The financial specialists that convert tax credits into capital to build new windmills and solar farms have all but disappeared
After years of fighting for stronger, more consistent state and federal support, the renewable-energy industry couldn't have asked for a better 2008. Although supplying just a sliver—barely 3%—of the nation's electricity, nonpolluting renewables such as wind, solar, and geothermal are the fastest-growing type of power being added to the grid. New installations of solar and wind power both hit record levels last year in the U.S.
In a year when the overall outlook for green businesses was mixed, renewables proved to be standout, says Joel Makower, executive editor of GreenBiz.com. Growth of renewable energy seems slow "because [of] the relative small size of the renewable energy sector, compared with the existing power generation industry," Makower points out in GreenBiz.com's just-released State of Green Business 2009 report. "But a closer look at the sub-sectors reveals impressive strides."
This year was shaping up to be even better. As part of the Emergency Economic Stabilization Act, signed into law last October, Washington granted unprecedented extensions of tax credits vital to the financing of solar and wind power projects. Then, in the first days of his Presidency, Barack Obama declared a goal to triple the share of the nation's electricity from renewables, to roughly 10%, by 2012. What's more, after years of production constraints keeping prices high, investments in new manufacturing capacity in both solar and wind have begun to produce more gear, lowering equipment prices.
The Money Dries Up
Just when things were looking up for the green energy sector, there's a new wrench in the works. The financial specialists that convert tax credits into capital that developers use to build new windmills and solar farms have all but disappeared—just when they're most needed. "For all the good news, the lack of project finance and capital means there's a real risk it won't be possible to hit Obama's goals," says Christopher O'Brien, head of North American market development for Oerlikon, a Swiss supplier of solar technology.
Here's the problem: To fund a renewable project, developers must convert tax credits into money they can use to pay for new photovoltaics and wind turbines. In recent years, a network of financiers has emerged to serve this market. Typically, small and midsize renewable project developers sell millions of dollars worth of tax credits to large, sophisticated financial entities that can use those tax credits to offset their own tax obligations or those of their clients.
As result of the capital crash, however, the pool of so-called "tax equity investors" has dwindled to around a half-dozen, from more than 20 in 2007. Key players such as Merrill Lynch and Lehman Brothers no longer exist. Others, including the likes of John Deere (DE) and Prudential (PRU), have backed out of the market, if only temporarily, according to research by Hudson Clean Energy, a private equity firm specializing in green energy. "This will be a constraining factor because the population of sophisticated buyers for these credits is too small," says Oerlikon's O'Brien.
While obscure, tax credits are a make-or-break ingredient for new renewable projects. They can comprise the bulk of the upfront funding used to build renewable energy projects. In a big wind development, for example, production tax credits can account for more than half of the capital structure. In a solar venture, tax equity accounts for 85% of the capital structure, according to Hudson Clean Energy data. Developer equity and debt typically make up the balance.
Tax credits are also important in the long term. Once renewable assets start generating income—from a combination of electricity sales, depreciation benefits, and tax benefits—the tax component can be the largest source of return for investors. For wind projects, the value of tax credits makes up about 21% of the long-term value of the project for investors. In solar farms, the value of the investment tax credit—at 30%—can be on par with the value of the electricity the panels will generate in their lifetime. Sophisticated investors like the tax credits because they typically trade at a slight discount to face value, and offer a cheaper way to pay down big tax bills.
The shortage of buyers couldn't have come at a worse time. To hit Obama's goals for new renewable energy, the industry will have to mobilize far more capital than it has had to before. This year, the tax equity market is expected to hit $11.1 billion and would have to rise to around $43 billion in 2012 to build all the capacity being called for. Yet in 2007, when the market had more than 20 buyers, investors bought up $5.4 billion in tax equity. Last year, just eight investors handled about $5.5 billion in 2008. "Between now and 2012, [tax equity] markets would have to grow four- or fivefold," says Arno Harris, CEO of Recurrent Energy, a renewables developer in San Francisco.
The industry has a solution, but it's not clear if the Senate and House will find common ground to make it work. Renewables players are lobbying for a change in rules that would temporarily convert tax credits directly into cash payments from the federal government. The bill would also temporarily extend the credits' lifespan. Today, credits are good only for the year they're granted. The new bill calls for them potentially to be used against past and future profits.
With the Senate now negotiating its version of the stimulus bill behind closed doors, it's impossible to predict how renewables will be treated. The starting version of the Senate bill lacked any funding to cash out renewable tax credits. According to Environment & Energy Daily, Senator Jeff Bingaman (D-N.M.) was open to the program but wanted assurance that taxpayers would be reimbursed from the gains of any successful projects. If Washington can't come up with a fix, the go-go growth of renewable energy could black out.