More Energy Tax Incentives

More Energy Tax Incentives | Norton Rose Fulbright

June 01, 2002 | By Keith Martin in Washington, DC

Developers planning new power projects in the United States should take into account the possibility that an array of new energy tax incentives will become law this fall.

The new incentives could affect the choice of fuel, equipment and plant design, and how projects are financed.

They are part of a national energy plan that passed the Senate in April. The same plan passed the House last July. The two houses must still iron out differences in content between the versions of the plan that each passed before sending the final measure to the president for signature. Most observers expect the process to take until October to play out.


Both houses of Congress have now passed a nearly identical tax credit for new cogeneration facilities. Therefore, assuming the national energy plan makes it the final step to the president’s desk, this credit is certain to become law.

A “cogeneration” facility is a plant that produces two useful forms of energy from a single fuel. One of the outputs must be steam or another form of thermal energy. The other can be electricity or mechanical shaft power. The tax credit is 10% of the capital cost of the project.

To qualify, the plant must produce at least 20% useful thermal output, and it must have an energy conversion ratio greater than 70%. That means that the energy content of the electricity or mechanical power must be more than 70% of the energy content of the fuel used to produce it. (The conversion ratio must exceed 60% for smaller projects of 50 megawatts or less in size.) The 20% thermal output test may be hard for many companies to meet. The test to be a qualifying cogeneration facility under the Public Utility Regulatory Policies Act used to be only 5% useful steam output, and this was often difficult to reach.

The Senate waived both these requirements for plants that “generate electricity or mechanical power using back-pressure steam turbines in place of existing pressure-reducing valves or which make use of waste heat from industrial processes such as by using organic Rankin, Stirling, or Kalina heat engine systems.” The House did not provide for a similar waiver.

Some projects will have to choose between tax credits and accelerated depreciation. Any taxpayer who claims a tax credit on his project cannot depreciate it faster than over 15 years using the 150% declining-balance method. Thus, there is no tradeoff for most gas- and coal-fired power plants, but there would be for projects that use waste fuels.

The credit can only be claimed on new plants that are put into service during a window period from 2003 through 2006. The credit is drafted currently in such a way that a plant placed in service during this window period qualifies for the full credit, notwithstanding that it may have been well under construction before 2003. Plants completed later this year would not qualify.

Developers with too little tax base to use the credit can transfer it to another company via a sale-leaseback. However, the sale must occur before the plant is put into service.

Section 45

The national energy plan will extend a section 45 credit for generating electricity from alternative fuels. The credit is currently 1.8¢ a kilowatt hour. It can be claimed currently by persons generating electricity from wind, “closed-loop” biomass and poultry litter. The current deadline for placing projects in service to qualify for credits is December 2003. Credits run for 10 years after a project has been placed in service. The amount is adjusted each year for inflation. “Closed-loop” biomass refers to trees or other plants that are grown exclusively for use as fuel in power plants.

Both houses of Congress have now voted to extend the deadline for placing new alternative fuels projects in service to December 2006. (The House did not extend the deadline for poultry litter projects.)

Both houses also voted to add to the list of eligible fuels.

The House would allow credits for the first time to persons who use “open-loop” biomass or landfill gas to generate electricity. “Open-loop” biomass is defined as “solid, nonhazardous, cellulosic waste material which is segregated from other waste material” and that falls into one of three categories. The categories are certain forest wastes, “solid wood waste materials” (like crates and construction wood wastes), and waste from “agriculture sources.” Municipal solid waste of the kind that is normally disposed in landfills, most old growth timber and paper that is commonly recycled are not “open-loop” biomass.

The Senate did not add landfill gas to the list of eligible fuels. However, it added a long list of other fuels: “open-loop” biomass, hog and cattle manure (and straw bedding), geothermal and solar energy, municipal biosolids, recycled sludge and small irrigation power projects of up to five megawatts in capacity that generate electricity “without any dam or impoundment of water through an irrigation system canal or ditch.” The Senate also voted to let credits be claimed by owners of some existing power plants that use biomass and that are modified to co-fire with coal. Many of the Senate additions are not expected to remain in the final bill.

The Senate voted to let tax-exempt electric cooperatives, municipal utilities, state and local governments and Indian tribes sell the section 45 credits on projects they own to other taxpayers for cash. It also deleted a rule under current law that a project cannot benefit from section 45 credits to the extent it was financed with tax-exempt debt.

The Senate had to scale back the cost of its provision because it added so many new fuels. Some projects that use fuels that the Senate is adding to the list of eligible fuels would qualify for only three or five years of credits rather than the full 10 years under current law. For example, open-loop biomass facilities would receive only three years of credits under the Senate bill.

Clean Coal

The national energy plan provides new tax incentives for retrofitting or repowering existing coal-fired power plants — or for building brand new plants — with clean coal technologies. There are three incentives in the Senate bill. There are two in the House bill. The provisions are almost impossibly complicated; they make a mockery of claims by Congress that it wants to simplify the US tax code.

The Senate voted for a tax credit of 0.34¢ a kilowatt hour for generating electricity at existing coal-fired power plants that are retrofitted within the next 10 years to use clean coal technologies. Credits would be claimed on the electricity output for 10 years after a plant is returned to service. The plant cannot have a nameplate capacity greater than 300 megawatts. Only 4,000 megawatts of capacity can qualify for this “retrofit” credit. Projects would have to be certified in advance by the Internal Revenue Service. The list of clean coal technologies includes advanced pulverized coal or atmospheric fluidized-bed combustion, pressurized fluidized-bed combustion and integrated gasification combined cycle. The bill imposes other requirements, such as maximum heat rates and emissions tests. The project could not have received any clean coal technology money from the US Department of Energy.

The Senate also voted for an investment tax credit for 10% of the capital cost of new or retrofitted clean coal plants. (A company whose retrofitted plant qualifies for the production credit of 0.34¢ a kilowatt hour could not also claim this credit.) A project would have to jump through a series of hoops to qualify. The hoops vary depending on the technology. For example, a plant using pressurized fluidized-bed combustion must be placed in service by 2016, and its heat rate and carbon emissions must comply with standards set by statute. Only 500 megawatts of pressurized fluidized-bed combustion projects in total can qualify for the tax credit, and only 250 megawatts of such capacity put into service before 2009 qualifies. Projects would have to apply in advance to the IRS for confirmation they fit under the megawatt cap.

Finally, the Senate voted for a production tax credit for the same projects that qualify potentially for the investment credit. This credit would run for 10 years. The amount would vary from 0.1¢ to 1.4¢ a kilowatt hour depending on when the power plant is placed in service and on its design net heat rate. Plants that produce fuel or chemicals from coal — rather than electricity — could also qualify. The credit would be claimed on each 3,413 Btus of fuel or chemicals produced.

Section 29

The Senate voted to allow more time for taxpayers to place projects in service to qualify for section 29 credits.

Section 29 credits are tax credits for producing oil from tar sands or shale, gas from coal seams, tight sands, Devonian shale, geopressured brine and biomass, or synthetic fuel from coal. The tax credit was $1.083 an mmBtu for such fuels (other than tight sands gas) produced during calendar year 2001. The amount is adjusted each year for inflation. The credit was originally enacted in 1980 after the Arab oil embargo as an inducement to Americans to look in unusual places for fuel. Credits run currently through 2002 on most gas projects. However, the wells had to have been drilled by 1992 to qualify. Credits for most syncoal projects and many landfill gas projects run currently through 2007. Landfill gas and syncoal projects had to be in service by June 1998 to qualify.

The Senate voted to create a new window period during which new projects can be placed in service.

The new window period — for projects other than synfuel plants — would run from the day President Bush signs the national energy plan into law through December 2004. Such projects would qualify for three years of tax credits on their output.

New synfuel plants would have through 2006 to be put into service and would qualify for five years of tax credits.

The credit for all new plants would be fixed at 51.7¢ an mmBtu. There would be no inflation adjustments.

The Senate voted to allow high carbon fly ash to be used as a feedstock in synfuel plants. Current law limits the feedstock to coal. The Senate also voted to tighten the definition of “synthetic fuel.” Future plants would be viewed as producing synfuel only if two things are true about the output. Nitrogen oxide and sulfur dioxide emissions from burning the synfuel must be at least 20% less than emissions from burning the raw coal used as feedstock, and the output must have a “market value” at least 50% higher than the raw coal. The Senate made a last-minute change in the provision at the request of Senator Max Baucus (D.-Montana) to allow a 20% reduction in mercury emissions to substitute for a reduction in sulfur dioxide. Baucus is chairman of the Senate tax-writing committee.

In what looks like an effort to help a single project, the Senate voted to allow credits to be claimed for another two years through 2004 at a coal gasification project that uses lignite as feedstock and produces coke, coke gas and other products. The facility was originally placed in service before 1993. Credits at it expire under current law at the end of this year.

The House voted as part of its version of the energy plan to extend section 29 credits, but not for synfuel plants.

Indian Reservations

Projects on Indian reservations qualify currently for special rapid tax depreciation and wage credits tied to the number of Indians hired to work on the project. A project must be operating by December 2004 to qualify. Both houses voted to extend this deadline by another year through December 2005. The House extends the deadline only for power plants, gas pipelines and a few other assets. The Senate extends it for all projects.

Fuel Cells

The Senate energy plan includes a tax credit for investing in fuel cell power plants and microturbines. The credit applies to equipment put in service by December 2006.

The credit for fuel cells is 30% of the capital cost. However, the amount claimed as a credit cannot exceed $1,000 per kilowatt of generating capacity. The fuel cell power plant must have a capacity of at least 0.5 kilowatts and operate at least at a 30% generating efficiency.

The credit for microturbines is 10% of the capital cost. The amount claimed as a credit cannot exceed $200 per kilowatt of capacity, and the microturbine must have a generating efficiency of at least 26%.


The energy plan the House passed last July has $32 billion in energy tax incentives. The Senate voted in April for $15 billion. Senator Charles Grassley (R.-Iowa), the ranking Republican on the Senate tax-writing committee, predicted soon after the Senate vote that the final compromise will be about $20 billion.

Enactment of the national energy plan is not assured. Gene Peters, vice president for legislative affairs for the Electric Power Supply Association, said in late May he gives it a 60% chance. Jonathan Weisgall, chief lobbyist for MidAmerican Energy Holdings Company, said he thinks the politics of the plan favor enactment this year. Farm-state Senators — including Tom Daschle (D.-S. Dakota), the Senate leader — like the ethanol provisions. President Bush has made enactment of the plan one of his goals for the year. And the Republicans who control the House see a benefit to passing a bill with strong incentives for renewable energy in an election year to counter charges that they are too closely aligned with big oil and too insensitive to the environment.

Nevertheless, the measure is on a slow track. The House and Senate passed different bills. The differences must be reconciled. The Senate moved quickly in early May to appoint 18 Senators as “conferees” to negotiate with the House. The House has moved more slowly, and could name more than 50 members of Congress as negotiators in early June. The process is expected to take until October to play out fully.

by Keith Martin, in Washington