Published on July 6th, 2012 | by Zachary Shahan3
Challenges with End of 1603 Clean Energy Grant Program
July 6th, 2012 by Zachary Shahan
The National Renewable Energy Laboratory (NREL) recently took an important look at what the end of the 1603 grant program for renewable energy means for developers in the industry. Here’s a summary of that:
Certain Types of Projects May Find It Harder to Attract Tax Equity Investors
The expiration of a federal grant program at the end of 2011 may make it more difficult and expensive for developers of certain kinds of renewable power projects to access private capital, a new report suggests.
That, in turn, may lead to fewer projects coming on-line.
“Our interviews with financial executives active in the renewable energy market suggest that the end of the Section 1603 Program of the American Recovery and Reinvestment Act means that financing renewable power projects is about to become more difficult,” said Michael Mendelsohn, an NREL analyst who co-wrote the report “1603 Treasury Grant Expiration: Industry Insight on Financing and Market Implications,” with John Harper of Birch Tree Capital, LLC.
In the United States, the renewable power sector has benefitted from federal tax incentives and the availability of institutional-scale tax equity investors able to use the tax incentives. The incentives include income tax credits – production tax credits or investment tax credits – that can reduce taxes owed by a project investor as well as reduced tax obligations resulting from accelerated depreciation of project assets.
These tax benefits can represent a powerful incentive for private investment, but realization of these benefits is hampered by the complexity of monetizing their value, the illiquid nature of the investments and uncertainty about how long tax policies will last.
Most renewable energy developers lack sufficient tax liabilities to benefit directly from the tax incentives. Instead, the developers have created partnerships and other financial structures with large financial and other companies that can make use of these incentives.
During the 2008-2009 financial crisis, tax equity investors largely withdrew from the renewable energy project financing market. The number of tax equity investors willing to make new investments decreased from about 20 to five.
“Industry experts told us that tax equity was almost unavailable for all but the largest and highest quality projects,” said co-author Harper. In response, Congress enacted the Section 1603 Program.
The Section 1603 Program, which expired December 31, 2011, offered project investors a cash payment equal to and in lieu of the 30% federal investment tax credit. The program freed many developers from having to rely on third-party tax equity investors to monetize the tax credits.
Interviews with industry participants led the authors to conclude that the Section 1603 Program provided multiple benefits to renewable energy projects, including:
- Increased speed and flexibility of project finance arrangements
- Lower transaction and financing costs
- Stretched supply of traditional tax equity
- Support for smaller and new-to-market project developers and projects using innovative energy technologies, both of which previously found it more difficult to tap tax equity markets
- Lower developer or project cost of capital as a result of the ability to use more debt
While impacts associated with the expiration of the Section 1603 Program are uncertain, the report says industry experts predict renewable power projects again will have to rely more heavily on external tax equity investors to obtain a portion of their financing. Several potential outcomes:
- Less-established renewable power developers, especially those with smaller projects, could have more difficulty attracting needed financial capital and completing their projects. Tax equity investors are likely to focus on established relationships with proven developers and on larger projects.
- Development of projects relying on newer or innovative technologies that lack extensive operational track records may be slowed because many tax equity investors are seen as highly averse to technology risk.
- Projects relying on tax equity financing likely will be more expensive to develop because of the transaction costs and potentially higher yields required to attract tax equity capital.
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