|April 2011, Volume II, Issue IV||Published By Novogradac & Company LLP|
After the University of Minnesota, Morris (UMM) in 2005 became the first American public university to erect a large-scale onsite wind turbine, it was ready for more. That year, UMM applied for clean renewable energy bonds (CREBs) to build five additional turbines on the Morris campus, but the amount of bonds the school requested exceeded the funds available at the time. UMM reapplied for CREBs in 2007 with a more modest request of $3.6 million for two turbines and received the allocation.
The university's celebration was cut short when it found itself in the unexpected position of having plenty of funding but no turbines to spend it on. "There were private developers who were willing to put in orders for 20-megawatt (MW) wind projects and you needed to get in line and you needed to compete. Smaller projects simply can't compete," said Lowell Rasmussen, UMM's vice chancellor for finance and facilities. UMM was forced to let its CREB allocation expire in December of 2010.
Turning instead to the Section 1603 cash grant in lieu of energy tax credits program, the university located alumni who were more interested in investing in a wind turbine than in donating to UMM, but the school did not have the legal framework in place to take advantage of the grant. Ultimately, the university regents issued conventional 20-year bonds to finance one turbine, which began operating in March.
"The bottom line is, if we did wait until we got cheaper financing, we'd be back to where we were – we'd have the dollars but we wouldn't have the equipment," Rasmussen said. "Demand [for turbines] would quickly ratchet up and we'd be back in that situation again."
Blessing in Disguise
In some ways, the economic slump increased the viability of small-scale projects with only a handful of turbines. Prior to the Section 1603 program's introduction, projects of that size were less likely to qualify for tax incentives such as the renewable energy production tax credit (PTC), which can be claimed only by a taxpayer with enough liability to offset the credits. Investors that meet those criteria tend to be large, corporate institutions and, because of transaction costs, it's generally more efficient for them to invest in larger projects, said Minneapolis, Minn.-based attorney and developer Jeff Paulson, who has 13 years of experience consulting on renewable energy projects. Section 1603, which in December was extended until 2012, allows the developer to claim a 30 percent cash grant in lieu of traditional renewable energy tax credits.
Another result of the recession was a severe drop in demand for wind turbines. "Before, you couldn't buy a tier-one manufactured wind turbine, but right now GE will sell you one or two turbines," said Tom Wind, owner of Iowa-based Wind Utility Consulting.
Paulson said that even with the Section 1603 grant, smaller projects are still disproportionately more difficult to develop than large-scale projects – particularly when maximizing renewable energy financing incentives – but with the right partners and a great deal of resourcefulness, they can be realized.
Before the recession, Luther College in Decorah, Iowa, was caught in the same gale as UMM. "I couldn't get GE or Vestas or Siemens to return my phone calls," said Jim Martin-Schramm, Luther College religion professor and wind project leader. "I asked for a quote for one turbine and they just laughed at me." Then pricing began to fall as the recession took hold, and the winds began to change; the college expected to finalize a turbine supply agreement with a tier-one manufacturer for a single 1.65-MW turbine shortly after this article went to press.
Luther College, the sole investor in its own project, formed a limited partnership and then a separate blocker corporation so that it can opt for the Section 1603 grant when the turbine is operational. The project is also eligible for Iowa's 476C production tax credit and a U.S. Department of Agriculture (USDA) Rural Energy for America Program (REAP) grant. "Without the grants or the state tax credit our cash flows would be too risky to move forward," Martin-Schramm said. "These incentives are critical to the industry."
Small Projects, Big Considerations
A January report from the Lawrence Berkeley National Laboratory explored the financing structures of five community wind projects, all of which relied on the Section 1603 grant. The report, entitled "Community Wind: Once Again Pushing the Envelope of Project Finance," highlighted wind projects with innovative financing strategies that included new markets tax credits (NMTCs), sale/leaseback structures, and high net-worth individual investors.
Although the report presented examples of atypical financing structures, in some cases the most conventional structure may be the only viable option, albeit not the ideal one. "It would seem that there should be another way to do it for a project of this size, but the most effective way has been the partnership-flip structure," said research scientist Mark Bolinger, the report's author, who cited the structure's high transaction costs and corporate investor component. "In some sense these equity partners can bring access to turbines, capital and more discipline from a development level, but on the other hand the locals end up giving away portions of these incentives in return."
In this difficult economic environment, you have to be creative, Paulson said. He and Wind have both been involved with Iowa projects that started out as separate 1- or 2-MW developments that were bundled together with nearby projects to create an economy of scale. When equipment is scarce, manufacturers are more likely to consider filling an order of 10 or 20 turbines than one or two. In addition, "it can provide the critical mass that might attract a larger investor," Paulson said, adding that Edison Mission served as the investor in a 20-MW bundled project he recently helped close, a project that was originally 10 2-MW partnerships. The trick, he said, is to make it look as much like the same project as possible while maintaining each project's legal independence.
Another way to take advantage of economies of scale is to share a construction team with nearby projects and schedule deliveries in sequence, Wind said. A developer can also cut costs by eliminating the mark-up associated with hiring a large-scale contracting company, according to Paulson. "It's a way to drive down costs without sacrificing quality," he said.
What's Paulson's tip for finding an investor for a small project? "Don't go to New York," he said, noting that finding non-traditional equity investors should be a high priority. He suggests seeking out companies such as New Energy Capital, an investor that focuses on providing equity to small and mid-sized renewable energy projects. On the debt side, he said potential investors will feel more comfortable if a local or regional lender is involved, the developer has a plan for the debt, and the leverage has been maximized. And, of course, he noted that developers should constantly be on the lookout for ways to improve the return to the investor, including maximizing federal, state and local grants and tax incentives.
Smaller project developers should also seek expertise, but Paulson warns that finding the right expertise at the right price is a persistent problem for inexperienced developers. "Lots of people are happy to sell you as many services as they can for a one- or two-turbine project. I've seen people pay hundreds of thousands of dollars for things they don't need," he said. He cautioned that figuring out exactly how much outside expertise your project needs and building a network of people you trust can take time, but is well worth the effort.
Small, community-scale wind projects tend to have larger returns and more local support than larger projects, and yet as of 2007 they composed only about 2 percent of the United States' wind power capacity, according to a 2009 National Renewable Energy Laboratory report. Some groups, including the American Wind Energy Association, have argued that short-term federal incentives have contributed to instability in the wind industry, and this may be one reason why it is disproportionately harder to use federal incentives to develop smaller projects.
"This is an outcome of having an energy policy that's renewed every two or three years," said UMM's Rasmussen, who added that the university is continuing to explore tax incentives to finance additional turbines. Rasmussen said UMM has even discussed the idea of using the proceeds from the sale of electricity generated by dedicated wind turbines to support a scholarship fund. "We're using our local resources to make ourselves less dependent on outside energy sources, and that will make us more stable."