Six Tips for Renewable Energy, Environmental Tax Incentive Developers
Published by Michael J. Novogradac on Monday, November 1, 2021
In the clean energy world, change is a constant. Technological advances interspersed with the ever-changing legislative and economic landscape, as well as ongoing and future supply issues, mean that renewable energy developers must keep one eye on the present, the other on the future.
This is truer than ever as we near the end of the first year of the Biden administration.
Climate change has helped motivate technological advancements, particularly by improving efficiency for solar and wind properties, allowing them to produce more electricity with same-size site and facility. Green energy has also seen technological advancements, such as in energy storage in lithium batteries and carbon sequestration. Wider use of battery storage allows solar and wind properties to store energy during peak production hours for later use when demand for energy is greater. Carbon sequestration involves the long-term removal, capture and storage of carbon dioxide with the goal of reducing climate change.
Policywise, President Biden made green energy a key component of his Build Back Better plan. The Growing Renewable Energy and Efficiency Now Act of 2021 (the GREEN Act) was introduced in Congress this year and would extend the renewable energy production tax credit (PTC) and investment tax credit (ITC) for certain technologies before beginning a phasedown and extend other energy-efficient credits and deductions. The Clean Energy for America Act, also introduced this year, would consolidate the current energy tax incentives into emissions-based incentives for all energy technologies that meet emissions reduction goals.
But that’s not all there is on the federal legislative front. A plethora of bills–any of which could be added to other legislation making its way to enactment–were introduced in Congress the past several months, including bills to extend the PTC and ITC. There was also legislation introduced to provide tax credits for the production of hydrogen to reduce carbon emissions, for facilities that produce offshore wind turbine components, for manufacturers in the solar supply chain and for manufacturers who retool or build new facilities to produce advanced energy parts or technology. Other bills would make additional technologies eligible for existing renewable energy tax credits and would make installation of carbon capture and storage equipment eligible for private activity bond financing.
Renewable energy developers must also be mindful of the state of the broader economy and continuing supply chain difficulties.
Federal legislation will likely bring changes to tax incentives. Technological advances will certainly improve the economic feasibility of renewable and green energy facilities, and the competitive landscape. Supply-chain and other economic issues will continue to bring challenges. Knowing all of this, wise green energy developers should be taking steps now to enhance the financial viability of projects under development and maintain and maximize the economic and social benefits of projects already in service.
Here are six tips for developers of renewable and green energy facilities.
1. Stay informed of the evolving landscape.
In a world where change is a constant, developers need to stay informed on what’s happening and what’s coming. Sometimes that involves technology and legislation, other times it’s a supply issue.
For instance, developers currently face issues with the availability of solar panel modules. That challenge comes in two ways, both of which can affect development. Some modules may be unavailable because factories are offline due to the pandemic. Other module producers–particularly overseas–stand accused of forced labor practices to the extent that participants in a transaction may consider them unfit as suppliers.
For solar developers, that means a major project cost is subject to significant fluctuations. Developers should track the availability of modules and work with consultants to keep their financing model updated with the latest pricing impacts.
Similarly, access to wind turbines and lithium battery components (which are increasingly used in automobiles) can create hurdles for developers.
As mentioned, the legislative landscape is fluid, so how should developers react? The simplest solution is for potential changes to be negotiated into new and existing investment agreements–including a tax credit true-up provision to ensure that if extra tax credits are available, the investor will invest additional equity on predetermined terms.
Developers who haven’t closed their transaction may want to delay their placed-in-service date with an eye on receiving tax credits at a higher rate. Studying the benefits and costs of such a decision is worth the effort–talk to your tax professional to run various economic scenarios.
Action step: Track availability of solar panel modules, wind turbines and lithium batteries and update financial models accordingly. Model the effects of potential changes in tax law so you have insight as to their financial effects and are better informed as you negotiate with your investors.
2. Account for the changing investor pool.
The pandemic and the related economic recession affected the market for green incentive investing, with some major investors pulling back and more small equity investors entering the market. That means there are more (smaller) potential investors for any green project, which means developers should be nimbler and run a variety of scenarios, based on differing investor profiles. Some investors may be interested strictly in tax benefits, while others are interested in the broader range of economic benefits. Some investors may prefer a time-based partnership flip, others a yield-based flip.
New investors mean developers should do more due diligence. Ask investors about their investment motivations and prior relationships. Determine if this is a one-off transaction or is there is potential for multiple investments. Learn what their exit plans are.
Developers should also be mindful that investors are often a few steps behind them in adapting to new technology and new incentives. It is worthwhile to run detailed models that compare the benefits generated by the new technology (or new tax incentive) to the benefits generated from their prior investments, if any. In addition to reviewing the projected investor benefit schedule, most investors will also want an independent engineering report to analyze the technology and to estimate how it will perform. Incorporate that data in the financial modeling.
Action step: Run various investor return scenarios to evaluate and compare different project designs and operating strategies–including the presence of new or modified incentives. Examine different financial structures, such as comparing a partnership flip and inverted lease structure.
3. Evaluate, maximize and quantify social impact.
There is ever greater interest in the social impact of investments, including by developers, lenders, cash flow investors, tax equity providers, government agencies, local community groups and more. Green energy developments that benefit low-income persons and/or BIPOC communities will be better supported by all involved.
Action step: Evaluate, maximize and quantify the social impact of your project.
4. Repower, if you can.
The advancement of energy technology in the past 10-plus years provides an opportunity for many existing qualifying facilities, most notably wind power, to repower and benefit from new tax incentives and generate substantially more cash flow.
In order to do this, a careful tax analysis needs to be performed to ensure that the facility qualifies for new tax credits. The facility often must, for instance, pass what’s referred to as the 80/20 test, wherein the fair value of the used equipment can’t exceed 20% of the fair value of the existing equipment plus the cost of the new equipment.
Action step: Assess whether existing property is eligible for repowering and qualifying for new tax credits.
5. Realize the value of storage.
Storage, as mentioned earlier, is one of the top-line issues in the green world. Not only are more jurisdictions requiring battery technology to be incorporated into new projects as a condition for permitting, many financiers prefer this even in jurisdictions that don’t do so. As a result, developers should consider adding batteries in most projects.
With batteries, wind, solar and other facilities can store electricity as power is generated and sell it at higher prices during times with greater demand. This generates more revenue.
Modeling the added revenue from batteries isn’t always that straightforward and can often times require sophisticated analysis, but doing so demonstrates the benefits of storage for both the developer and investor.
Action step: Prepare and assess a financial model
that includes storage and the associated additional revenue.
6. Correctly value early development.
In renewable and other green energy properties, early stage developers typically get projects off the ground and permitted, then sell after receiving a notice to proceed (i.e., when the project is “shovel-ready”). Those developers can benefit by better understanding the value their project.
Once developers better understand the current and expected future value of their project, they may discover that they’re better off retaining their facility. At worst, they have a better-informed understanding of the value of their facility before entering negotiations.
Action step: Get a sophisticated study of the current and expected future value of your facility before entering negotiations.
Information is Power
The green, clean-tech world continues to change and the pace of disruption is more likely to speed up as opposed to slow down. This means the importance of staying informed has never been greater.
The coronavirus pandemic and resulting recession contributed to changes in the investor market, and magnified the importance of the social impact of renewable and green energy developments. Advances in repowering and storage provide developers with additional opportunity.
All of this makes valuing early development more challenging, but more important.
Novogradac can help developers and investors enhance the economic and social impact of their renewable energy and other green energy projects.