Inflation Reduction Act Shines a Bright Light on Renewable Energy, but Guidance is Needed
The renewable energy industry is excited about the enactment of the Inflation Reduction Act of 2022 (IRA)–and rightfully so.
The IRA, signed into law Aug. 16, has substantial implications for the tax credit community, especially renewable energy.
Renewable energy investment tax credit (ITC) and production tax credit (PTC) investors and syndicators weighed in on the most impactful provisions, including:
- extension of the ITC/PTC,
- transferability of tax credits,
- new technologies eligible for the ITC, and
- bonus credits.
“The IRA has a significant impact on [ITCs],” said Ed Rossier, managing director, head of climate finance at Enhanced Capital, a national impact investment firm with 22 years of experience. “It does three exciting things. One, the transferability of credits. Two, the availability of orphaned technologies. And three, bonus credits for triple bottom line, impact-driven investment.”
“There is so much more opportunity to use these credits because of the Inflation Reduction Act,” said Matt Meeker, a partner in the Dover, Ohio, office at Novogradac. “The IRA will have a big impact. We just don’t know exactly how to monetize it yet.”
“Projects that were not viable before now can be because of the many changes under the IRA,” said Bryen Alperin, managing director of Foss & Company, an ITC syndicator.
Among clean and renewable energy provisions in the bill is essentially an extension of the PTC and ITC for facilities that start construction after Jan. 1, 2022, and before Jan. 1, 2025, under existing technologies–with the PTC at $26 per megawatt-hour as adjusted by inflation annually and the ITC at 30% of eligible costs if they adhere to the labor requirements on prevailing wages and apprenticeship programs. After 2024, the PTC and ITC will transition to a technology-neutral production and investment tax credit for facilities that start construction by the end of 2032.
“A 10-year runway is a big runway,” said Jon Peeples, director of business development for environmental finance at U.S. Bank. “This is a big positive for an industry that typically gets shorter extensions.” U.S. Bank–through U.S. Bancorp Community Development Corporation, its tax credit and community investment division–invests across a variety of tax credit incentives, but in the renewable energy sector it currently focuses on ITCs.
“People are concerned about the supply chain delays,” said Meeker. “Solar, like most assets, has been affected, but that concern has been alleviated a little with the 30% ITC being extended for the next 10 years.”
Industry participants are excited at the prospect of the ITC being transferable. Starting in 2023, companies with taxable income will be generally allowed to transfer ITCs and PTCs, along with other tax credits, for cash to unrelated parties, and the proceeds from the transfer is not taxable income.
“The transferability of credits brings in new investors to the market,” said Rossier. “Renewable energy has a $20 billion tax equity market. There are banks, family offices, corporate investors, and individual investors who understand the tax and accounting implications of partnership tax equity, but there are many more investors who don’t want to face the learning curve of investing in tax equity.” Rossier went on to say that the transferability provision can bring those other investors into the renewable energy market.
“Investors now have the option to forgo a partnership investment if that is preferred,” said Peeples. “Some investors may prefer the direct purchase of credits versus the various analytical, legal and accounting nuance that comes with a partnership investment.”
In addition to bringing new investors into the renewable energy market, the transferability of credits has other benefits as well.
“The transferability of credits may help sponsors and projects that can’t access efficient tax equity,” said Eric Heintz, managing director of renewable energy finance at M&T Bank, an ITC investor.
However, questions remain before this provision is used.
“The industry is waiting on more guidance from the U.S. Department of the Treasury before they move forward with tax credit transferability,” said Heintz. “[In the meantime,] I see other challenges that guidance likely won’t solve. For example, what happens if you can’t monetize depreciation and how can an investor lay claim to additionality with respect to [environmental, social and governance] ESG reporting?”
“How do you acquire credits without having an interest in the partnership?” asked Rossier. “It’s new to transfer federal credits. Usually, you can’t purchase federal credits.”
The transferability of tax credits may have an effect on tax credit equity pricing.
“If projects can sell/transfer credits, I see potential for pricing to increase,” said Meeker. “Selling credits would simplify monetizing the credits when compared to a typical tax credit investment.”
New Technology is Eligible for the ITC
“With the IRA, the first thing that comes to mind is standalone battery storage is now eligible for the ITC even without being tied to solar,” said Heintz. “Standalone battery should expand the volume of ITC projects and may entice new ITC investors into the market. There will also be new opportunities to pair ITC on batteries with PTC on solar or wind components of a facility.”
But standalone battery storage isn’t the only technology eligible for the ITC. Industry participants are also excited to be able to invest in other tax credit eligible technologies, thanks to the IRA.
“Fuel cells, biomass technology, standalone energy storage, electric vehicle charging, and geothermal technology are all eligible for the ITC,” said Rossier. “We can finance these using our debt products now and have them aligned with our tax credit business.”
Peeples said making these technologies eligible for the ITC will grow the equity market.
“Now that additional technologies are eligible for the ITC and PTC it will increase the supply of tax credits, which may have the potential to attract new entrants to the tax equity market,” said Peeples.
Alperin believes that the supply and demand balance will be maintained despite adding new technologies into the fold. “A large volume of tax credits are entering the market,” said Alperin. “But there will also be an increase in the investor pool to balance the market.”
That being said, Alperin expects it may take time for the investor pool to grow. “Usually it takes 12-plus months to educate new investors. There could be a period, for much of 2023, where the amount of tax credits exceeds the investors, but that shortage of investors will balance out.”
In addition to new technologies becoming eligible for the ITC, certain projects are also eligible for bonus credits under the IRA. What this means is the ITC increases from a 30% credit to a 40% credit if certain provisions are met. There are several of these “adders” listed in the IRA, but those who spoke to the Novogradac Journal of Tax Credits listed a few provisions in particular: energy projects located in an energy community, a project that uses domestic content and a project located in a low-income census tract.
An energy community is an area that has a closed coal mine or coal-fired generating station or had significant employment related to the extraction, processing, transport or storage of coal, oil or natural gas and meets certain unemployment levels. “All of these adders should make more projects viable. However, until we have guidance, most of the adder strategies will be difficult to execute on,” said Heintz.
The domestic content provision encourages project developers to source materials in the United States. Domestic content is defined as any steel, iron or manufactured product which is a component of a renewable energy facility that was produced in the United States.
“A large majority of solar projects in the United States include imported equipment,” said Peeples. “The domestic content [adder] is important because post pandemic supply chain issues and tariffs have wreaked havoc on construction timelines.” Peeples went on to say that sourcing material domestically could help mitigate some of those supply chain issues.
While Heintz is excited about the domestic content adder, he said it is difficult to know what qualifies as domestic content without further guidance from the Department of the Treasury.
Equity Pricing May be Affected by Future IRA Guidance
Tax credit pricing for the ITC has always been specific to each individual investment.
“The price per credit is such a wide range, easily a 10 cent range based on a number of factors,” said Meeker. “The ITC is such a unique program. Commercial solar differs from community solar which differs from residential. It really depends on the asset type, the financial strength and experience of the developer and the parties involved.”
Rossier said that not many ITC-financed projects were placed in service in 2022. “In 2022, everything was delayed,” said Rossier. “For projects placed in service in 2022, people were willing to pay a premium. For 2023, we may see aggressive pricing as well.”
Alperin expects 2023 to look much like 2022. “In general, not too much will change from 2022 to 2023,” said Alperin. “In 2023, we will be looking into expanding into standalone battery storage and taking advantage of the transferability of tax credits to offer a different avenue to our investors.”
“2023 may be a little bit of a gap year depending on guidance,” said Peeples. “What will the Treasury guidance say?”
But these IRA provisions may very well impact pricing. However, exactly how the IRA impacts pricing is unknown.
“Pricing is to be determined,” said Peeples. He noted that investors can’t yet transfer credits and that more guidance is needed to define what qualifies for each adder provision. “There are a lot of variables at play. It’s too soon to opine on pricing.”
Heintz and Rossier expressed very similar sentiments.
“We want Treasury guidance,” said Heintz. “It’s not in your best interest to get too far ahead with these adders until more guidance comes out. It’s hard for investors to commit right now.”
“It’s hard to put together proposals with clarity because of these unknowns,” said Rossier. “But long term, the IRA is great for the industry. It’s just this interim period where there is hesitation.”
Meeker expects Treasury guidance to come in 2023.
“I don’t expect Treasury regulations until early 2023,” said Meeker. “Obviously the sooner, the better so the industry can move forward with their financing arrangements.”