California CCAs and prepaid PPAs
Four California CCAs that are planning to use a form of prepaid power contract may find the structure hard to implement.
A joint powers agency called the California Community Choice Financing Authority formed by the four said in a July 29 press release that it will help the CCAs reduce their electricity costs by 10% or more by borrowing at tax-exempt rates to enable the CCAs to prepay for electricity under long-term power purchase agreements.
CCAs — short for community choice aggregators — are county-level entities in California and some other states that buy electricity to supply to local residents. By buying in bulk, they hope to secure better electricity rates than the retail rates that local residents would otherwise pay the local utility. They may also make it a priority to buy renewable electricity.
A number of municipal utilities signed long-term contracts in the early 2000s to buy electricity from wind farms in which they agreed to prepay for a large share of the electricity. The contracts were structured so that the project owner would not have to pay taxes immediately on the prepayment.
From the standpoint of the project owner, the prepayment had many features in common with cheap long-term debt. The money was raised in the tax-exempt bond market. It could be repaid over the power contract term. It filled a slot in the permanent capital stack for the project. The utility making the prepayment had a first lien on the project. The prepayment was worked off as electricity was delivered over time. The project owner reported the prepayment as income over the same period as electricity was delivered. (For more details, see “Prepaid Power Contracts” in the September 2012 NewsWire and “Green Light for Prepaid Electricity Deals” in the August 2003 NewsWire.)
Special rules in the IRS regulations at the time allowed this type of arrangement. If the prepayment had had to be reported by the project owner as income immediately upon receipt, then it would have left a hole in the capital stack.
Congress repealed the provision that allowed deferral of the prepayment income at the end of 2017 and required that the remaining unamortized prepayment amounts under such contracts had to be reported as income over the next four years. (For more details, see “Final Tax Bill: Effect on US Project Finance Market” in the December 2017 NewsWire and “Prepaid Power Contracts Harder To Make Work” in the December 2018 NewsWire.)
In 2019, the IRS issued regulations that may have reopened the door to use of the structure, at least in cases where contracts are structured to fit in a “specified goods exception” that allows manufacturers in certain cases where goods are paid for more than two years in advance to defer reporting the advance payments as income. However, the regulations left key unanswered questions. (For more details, see “Prepaid Power Contracts: New Lease on Life?” in the October 2019 NewsWire.)
A practical challenge with the structure today is the tax equity market is generally no longer open to financing projects with senior permanent debt that sits ahead of the tax equity in the capital stack. Most utility-scale renewable energy projects are financed in that market.
The four CCAs behind the California Community Choice Financing Authority are Central Coast Community Energy, East Bay Community Energy, Marin Clean Energy and Silicon Valley Clean Energy.