Renewable energy is certainly a hot topic these days. For some, it is the subject of a debate about national security and energy independence. For others, the conversation is entirely an environmental issue. However, at the November 2010 Renewable Energy Finance Conference (REFC) in Washington, D.C., it was money that did all the talking. More than 100 attorneys, accountants and project developers gathered to discuss structured project finance and clever mechanisms to squeeze out every last drop of monetary benefits.
REFC was definitely a practitioner's conference. You didn’t hear policy debates or see technology demonstrations. Rather, it was a display of technical accounting skills and project finance expertise from the foot soldiers in the field.
The mood among conference goers was upbeat. Sure, it wasn’t the jubilation seen in the pre-recession era. However, with increasing deal flow and several new participants in the tax equity market, things are starting to look up.
Tax Equity Missing Links
Tax equity partners are entities with a sufficient tax liability to absorb the 30 percent Investment Tax Credit (ITC) or the Production Tax Credit (PTC) for qualified renewable energy projects. Their role is particularly important given the questionable future of the alternative Treasury 1603 program. The 1603 program, which provides a cash grant in lieu of tax credits, is scheduled to expire for projects that begin construction after 12/31/2010.
Many at the conference questioned whether the 1603 program would be extended. A straw poll of the audience revealed that only half expected to see an extension granted during the lame duck session of Congress. However, if the extension is not granted by year's end, most in attendance believed that it is unlikely to happen in next year’s legislative session.
In the absence of an extension, it’s important to remember that the ITC and PTC federal tax incentives are non-refundable credits. Therefore, the tax equity partner is an essential participant in a structured finance deal. Without them, a project would accumulate tax credits faster then it generates a tax liability, making the credits useless until later carry-forward years.
In 2009, only three or four large tax equity players were active in the market. However, today, that number is nearly 20. As the economy continues to recover, it is expected that more companies will develop an appetite for these credits, which will in turn provide additional pathways to monetize the federal tax incentives.
Bean Counters Rejoice
Given that renewable energy is an incentives-driven industry, it should be no surprise that making projects economically viable requires an intimate working knowledge of tax laws, corporate structures and rebate opportunities. This complex landscape includes federal legislation, as well as state and regional policy considerations.
The conference demonstrated that there are many qualified and skilled professional service firms that can expertly guide your project. However, if you need help structuring a complex partnership flip, sale-leaseback or inverted lease/master lease pass-through, be prepared for significant legal and accounting fees. This may be good news for accountants and attorneys, but the high transaction costs present real challenges for the industry.
If your project size is north of $100 million, you’re in a much better position to participate in this fee environment. On the other hand, if you’re trying to develop a more modest project, be patient, because some new alternatives may be just over the horizon.
A Ray of Sunlight
“This industry got very complicated very quickly, and it’s unfortunate. There are better ways to finance these projects. It’s unfortunate that we don’t have a feed-in tarriff system,” said Eli Katz, a partner in the New York office of Chadbourne & Parke, LLP.
“Anytime there’s a heavily subsidized industry, the transactions tend to get pretty complicated. But there is a shift to try to streamline these processes and make them simpler.”
A simplified project structure reduces risks and lowers transaction costs, resulting in a greater number of financially viable projects.
“This is an industry that still struggles to hit the fast ball down the middle,” said Dick Rai, Manager at PNC Equipment Finance Energy Capital. “Curve balls are a little harder for us.”
“I’ve been in financing for a number of years. From my personal perspective, I always worry about financial engineering. It’s always that sexy stuff that gets you into trouble,” added Rai. “If you have a project that’s going to pay you eight dollars instead of ten, well, guess what, it pays you eight. As soon as you lever it with fifteen different financial derivatives to make it sexier to try to get to ten, it may come back to haunt you.”
The Dawn of Enlightened Leadership?
It’s clear that the marketplace craves simplicity. Unfortunately, complex deal structures remain the norm because they merely reflect the requirements of the current renewable energy policy landscape. Perhaps not coincidentally, the REFC conference was held in Washington, D.C., where the debate over these policies will likely echo through the halls of Congress in the coming months.
Until simpler deal structures and risk models exist, the industry will fall short of its potential. Getting there will require the streamlining and reexamination of tax credits, rebates and other incentives. In the absence of clear and compelling federal leadership, the hodgepodge landscape of “carrots and sticks”-based renewable energy policy will continue to add complexity to the marketplace.
Lee Barken, CPA, LEED-AP is the IT practice leader at Haskell & White, LLP and serves on the board of directors of CleanTECH San Diego and the U.S. Green Building Council, San Diego chapter. Lee writes and speaks on the topics of renewable energy finance, green building, IT audit compliance, and wireless LAN technology. You can reach him at 858-350-4215 or firstname.lastname@example.org.