.

But there has been a recent break in the regulatory clouds.

The First Tax Equity Plan Was Just Approved (Sort Of)

In the fall of 2017, a regulated utility called Empire District Electric Company (Empire) filed an application with the Missouri Public Service Commission for approval of plan to use tax equity to finance up to 800 MW of wind generation.

After an eight-month regulatory proceeding, Empire reached a proposed settlement agreement with most of the intervenors in the docket, including Commission staff, industrial customers, a renewable energy group, and the Missouri Division of Energy. The proposed settlement trimmed back the details of Empire’s plan but left it largely intact: the proposed settlement allows Empire to pursue tax equity deals to finance 600 MW of wind projects (rather than the initially planned 800 MW) in accordance with some basic tax equity deal parameters.  According to Empire, this modified plan would save customers $295 million over thirty years.

On July 11, 2018, the Missouri Public Service Commission issued an order that largely approved Empire’s settlement and proposed plan, except for perhaps the most important part: the tax equity component.

The Commission said that it simply couldn’t opine on the reasonableness of using tax equity to finance Empire’s wind expansion because Empire had yet to identify sites for the proposed wind farms, contractors to build them, or tax equity partners to provide financing. Those issues would all have to be subject to future proceedings before the Commission.

But there’s an important takeaway: the Commission didn’t say no to the tax equity financing piece, either. In fact, it generally agreed that more renewables and lower costs would be a considerable benefit to Empire’s customers and the entire state.

To our knowledge, this is the first time a regulatory commission has been formally asked to weigh in on this issue. As such, renewable-minded utilities, developers and investors alike should watch the subsequent Missouri proceedings closely. They could offer a new model of renewable financing for utilities, and help keep the renewable industry’s momentum going for years to come.

Original Source: