The Milford Wind Corridor Project north of Milford, Utah, sells electricity to the Southern California Public Power Authority.
Companies in the U.S. may soon be able to bypass Wall Street to access billions of dollars in government incentives for renewable energy projects.
More than 180 Democrats in the U.S. House of Representatives on Aug. 10 called for project developers to be allowed to claim cash payments in lieu of tax credits, a move lawmakers say would drive more investment in the renewable energy industry.
Because most renewables developers do not owe enough in taxes to monetize the credits, to obtain project financing they typically exchange them for tax equity funding from banks and other investors. It is a costly and cumbersome process, and the renewable energy industry has long complained that tax equity is in short supply. That deficit widened during the past year as economic shocks from COVID-19 scared investors away. Meanwhile, demand continues to grow as Democrats push to accelerate the build-out of green energy infrastructure.
In a letter to House Speaker Nancy Pelosi, D-Calif., and House Majority Leader Steny Hoyer, D-Md., Democratic lawmakers said clean energy tax incentives and a direct pay provision should be included in infrastructure legislation that the House is taking up after it passed the Senate.
"This is a much more efficient way to directly provide the federal benefit" offered by tax credits, Rep. Earl Blumenauer, D-Ore., who proposed a direct pay option in May, said in a recent interview. "[It] sidesteps some of the attorneys, consultants, accountants," Blumenauer said.
Lobbyists for the renewable energy industry, as well as for some utilities and nonprofit power companies, have pushed for years for such a change.
Rep. Earl Blumenauer, D-Ore., speaking at an "End Fossil Fuel" rally on June 29 in Washington, D.C., proposed a direct pay option for renewable energy tax credits.
"The system we have in place today has made it really difficult to secure the critical financing needed for these major new clean energy projects," said Shannon Maher Bañaga, a spokesperson for The Partnership for Clean Energy Investment, whose members include project developers Apex Clean Energy Inc. and 8minute Solar Energy LLC, as well as Xcel Energy Inc., a utility. The group is calling for direct payments equal to 100% of the value of available tax credits.
In 2020, tax equity financing increased by at least 31% to between $17 billion and $18 billion, and even more is likely to be invested this year, said Anand Dandapani, an executive director at JPMorgan Chase & Co. For typical wind and solar projects last year, tax equity accounted for approximately 65% and 35%, respectively, of project financing, according to Keith Martin, co-head of projects at the law firm Norton Rose Fulbright US LLP.
While the volume of tax equity investment is increasing, investors and project developers say the money is becoming harder to find as demand soars. In a survey published by the American Council on Renewable Energy, 46% of investors and 35% of project developers reported a decrease or significant decrease in the availability of tax equity during the past year.
Some of the country's leading tax equity investors — including Bank of America Corp., which engaged with the government on the topic of direct pay earlier this year, according to federal lobbying disclosures — either declined to comment or did not respond to messages seeking comment.
"There has always been a supply-demand imbalance in the tax equity market. We've never had enough tax equity investor dollars to supply all the good projects," Marshal Salant, a managing director at Citigroup Inc. and head of the firm's alternative energy finance group, said at a conference in June.
"The programs that have been rolled out in the various bills could double the size of the demand for tax equity, and there's no possible way that the tax equity market could absorb all of that right now," Salant said. "So direct pay becomes essential."
Demand for financing for renewable energy projects like this solar array near Santa Ynez, Calif., is set to soar under the Biden administration's energy and climate policies.
The decision to implement energy policy through the tax code has been particularly problematic for tax-exempt power companies, which serve approximately 28% of U.S. retail electricity customers, said John Godfrey, senior government relations director at the American Public Power Association.
While the entire renewable energy industry has had to rely on tax equity investors to make use of the credits, "for us, it goes still further," Godfrey said, since projects owned by tax-exempt entities are not eligible. As a result, he said electric cooperatives and municipal utilities have to sign power purchase agreements to procure green energy.
"The value of the credit flows through not just the tax equity partner but also the owner of the project," Godfrey said.
BloombergNEF, a research firm, recently said achieving net-zero carbon emissions by midcentury will require the addition of about five times more wind power annually than was installed in 2020 and more than three times more solar power.
In the U.S., annual investment in the renewable energy industry needs to increase by about 60% to achieve President Joe Biden's goal of creating a carbon-free power sector by 2035, according to American Council on Renewable Energy President and CEO Gregory Wetstone.
Conditions in the U.S. tax equity market are already expected to tighten further as developers of large offshore wind projects and companies pursuing eligible carbon-capture projects start looking for financing.
During the first quarter of 2021, installations of utility-scale solar projects in the U.S. increased by 36% year over year to approximately 2.8 GW. Wind installations jumped by 75% to around 3.3 GW.
Given the existing constraints, direct pay will be crucial if Democrats pursue "a robust tax incentives package," Jesse Jenkins, an assistant professor at Princeton University with a joint appointment in the Department of Mechanical and Aerospace Engineering and the Andlinger Center for Energy and Environment, said in an email.
"There will be far more demand for tax equity from these clean energy projects than the investment community can provide," said Jenkins, who has advised lawmakers on energy policy. "Direct pay would mean more taxpayer dollars flowing to where they are intended: new clean energy projects, not Wall Street banks."
Direct pay provisions were included in two major Democratic tax proposals this Congress — the Senate Finance Committee's Clean Energy for America Act and the House Ways and Means Committee's Growing Renewable Energy and Efficiency Now Act.
As lawmakers put together legislation to fulfill a $3.5 trillion budget proposal from Senate Democrats, the Clean Energy for America Act will be the "linchpin" of the package's climate efforts, said Ron Wyden, D-Ore., chairman of the Senate Finance Committee. The budget proposal is the first step in a reconciliation process, which Democrats plan to use to pursue major climate and clean energy programs.
Despite partisan differences, Congress has repeatedly passed legislation to extend or enhance clean energy tax incentives. In December 2020, former President Donald Trump signed a combined stimulus and government spending bill that included a one-year extension of the land-based wind power production tax credits and a two-year extension of the solar energy investment tax credit.
The bill also created a 30% investment tax credit for offshore wind projects that start construction from 2017 through 2035.
The reconciliation process, which requires a 51-vote majority in the Senate rather than the 60 votes required to avoid a filibuster, is the "best hope" for enacting a direct pay provision in the coming months, given Democrats' razor-thin Senate majority, a Senate Democratic aide said.
However, given the political difficulties of enacting such a massive spending program, members of Congress could try to insert direct pay language into a bipartisan infrastructure package that the Senate recently passed.
A worker walks through rows of solar panels on a farm in Grafton, Mass. Proponents say a direct pay option for renewable energy tax credits would drive more investment in the industry.
'It can't scale'
When cash grants were available through the American Recovery and Reinvestment Act of 2009, project developers continued to use tax equity as a form of bridge financing until grants were paid and to monetize the incentives' depreciation benefits, said Martin of Norton Rose Fulbright.
Market participants expect something similar if direct pay were available now. Project developers Invenergy LLC, Clearway Energy Group LLC and AES Clean Energy Development LLC, a subsidiary of AES Corp., have said they would likely use a combination of direct payments and tax equity, depending on the project.
Under the direct-payment schemes Congress is considering, developers would have to wait longer to receive their money than they did under the Treasury cash grant program, Martin said in an email, adding that developers might decide to use tax equity to "efficiently" monetize depreciation.
"I think even in a direct pay environment, we'll see some players — many players, actually — still electing to use third-party tax equity to fully monetize those benefits and not leave money on the table," James Wright, a managing director at CIBC Capital Markets and head of the firm's U.S. Project Finance & Infrastructure group, said at a conference in June.
Still, Wright offered a "word of caution" about ditching tax equity. Without those investors, he said the renewable energy market would lose gatekeepers who have kept risk in check by deciding which projects are good enough to get financing.
The supply-demand imbalance in tax equity, while irksome to renewable energy developers, is a "natural constraint" that enforces market discipline, Wright said.
CIBC did not respond to a message seeking comment on direct pay.
Sasha Mackler, executive director of the Energy Project at the Bipartisan Policy Center, dismissed Wright's warning, saying he does not consider tax equity investors to be "the experts in the marketplace in terms of what should be built and what shouldn't be built."
"We've been using the tax code, in a lot of ways, to really be the linchpin for the clean energy transition. And I think that as we have currently structured that market, it can't scale to where we need to go," Mackler said. "I think there's broad recognition that we need to be doing and building much more than we are right now to hit our climate targets."