Financing and liquidity challenges coupled with volatile oil and gas markets have slowed progress in the renewable energy industry. The American Recovery and Reinvestment Act of 2009 (“ARRA” or the “Act”) has breathed new life into this sector and offers many new financing options, which may attract new industry entrants, such as utilities, municipalities, and private equity funds. These new initiatives, existing programs, proposed climate change regulation, restructuring in the sector, and the forging of new alliances within the industry will, together, shape future development and opportunities.
This article originally appeared in the July/August 2009 issue of Executive Counsel magazine.
Stimulus Act Initiatives—Tax Credits; Treasury Department Grants; CREBs
The Obama administration has made jumpstarting the renewable energy business a keystone of its stimulus strategy and intends to create millions of new green-collar jobs. The energy-related provisions of the ARRA extend the applicability of the Section 45 production tax credits for wind, biomass, geothermal, and landfill gas projects. The ARRA also allows a wide range of PTC-eligible facilities to claim the 30-percent Section 48 investment tax credit, in lieu of the production tax credit. These include wind, biomass, geothermal, landfill gas, trash, qualified hydropower, and marine and hydrokinetic facilities placed in service from 2009 through 2012 (for wind) and through 2013 (for the other power resources). This significant change now means that PTC facilities are no longer required to sell electricity to a third party in order to generate the credit, and the entire 30 percent may be obtained at once, rather than over 10 years. Utilities may find this particularly important as they consider becoming direct owners of renewable energy projects.
The ARRA has also created grant opportunities for renewable energy projects. Subject to certain exceptions, facilities eligible for the investment tax credit can instead claim a dollar-for-dollar grant from the U.S. Treasury. Eligible facilities include both those that have always been eligible for energy credits—in particular, solar and fuel cell projects—as well as the new PTC-eligible facilities that elect Section 48 treatment.
The Act increases the authorized amount of Clean Renewable Energy Bonds (CREBs) that benefit state, local, and tribal governments, public power providers, and cooperatives by $1.6 billion, and the authorized amount of qualified energy conservation bonds for state, municipal, and tribal government programs, as well as utility programs that provide energy-efficient property to rate-payers, by $2.4 billion. This program was implemented in 2005 and was designed to provide PTC-like incentives for non taxpayers, such as electric cooperatives, public power, and municipalities, to build new renewable energy facilities and invest in energy efficiency.
The level of success that these significant changes will ultimately achieve in spurring activity in the renewable energy space will become evident during the coming months as regulations are promulgated, parties become more familiar with their implementation, and investors address issues relating to efficient, full utilization of depreciation deductions in the context of these new structures.
Proposed Federal Climate Change Legislation; Renewable Energy Credits
Proposed legislation announced by House Energy and Commerce Committee Chairman Henry A. Waxman and House Energy and Environment Subcommittee Chairman Edward J. Markey, calls for reducing greenhouse gas emissions by 17% below 2005 levels in 2020 (please note that the precise target level continues to be the subject of much debate in Washington). All industries should closely monitor the ongoing hearings on this significant federal cap-and-trade initiative. Renewable energy project financing in certain regions have been based, in part, on monetization of tradable renewable energy credits (“REC”) created by such projects. State and regional initiatives, such as the Northeast’s Regional Greenhouse Gas Initiative and New Jersey’s SREC Program, are advancing; we expect that the markets for RECs will continue to grow and become more sophisticated in the future.
Department of Energy (“DOE”) Loan Guarantee Program—Innovative Technology
The DOE Loan Guarantee Program included in the Energy Policy Act of 2005 (“EPAct 2005”) provides, inter alia, up to $10 billion in loan guarantees to selected projects offering energy efficiency, renewable energy, and advanced transmission and distribution technologies. The program, which is only now beginning to make loan guarantees available, is designed to support early commercial use of new or significantly improved technologies in the energy sector. Because the loan guarantee program limits governmental support to 80 percent of project costs (not including the DOE’s “credit subsidy”), selected projects will need to complete their capital structure using other means, thereby presenting funding opportunities to both equity and debt providers. The terms of the intercreditor arrangement between the DOE and other lenders to a supported project are governed by the final regulations issued by the DOE in October 2007.
DOE Loan Guarantee Program—Temporary Program; Proposed 21st Century Energy Technology Deployment Act
The ARRA appropriates $6 billion for the cost of guaranteed loans authorized by Section 1705 of EPAct 2005. This appropriation is expected to support approximately $60 billion of additional loan guarantees. Section 1705 was added to Title XVII of the EPAct 2005 by the ARRA and temporarily directs the secretary of energy to make guarantees under the existing loan guarantee program for renewable energy systems, electric power transmission systems (including upgrading and reconductoring projects), and leading-edge biofuels projects (up to a limit of $500 million), each of which must commence construction no later than September 30, 2011. This portion of the program, unlike the earlier program, is not restricted to innovative technology, will be administered on a rolling submission basis, and provides that the government, rather than the applicant, pay the applicable credit subsidy. Secretary of Energy Chu has made recent announcements detailing modifications intended to streamline the current program. Regulations implementing Section 1705 are expected within the coming months. When making guarantees under Section 1705 the DOE may consider the viability of the project absent the guarantee; the availability of other federal and state incentives; importance of the project in achieving reliability needs; and its effect in meeting a state’s or region’s environmental objectives. Projects that benefit from the DOE’s loan guarantees are required to comply with Davis-Bacon wage requirements.
Companion bills entitled “The 21st Century Energy Technology Deployment Act” were recently proposed in the House by Representatives Jay Inslee and Steven Israel and in the Senate by Senators Jeff Bingaman and Lisa Murkowski, and aim to establish a government-backed “green” bank that would partner with the private sector to make reliable, low-cost financing available to support renewable projects and related infrastructure. As proposed, the “Clean Energy Investment Fund,” through a new entity to be housed in DOE, the Clean Energy Deployment Administration (CEDA), would supplant the current DOE loan guarantee program and have the ability to provide various types of credit to support the deployment of clean energy technologies, including loans, guarantees, and credit support backing bonds. Proponents believe that this structure would address a number of the bureaucratic delays that have slowed the making of guarantees under the existing DOE loan guarantee program.
New Markets Tax Credits
The New Markets Tax Credits (NMTC) Program was extended through 2009 by the Emergency Economic Stabilization Act of 2008 (EESA). The New Markets tax credit allocation was authorized in the amount $3.5 billion. The goal of the program is to spur revitalization efforts of low-income and impoverished communities. The NMTC Program provides tax credit incentives to investors for investing in communities that are economically distressed or have low-income populations. These credits have been used to promote renewable energy and biofuels facilities and in some cases can be utilized in concert with other tax incentives. We note that the Act repeals the rule that reduces the amount of the Section 48 energy credit if a project benefits from below-market financing or tax-exempt debt. The ARRA provided an additional $3 billion in allocation authority to the NMTC Program, which will enable it to award a total of $10 billion in New Markets Tax Credits through the 2008 and 2009 rounds of the program.
Municipalities are examining the feasibility of entering into prepaid electricity purchase agreements with energy projects, where the prepayment is obtained through the issuance of tax-exempt debt or through the newly authorized, taxable Build America Bonds (“BAB”) created under the ARRA. BABs are a new type of tax credit bond that pays investors taxable interest, thereby expanding the base of potential bond buyers, and alternatively provides (x) the issuer the ability to receive a 35 percent interest rebate or (y) the investor a federal tax credit equal to 35 percent of the taxable interest. Bond proceeds must be used only for capital expenditures, issuance costs, and reserve funds. Further review is required to determine whether a prepayment for electricity qualifies as a capital expense. While a limited number of projects have used tax-exempt bonds in this structure, there remain some questions relating to income recognition by the energy project developer for tax purposes, security arrangements, and the availability of credit support. If these questions can be satisfactorily resolved through IRS pronouncements, industry consensus, or otherwise, this structure could present a cost-effective alternative and/or complement to traditional financing methods.
The EESA renewed the Brownfield Tax Incentive through December 2009. This program benefits projects constructed on former industrialized properties and allows for the expensing of remedial costs in the year incurred rather than requiring that such amounts be capitalized and deducted over time. The ARRA allocated $100 million in additional funds to the United States Environmental Protection Agency (EPA) for its brownfields program. This is a nationally competitive program for the assessment and cleanup of brownfield properties available to government entities and nonprofit organizations. Additional information is available on EPA’s brownfield website: http://www.epa.gov/brownfields/eparecovery/index.htm
The USDA, through the Rural Utility Service, has been tasked with taking a more proactive role in supporting renewable energy projects. The Farm Bill, which was passed in May 2008 over former President Bush’s veto, authorized the RUS to make direct loans and provide loan guarantees for electric generation from renewable resources for resale to rural and nonrural residents. The regulations implementing this new program are still under development; proposed rules have been the subject of industry comment and critique. Program funding remains dependent on appropriations. This new program is in addition to existing renewable programs established under the Rural Electrification Act of 1936, as amended. Clarity from the Obama administration about program rules, size limitations, fund allocation, eligibility, and timing will determine whether this program will be a successful part of the economic stimulus efforts.
In recent months cash strapped developers have exhibited a heightened interest in partnering with landowners, equipment manufacturers, contractors, utilities, municipalities, and others in combinations where participants make “in kind” contributions. These arrangements take advantage of the party’s respective strengths, assets, and third-party relationships. Equipment manufacturers may realize that becoming an equity participant in a project may ensure a continuing market for their products, showcase their product’s quality, and provide a competitive advantage over other manufacturers unwilling to receive royalties or other back-ended compensation.
Increased Utility Participation
Many states currently have Renewable Portfolio Standards that require that utilities source an increasing percentage of their power generation from renewable sources. Utilities are considering whether it will be more economical to develop and construct these commercial-scale renewable projects on their balance sheet, using their relatively low cost of capital, rather than entering into long-term power purchase arrangements with private project developers. Such power purchase agreements may be less attractive than direct ownership because they typically include premiums over cost and subject the utility, indirectly, to completion and financing risks, especially in the current credit environment. Utilities often can obtain favorable pricing from equipment suppliers for bulk purchases, may have access to land not available to private companies, and have superior knowledge with respect to load demographics. Although questions remain about the utilities’ ability to recoup the cost of renewable energy directly in their rate base, utilities are looking at outright ownership of renewable assets, particularly in the solar area where recent changes in the tax code now allow utilities to take advantage of the investment tax credit. In addition, utilities are examining their possible role as a tax equity investor, equity investor, lender, and party to Build Transfer (BT) and Build Transfer Operate (BTO) transactions in order to advance renewable energy projects.
Secondary Market Project and Asset Sales
There has been a recent up-tick in project and asset sales by developers. Tax equity investors are similarly looking to exit their positions to raise cash. Until the industry sees a measurable increase in finance activity, the distressed asset market will provide real opportunities to savvy buyers who are in a position to quickly vet prospects, afford to wait out the credit crisis, and/or provide a higher level of equity support. Changes in equity ownership on newly constructed solar projects may be more limited, given ITC recapture considerations resulting from a change in ownership during the five-year period beginning on the project’s “in service” date.
We expect to see consolidation in the renewable energy industry. Private equity funds and other investors will seek to take advantage of market weakness with the expectation of significant future growth. Developers with a pipeline of projects in the advanced stage of development and/or equipment for which a large portion of the purchase price has already been paid will likely be attractive targets.
The renewable energy industry may soon see a significant increase in activity as a result of the epic level of government support and incentives discussed above. We welcome the opportunity to discuss this article and the options detailed above with you. Further information with respect to many of the above initiatives is available on our website: www.nixonpeabody.com.
Ellen S. Friedman is a partner with Nixon Peabody LLP. She regularly represents developers, equity providers and lenders in energy finance and M&A transactions. She was recently recognized by Chambers USA: America’s Leading Lawyers for Business 2009 in the area of energy finance. Ms. Friedman is a member of the firm’s Energy and Environmental practice group.
Contact Ms. Friedman at email@example.com or 212-940-3053.