While much of the immediate focus around last year’s passage of the Inflation Reduction Act (IRA) has been chatter about its shorter-term complexities such as what defines domestic content and the transferability of tax credits, the 10-year extension of renewable energy tax credits (RETCs) such as the investment tax credit (ITC) and production tax credit (PTC) also portend longer-term ramifications for the market.

Namely, they bring something the RETC investor market has long lacked: Certainty. Knowledge that the credits aren’t going to vanish in a few years gives investors more confidence going forward. In the longer term, that gives existing investors confidence, but could also draw new financiers, too.

“All the buzz around it makes investors feel like, OK, this is here to stay and it’s for 10 years,” said Karin Berry, managing director of renewable energy for National Trust Community Investment Corporation’s National Trust Solar platform.

Eric Heintz, managing director of renewable energy finance for Buffalo, New York-based M&T Bank, said the long-term horizon is great for everyone.

“It gives certainty in an environment that didn’t have certainty by way of incentives,” Heintz said. “ITC and PTC extensions in the past was always a very last-minute thing. We’re now in a regime that is entirely different–in a very good way.”

Chris Roetheli, senior vice president at U.S. Bank, expressed optimism about what the IRA will do.

“I think the IRA is going to bring more folks into this space because now I think folks see that there’s a runway to make this a meaningful part of their investment activity,” Roetheli said last year at the Novogradac 2022 Fall Renewable Energy and Environmental Tax Credits Conference.

Seasons of Struggle

Investors and syndicators working in RETCs said that sometimes, since the introduction of the credits in the 2000s, it has been complicated to get investors on board.

For example, Taylor Mayeux, director of tax credit services for Stonehenge Capital, said bringing new investors into RETCs has been tough in the past because of the amount of education involved and the short time frames for which the credit window was open.

“Nobody wanted to learn this process and invest in a market that you could only do it for the next two years,” Mayeux said at the Novogradac 2022 Fall Renewable Energy and Environmental Tax Credits Conference. “That didn’t make any sense.”

Heintz said after an initial flurry of activity and optimism to enter the space in the early 2010s, internal approvals for renewable energy tax equity as a new product hit a wall in the mid-2010s due to the lack of clarity on future incentives.

“It took several years thereafter to restart and become an active investor,” Heintz said. “One of the critiques was ‘Why are you trying to do this now, Eric? What happens when the credits start to roll away?’ I’ve been in situations where people said, ‘The credits aren’t going to be around forever. Don’t bother, Eric.’”

With the passage of the IRA, Heintz said the conversation is beginning to change.

“I think extension of credits for sure is helpful when entrepreneurs inside of corporations’ financial institutions and inside of banks are able to go to their committees and boards and say it really makes sense now with this long horizon,” Heintz said. “I don’t know how many other investors, but I expect it to bring some. It’s clearly a very helpful thing.”

Possibilities Posed

Berry expressed optimism about a provision in the IRA that extends the carryback period for certain tax credits to three years. She said combining emerging technologies may prove more beneficial to underwriting a transaction than investing in them on their own, but the infrastructure to support new technologies needs to come online.

“Manufacturing isn’t up and ready yet,” Berry said. “And new technologies will continue to have the same problems associated with all projects–tolling agreements for fuel supply, uncertain future revenue, volatile natural gas prices? The tax credit doesn’t fix that.”

Heintz said having a more robust market could spark investment in more emerging technologies.

“Folks are optimistic about transferability as a potential solution to this issue,” Heintz said. “The tax equity markets remain constrained. Hopefully, new investors come in and good projects are able to find good capital. The challenge will be if tax investors can find product that they’re accustomed to, e.g. solar and wind, emerging technologies may continue to struggle finding tax equity. That’s where transferability may be a solution.”

Challenges

Berry, meanwhile, sees some potential hurdles when it comes to transferability. She’s skeptical transferability alone will draw new investors.

“I don’t think developers will do it often,” Berry said. “It doesn’t serve their interests. I think investors, especially new investors, will think, ‘Oh good, cash for credits.’ Except there aren’t many deals where a developer will accept that kind of arrangement. … I don’t know how many developers look for a cash-for-credits option.”

As for direct pay, Berry wonders how many takers there will be as the non-taxpayer will have to pay the up-front cost of building the renewable installation–a capital expense, whereas now they only buy the power at a discounted rate, an operational expense. Berry also said one of the direct-pay conditions that may impact the execution of credit transfers is also important.

“The IRA requires a decision as to finance or direct pay up front before construction completion,” Berry said. “Once a deal has been financed, I’m not sure how additional credits, for example from an adder, might be sold. Who sells the credits and to whom?”  

Berry said adders, rules and regulations might draw more investors, but will assure higher transaction costs and likely lower returns as well. She fears a possible recession could further suppress the investor market.

While the adders could move the base rate as high as 50% to 60%, getting more credits in individual investments is “not necessarily a recipe for explosive growth,” Berry said.

Berry said that while the 10-year extension is important, at least a 30% credit is still necessary.  “Six percent isn’t worth it,” Berry said, referencing the Section 48 credit base rate. “Thirty percent is.”

Berry’s biggest question about the IRA is how treasury is going to determine allocation for the low- and moderate-income benefit, saying the 1.8GW limit may be difficult to reconcile with projects already in the market. Many states already have similar adder programs in process.

Heintz, too, is eagerly anticipating guidance about adders and other regulations from the IRA.

“I think there’s a whole lot of frothiness, just generally speaking,” Heintz said. “There’s a whole lot of excitement with regard to adders. It gives me pause that folks are a bit overly optimistic that certain projects may qualify for adders. The valuations of projects may be increased just because an adder for a project may be eligible. That gives me concern that some sponsors may be too aggressive with valuations. That’s a big concern of mine, at least from industry risk perspective.”

Heintz encouraged colleagues working in RETCs not to push valuations too far.

“Be cautious with regard to adder eligibility,” Heintz said. “I think, in the end, there’s just tremendous opportunity for all of us. What we don’t need is several bad actors creating issues industry wide. Be cognizant and prudent and diligent with regard to tax analysis. Have it buttoned up before coming to financing parties.”

Looking to the Future

Berry said the first order of business is the much-anticipated guidance from the U.S. Department of the Treasury that industry leaders hope will provide ground rules for how components of the IRA such as adders and transferability can be used.

Despite the complications, Berry said the passage of the IRA isn’t going to drive investors away.

“The question is about pulling new investors into the market and that’s where the uncertainty is head spinning,” Berry said. “Investors who are interested and have a tax appetite will continue to invest.”