In recent years, the financing of renewable energy has played an ever greater role in how many architects and green building developers approach sustainable urban planning and design. The American Council On Renewable Energy (ACORE) recently launched two new initiatives – the Renewable Energy, Green Building and Energy Efficiency Committee (REGBEE) and the US Partnership on Renewable Energy Finance (US PREF) to look into greater way to “connect the dots” between RE, GB and EE, as well as work to champion a more in depth understanding of how renewable energy finance and development really work. Federal policy incentives from Washington in combination with a stronger private capital market will give the industry the necessary support and sustainable strategy to scale up renewable energy in the United States. As such, it is vital for many in the green building sector to take a closer look at the incentives and other mechanisms that are contributing to the growth of this ever important sector.

Today’s renewable energy financing market is largely reliant on tax incentives and other funding mechanisms put in place by the American Recovery and Reinvestment Act of 2009 (ARRA), otherwise known as the Stimulus Bill. The promise of money coming in has held the market steady, but work must be done to accelerate the allocation of these funds to renewable energy projects in the US.  It is important to get the current mechanisms working quickly and efficiently, which requires clear, predictable, and long term policies. Current renewable energy finance policies include:

• Tax incentives (Production Tax Credit, “PTC”and Investment Tax Credit, “ITC”), and a cash grant under ARRA section 1603, which are not dependent on financial institutions to be monetized
• The DOE Loan Guarantee Programs (1703 and 1705), which lower the cost of debt financing  and reduce lender risk, encouraging the financing of renewable energy projects

Together, these policies help to sustain the current renewable finance market. Proposed policy concepts that would further support the development of the market include:

• A National Renewable Electricity Standard (RES), which would enhance existing state level renewable portfolio standards (RPS) providing sustained, long-term demand
• A feed-in tariff structure that offers a direct incentive to project owners for the total amount of renewable electricity they produce
• A Clean Energy Deployment Administration (CEDA), which would administer various types of credit instruments such as loan guarantees, insurance products, and secondary market supports with the aim of accelerating private sector investment in the clean energy sector

The long term adoption of these programs could build a durable, financeable renewable energy market to drive renewable investments. Analyses of the current policies in place to sustain renewable energy financing are included below.

Market Conditions and the 1705 Loan Guarantee Program[1]
Reduced taxable income for corporations has resulted in tax credit incentives being largely ineffective in today’s economic environment.  Additionally, the tightening of the credit markets has limited the availability of debt funding and increased borrowing costs to rates unattractive to project sponsors.  These barriers are currently preventing private sector investment needed to reach U.S. goals for the expansion of renewable energy.  The comparison below, between 2006 and 2009 financing environments, highlights these challenges and shows how the 1705 loan guarantee program, if implemented well, can address some of them. 

Typical Financing Structure in 2006: Historically, project-level debt has come in the form of tax equity and back leverage. Back leverage is term debt (raised in the capital and private placement markets) secured by the assets of the project and is sized based on the project’s projected cash flows.

This historical financing structure was predominantly utilized by independent developers, who represented the vast majority of incremental renewable generation. Independent developers, unlike domestic and foreign utilities and exploration and production companies, lack large balance sheets, investment grade parents and taxable income. This has historically driven developers to utilize project-level financing including the use of tax equity. Investment grade balance sheet players with taxable income were able to either mimic this approach or finance their developments on their own balance sheets and utilize their taxable income to monetize the tax attributes and MACRS depreciation[2].

Typical Financing Structure in 2009:  Given the current state of the credit markets, banks and other renewable energy lenders are unable to provide the same level of financing to the industry. Despite no changes in the project-level cash flows, lenders are now sizing their tranches on much more stringent terms, depressing the overall level of financing.  As seen on the next page, a hypothetical wind farm’s “financeable” EBITDA[3] (as determined by banks/lenders) is currently down over 50% from 2006 levels. In today’s market, tax equity has been replaced with the ITC grant. Further, unless an ITC grant partnership[4] can be achieved, where the MACRS depreciation is monetized, the benefit of the MACRS depreciation tax shield is instead carried forward to offset prospective taxable income.

This current financing structure is the alternative for independent developers, and is a problematic situation. While this approach can also be utilized by investment grade large balance sheet players, given the current state of the markets, these players are likely to utilize their own investment grade balance sheets and taxable income first.

Hypothetical Wind Farm

Analysis of the Treasury PTC, ITC, and Section 1603 Grants [5]
Until passage of the ARRA, there were few decisions to be made regarding the type of tax credit to claim under the Internal Revenue Code (“Code”) for a renewable energy project.  Facilities like wind, biomass, geothermal and landfill gas qualified for a production tax credit (“PTC”), and solar facilities qualified for an investment tax credit (“ITC”).  Now, after the passage of the ARRA, for many types of facilities taxpayers can choose among a PTC, an ITC and something new – a cash grant from the Department of the Treasury under ARRA section 1603 (“Section 1603 Grant”).

The PTC provides a tax credit per kWh of electricity sold by a taxpayer from a qualifying facility to an unrelated person.  For facilities selling electricity generated from wind, closed-loop biomass and geothermal sources, the PTC rate is 1.5 cents per kWh, an amount that is adjusted for inflation and is 2.1 cents per kWh in 2009.  For persons selling electricity generated from open-loop biomass, landfill gas, trash, qualified hydropower or marine and hydrokinetic sources, the credit rate is half the credit rate for wind (1.1 cents per kWh in 2009).  The PTC can be made for sales in the first 10 years from the time the facility is originally placed in service.

The ITC is based on a percentage of a taxpayer’s investment in qualifying energy property.  For example, if the taxpayer’s investment in qualifying energy property is $100 and the credit rate is 30%, the amount of the ITC is $30.  In general, the investment in energy property is the cost of the facility.  Note that the investment for this purpose does not include all costs of a project.  For example, it would not include the costs of land, buildings, certain land improvements, the acquisition of certain intangible assets like certain licenses and costs of obtaining financing.  In the case of facilities generating electricity from solar and fuel cells, the ITC percentage is 30% as long as the facility is placed in service by the end of 2016.  The ITC rate is 10% for combined heat and power facilities and for microturbines.

Under the ARRA, alternatively, a taxpayer may elect to apply to the Department of the Treasury to obtain a Section 1603 Grant for most types of property qualifying for the PTC or ITC.  In general, with respect to property that otherwise would be eligible for the PTC, the Section 1603 Grant amount is 30% of the basis of the property that would comprise a qualified facility under Code section 45.  This election can be made by a taxpayer that owns a wind facility, a closed-loop biomass facility, an open-loop biomass facility, a geothermal facility, a landfill gas facility, a trash facility, a qualified hydropower facility or a marine and hydrokinetic facility.  With respect to property that could have claimed the ITC but not the PTC such as solar, fuel cells, microturbines and combined heat and power property, the rate for the Section 1603 Grant is the same as the ITC rate.

The cash grant program is successful thus far.  Some projects which are eligible for the cash grant may be better off using PTCs (e.g. geothermal and sites with strong wind).  Those projects may prefer to use traditional tax equity, if it is available.  However, there is clearly still a need for tax equity financings even in the absence of ITC and PTCs.  The program has had a stimulative effect because the use of a cash grant in lieu of tax credits effectively reduces the amount of the investor’s tax capacity used for a particular project, expanding the number of projects it can finance.  The cash grant enables monetization of the majority of the tax benefits traditionally absorbed by tax equity investors, but outside of the tax system.  Transactions now only require tax capacity associated with MACRS depreciation and interest, if any, and do not require the large additional front-loaded tax capacity required by ITC, or the long term predictability of tax capacity required by investors using PTCs.

Of the $66bn given to clean energy development in the ARRA, over $31bn has been allocated over the past year. However, it is estimated that only about $9.4bn of these funds have completed delivery agreements in place.[6] Much money remains to be allocated and spent, and it is essential to the development of clean energy in the US that the remaining stimulus dollars are dispersed before the DOE and Treasury programs expire. Progress has been made in renewable energy development in the past year, especially taking into account the state of the nation’s economy, but much remains to be done in the coming years.  The financial outlook for renewable energy projects remains solid and is continually picking up speed in 2010.

[1] Excerpt from US PREF white paper “Renewable Energy Market Conditions and the 1705 Loan Guarantee Program”

[2] MACRS (Modified Accelerated Cost Recovery System) – a system for accounting for depreciation of an asset on an accelerated basis. The value of the asset is considered depreciated, or lost, for tax purposes, over a period of time much shorter than the actual life of the asset, e.g. 5 years instead of 30 years, reducing the tax liability of the asset in its earlier years, and increasing the financial returns for investors in the asset.

[3] Financeable EBITDA – the Earnings of a project Before Interest, Taxes, Depreciation, and Amortization that a bank will consider in defining the terms of the a loan for a project. The higher the EBITDA, the better the terms the project should be able to expect from a lender.

[4] ITC grant partnership – where a financial institution finances the ITC grant in advance of its receipt either during or before construction and monetizes the MACRS depreciation.

[5] Excerpt from US PREF white paper “PTC, ITC, and Section 1603 Grants: Compare and Contrast”

[6] Bloomberg New Energy Finance, “One year later: the US economic stimulus package”, February 16 2010

About US PREF
The objective of the US Partnership for Renewable Energy Finance (US PREF) is to unlock private capital flows to new, large-scale and distributed renewable energy projects in the United States.  To achieve this objective, a balanced and credible group of highly experienced renewable energy financiers from financial institutions, investors, professional services firms, utilities and others, working with leading non-government organizations, have convened as US PREF. US PREF, founded in 2009 with support from the consulting firm Green Order, is a program of the American Council On Renewable Energy (ACORE).

American Council on Renewable Energy
ACORE, a 501(c)(3) membership non-profit organization headquartered in Washington, DC, is dedicated to bringing renewable energy into the mainstream of the US economy and lifestyle through research and communications programs and membership committees. ACORE’S membership works in all sectors of the renewable energy industries including wind power, solar energy, geothermal energy, hydropower, and more. ACORE provides a common platform for the wide range of interests in the renewable energy community including end users, technology companies, manufacturers, utilities, professional service firms, financial institutions, colleges and universities, associations, non-profit organizations and government agencies. ACORE serves as a thought leadership forum through which these parties work together on common interests. Additional information is available at www.acore.org.