Summer market survey

Summer market survey

August 13, 2021 | By Keith Martin in Washington, DC

Five market veterans had a wide-ranging discussion this summer at the annual ACORE Finance Forum—what used to be called REFF Wall Street conference—about current issues in the market, including how companies are handling forced-labor issues in Xinjiang, inflation, tax equity scarcity, equity returns, carbon capture projects, current discount rates to price M&A bids, capital costs to assume in PPA bids and more. The conference this year was virtual.

The panelists are Himanshu Saxena, CEO of Starwood Energy Group, Gaurav Raniwala, global renewable energy lead at GE Energy Financial Services, Martin Torres, head of renewable power in the Americas for BlackRock, Ja Kao, CEO until April of Blackstone portfolio company Onyx Renewable Partners, and Anand Dandapani, executive director on the tax equity desk at JPMorgan. The moderator is Keith Martin with Norton Rose Fulbright in Washington.

Tax equity

MR. MARTIN: Himanshu Saxena, many companies found it challenging last year to raise tax equity. Was that your experience, and have things improved this year?

MR. SAXENA: For good projects, with good offtake contracts and a good story around electricity basis risk and curtailment, there is tax equity available. Good projects will attract tax equity. Projects that are marginal are going to have a hard time.

MR. MARTIN: Have you seen any change between last year and this year?

MR. SAXENA: We have not had trouble raising tax equity to date. We try to do good projects, and good projects tend to find tax equity.

MR. RANIWALA: I agree. Last year, COVID, for a period of time, scared away some tax equity investors. Most of those investors have come back to the market, in some cases with a broader strike zone and a larger ticket size. There is sufficient tax equity for onshore wind. Solar might be slightly different.

In fact, as we continue to do deals, we are getting inquiries from other tax equity providers asking whether our portfolio is for sale, because there is hunger for more tax equity in the market. Overall, the market is back and fully functioning.

MR. MARTIN: Are you, as GE, investing only in projects that use GE equipment?

MR. RANIWALA: That is correct. Historically, we have been technology-agnostic, but for the past four or five years, we have been focused purely on projects that use GE technology. We try to ensure that any such project has tax equity available to it.

MR. MARTIN: Anand Dandapani, for you it has probably felt like a treadmill moving at rapid speed. JPMorgan is about a quarter of the US tax equity market. Have you seen any difference between last year and this year?

MR. DANDAPANI: It is much of the same. We counted $17 to $18 billion of tax equity raised last year. We are seeing at least as much, and probably more, likely to be raised this year. Let me also add to the earlier comments that well-structured projects that have the technical due diligence well organized are easier to get done. It is hard to get attention from investors for projects that are still early in the development stage.

MR. MARTIN: Ja Kao, did Onyx have any trouble last year raising tax equity?

MS. KAO: We did not. In the large utility-scale space, you have more emphasis on the quality of the project and the quality of the names behind it. For mid-size projects and developers, it is really about the sponsor. For mid-size developers, the tax equity market was either open or it was not open for the last year and a half.

MR. MARTIN: And there is no change today?

MS. KAO: No. [Laughter] Some things never change in the market.

MR. MARTIN: Martin Torres, sponsors last week at the CLEANPOWER 2021 conference said that unlocking ITC tax equity has been a challenge this year for just about everybody. I noticed you invested in a commercial-and-industrial solar platform. Do you agree with that statement and, if so, is it slowing new construction of such projects?

MR. TORRES: The only projects for which we raised tax equity last year were solar projects, and we did not really see any challenges. We were not in the market with utility-scale solar deals. They were smaller portfolios.

MR. MARTIN: C&I solar has been the next big thing for more than a decade, but high transaction costs have been an impediment to getting much traction. Has that situation improved?

MR. TORRES: Yes and no. There has been some consolidation, allowing some platforms and investors to figure out how to do financings more efficiently. So the answer is it probably has improved. At the same time, there are still cost inefficiencies and scaling issues. The fact that there is room for improvement is why we find it an attractive place to invest.

MR. MARTIN: Has anyone else had difficulty unlocking tax equity for projects on which investment tax credits will be claimed?

MR. SAXENA: We saw toward the end of last year and the beginning of this year that certain tax equity investors were looking for deals with production tax credits rather than investment tax credits. Recognition of the full tax credit in one year can obviously be a challenge, especially last year when folks didn't know what their tax appetites would be. There was a logjam of tax equity deals not happening on the solar side toward the end of last year.

That has largely gotten unblocked this year because it is a little easier to forecast tax appetite over the course of 2021 and even beyond with the economy reopening.

MR. MARTIN: Gaurav Raniwala, has it become easier to forecast GE's tax capacity?

MR. RANIWALA: It is never going to be an easy thing to do for a big corporation, but to Himanshu's point, as the economic activity picks up, people are much more comfortable with longer-term PTCs and are able to manage the economics in that context.

Despite COVID last year, we never backed out of the tax equity market. In fact, we had to step in for some banks that had backed away to make sure that GE customers were able to get their projects to the finish line.

It has been working out fine because, like I said, we have been getting inquiries from other investors, so to the extent that we need to manage our own balance sheet, we can manage it by finding other partners at the right time.

New investors

MR. MARTIN: Obama ironically had little success drawing corporations as new investors into the tax equity market. Trump had more success because the economy was booming. Companies had large profits to shelter. Do you expect to see a lot of new tax equity investors if the gross domestic product grows at a 6% to 8% rate this year?

MR. RANIWALA: We are certainly working in that direction. We continue to engage with multiple potential corporate investors.

The challenge is twofold. One challenge is that this is a complicated product, so it is not easy for corporate finance departments to take on something like this. The other challenge is accounting. The profits come in below the line, which shareholders may or may not understand and therefore may penalize some of these corporations for making good investments. Both issues need to be solved before we can get a big chunk of corporate business into this market.

MR. MARTIN: Explain what "below the line" means in this context.

MR. RANIWALA: Most corporations are measured on operating profits. With tax equity, the investment return comes in the form of tax benefits taken into account after operating profit. Your operating profit is negative from investing in a tax equity transaction because you are writing off your investment for a period of time through book depreciation, reducing your operating profit, but you earn a return by taking tax benefits over the same period of time.

The investment might look like a negative investment from an operating profit perspective, but the company is getting all of its investment back and then some on the tax line that comes after operating profit. Shareholders may or may not understand this when measuring a corporation using operating profit as a benchmark.

MR. MARTIN: I thought the reason that the big internet retailers who have done well during the COVID lockdown are not coming into the tax equity market is they can earn more in their own businesses by plowing profits back into them than they can in the tax equity market. Is there any truth to that theory?

MR. RANIWALA: Sure, they can earn a lot more by investing in their own businesses, which are high-risk, high-reward businesses, but most of them are sitting on piles and piles of cash and are looking for ways to invest. Tax equity investments tend not to be high-risk investments. They are reasonably low-risk investments and tax equity definitely gives them a significant increase in yield if the alternative is keeping cash in a bank. The problem is most of them lack the corporate capability to take on the product itself.

MR. MARTIN: Anand Dandapani, you said you think tax equity volume this year will probably be higher than last year. Last year was $17 to 18 billion, as measured by looking at commitments. What do you think the number will be this year?

MR. DANDAPANI: It is hard to say, but we put it at between $17 and $20 billion.

MR. MARTIN: Last year, JPMorgan did about $4.5 billion. Will it invest more this year?

MR. DANDAPANI: I think so. The size of investments has increased. We are doing a lot more solar, and solar project sizes have increased, particularly with the addition of batteries.

MR. MARTIN: Do you have a number: $5 billion, $5.5 billion?


MR. MARTIN: Himanshu Saxena, many developers ask what tax equity yields to assume in models when they are bidding to supply electricity. What is the answer this year?

MR. SAXENA: The answer is start with whatever you think is fair and add 200 basis points to it. [Laughter]

Tax equity costs have really fluctuated quite a bit over the past 12 to 24 months. We think they range from the low 6% range for a utility-scale project with a busbar PPA and high-quality, creditworthy counterparty to a number in the 8% range for uncontracted assets or projects with offtake contracts but with significant electricity-basis or curtailment risk in certain markets.

MR. MARTIN: Martin Torres, same numbers?

MR. TORRES: Yes, that's pretty accurate. We have seen a lot more variability. That is probably because projects today exhibit a broader range of risks than they did more than five years ago.

Carbon capture

MR. MARTIN: The tax equity market is about to have a lot more strain put on it. The first $3+ billion offshore wind project—Vineyard—could be in the market as early as this year for tax equity, although the tax equity part of the financing could slip to next year. Biden wants to complete another 36 offshore wind projects of similar size by the end of this decade. In addition, a lot of carbon-capture projects are coming to market with production tax credits over 12 years of $50 to $150 million per year per project at industrial facilities that emit one to three million tons of carbon dioxide a year.

Are you aware of any carbon-capture tax equity deals that have closed so far? Anyone?

MR. RANIWALA: I heard about one carbon-capture deal that was done a couple plus years ago, but it was focused on enhanced oil recovery, and I think the project may no longer be operating after oil prices crashed.

MR. SAXENA: We have two carbon-capture projects in our portfolio currently. We are looking at many other projects. The number you need to make some of these commercial carbon-capture projects work is significantly above $50 a ton. The number is somewhere between $50 and $100 a ton. It is very challenging to make the numbers work with the tax credit at the current level.

We have heard of two projects—one methanol and one ethanol—that are in an advanced stage, but neither of those deals has closed.

The cost of tax equity for such projects is high. It is high not because the stated yield is high, but because the tax equity investor is looking to share in certain benefits that are unrelated to the tax benefits. These investments are more like true equity than tax equity.

The whole area is new, and people are still figuring out how best to monetize section 45Q tax credits.

Offshore wind projects are likely to claim ITCs and to compete with solar for tax equity. Carbon-capture projects will claim PTCs and compete with onshore wind for the same scarce tax equity dollars. There is not enough tax capacity from what we can tell to do all these projects. Congress is going to have to provide a safety valve through a direct-pay alternative.

The message is that you don't need tax equity in the middle if you are trying to create an incentive. The friction cost of tax equity is just too high to do a carbon-capture project. The structures are too complex and guarantees that the investors will want pertaining to carbon sequestration are not guarantees that most projects can provide. It will be very hard commercially to monetize section 45Q credits.

MR. MARTIN: You said the reason yields for tax equity for carbon-capture projects are so high is investors are looking for more than just tax credits. What else are they looking for?

MR. SAXENA: We have seen everything from sharing LCFS credits in California to sharing in the value of the CO2 that is being sold. Everything is on the table. We have seen some tax equity investors take a view on all-in returns with multiple revenue streams. It is a different mindset than we have seen in solar and wind so far.

MR. MARTIN: Biden proposed in his budget message to Congress in late May to increase the credit amount, but not for ethanol, natural gas processing or ammonia plants.

Direct-pay alternatives

MR. MARTIN: Ja Kao, suppose Congress enacts a direct-pay alternative to tax credits? Will that put downward pressure on tax equity yields?

MS. KAO: Yes.


MS. KAO: I think it will help developers advance projects that are harder and more complicated. There will always be large projects that need an institutional tax equity investor. GE was a tax equity investor long before renewables existed. There have always been tax credits and depreciation. For the large projects, there will always be a tax equity market.

The expansion of the credits requires there to be some other alternatives for new technologies as well as for smaller-scale projects.

MR. RANIWALA: The internal rate of return for tax equity transactions, if you exclude depreciation and just take tax credits into account, is comparable to the cost of debt. The rest of the benefit comes really from depreciation monetization. In my mind, while there might be some impact on pricing, tax equity will continue to add value if done right.

MR. MARTIN: The direct payments will have at least a one-year lag after the project is put in service. Himanshu Saxena, would you go into the tax equity market if you have a direct-pay alternative, or would you borrow to bridge the cash payment and keep the depreciation yourself?

MR. SAXENA: I think those are two separate questions. Borrowing against a stream of cash flow from the government will be the cheapest route. There is no reason to bring tax equity into the middle of that transaction. We have seen this with section 1603 cash grants.

In terms of whether to raise tax equity to get value for the depreciation, that would be case by case. Depreciation accounts potentially for about 10% of the capital stack. If the project economics are tight, then you might need to monetize the depreciation.


MR. MARTIN: Martin Torres, interest rates on back-levered debt in January were somewhere between 125 and 175 basis points over LIBOR, depending on the project. Where are they today?

MR. TORRES: We have not seen spreads widen. The spread depends on the underlying characteristics of the project. Lenders are probably looking differently at underlying revenue contracts after what happened in Texas in February, so some lenders might have a different perspective, but the debt market has not changed for projects with power purchase agreements.

MR. MARTIN: Has there been any change in tenors, debt-service-coverage ratios or other terms in the debt market?

MR. SAXENA: We are seeing folks go beyond the PPA term in structuring the debt amortization, which is an interesting evolution in the market. There are not enough good projects for lenders to lend to, so they are taking certain risks that they have not taken in the past to win mandates.

MR. MARTIN: Are you talking about back-levered floating-rate debt or fixed-rate project bonds?

MR. SAXENA: It is floating rate, and the same thing is true whether it is back-levered or at the project level.

MR. MARTIN: The Economist magazine said this week that $178 billion flooded into green investment funds in the first quarter this year. That's a global number. Is it getting easier for investment funds focused on the renewable energy sector to raise capital?

MR. TORRES: I don't know that it is getting easier. It is easier to have certain conversations in certain geographies where there was historically more reluctance to invest in the sector, but fundraising is easier or harder based on the track record and experience of the fund manager. That said, investors are more open to sector-specific strategies at this point.

MR. MARTIN: Where is the money coming from?

MR. TORRES: We see money coming from all around the globe. For sustainable ESG-driven clean energy investments, the institutional investors in Europe have long been ahead of the curve on a regionally comparative basis. However, investors across the US and the Asia-Pacific region are all investing behind these strategies.

Renewables growth

MR. MARTIN: The installed base of renewable energy in the US needs to rise about three-fold in order to meet US carbon reduction goals. Where is the room for such a large increase if demand for electricity remains flat and if states and the federal government are throwing money at nuclear plants and carbon capture credits at fossil-fuel plants to keep them open?

MR. SAXENA: Carbon credits are not going to keep coal plants alive. We have had coal plants come to us for capital to install carbon-capture projects. We don't think there is any appetite for that in the market. If you call JPMorgan and say you need a billion dollars of tax equity to put a carbon-capture project on a big coal plant in the Midwest, they will hang up on you.

There is a lot of inefficient generation in places like PJM. A lot of this is coal; it has to go away. Coal in this country accounts for almost 200,000 megawatts of generating capacity. It is not a small amount of capacity that will shut down over the next five to 15 years. Yes, it is true that the demand is not growing, but we think retirements will accelerate.

MR. MARTIN: You said 200,000 megawatts. That is not a three-fold increase in renewable capacity. That does not leave enough room.

MR. RANIWALA: We are also expecting a significant increase in demand for electricity as the transportation sector electrifies. The expectation is for somewhere between a 50% and 75% increase in demand.

MR. MARTIN: The most recent study I saw projected a 25% increase in electricity demand. However, estimates vary. We held a panel discussion with a number of experts about this two years ago, and the consensus was a mass shift to electric vehicles would shift time of use, but lead to only a negligible increase in electricity demand. Himanshu was there. (For more detail, see "The Shift to Electric Vehicles" in the August 2019 NewsWire and "How Electric Vehicles Are Transforming the Power Sector" in the April 2018 NewsWire.)

MR. SAXENA: What is the saying: 90% of the facts are made up on the spot? [Laughter]

The studies that I have seen lately point to a significant increase in demand. It could be as much as a 20% to 30% increase.

More importantly, that demand growth will be concentrated in certain places. It will not be uniform. I think buying gas-fired power plants that are close to load centers is the way to go because that is where you are going to see the greatest uptick in demand.

It is like a hotel business. You want to buy a hotel in midtown Manhattan. You may have short-term bumps, but over the long term, you will do fine. Gas has a place to stay.

I think the stories about the demise of gas are vastly exaggerated. If you eliminate gas, you have what we saw in Texas last February and in California this week. There is a 0% chance that in the next 10 to 15 years you can remove gas from the grid. Even the G7 leaders who met last week talked about not financing coal, but there was no mention to cutting off financing for oil and gas. They understand that gas is a key part of the supply chain.

Equity returns

MR. MARTIN: Ja Kao, Himanshu is always good for epigrams. A couple years ago, he said he planned to have t-shirts printed that said, "Who needs returns when you have solar?" Has there been any improvement or have equity returns in the solar market worsened?

MS. KAO: Oh, that's a loaded question. I think it depends on where you are in the market. The return thresholds for investors have certainly gone down. We can see this in the bidding on projects and portfolios that have changed hands. I think it reflects the competition on the investing side. The returns for middle-market projects are still robust because they are more challenging to finance.

MR. MARTIN: The Economist also said this week, "A mass of money chases a few renewable energy firms. Valuations have been stretched into bubbly territory." The competition for assets is coming not just from private equity funds, but it is also from SPACs, from oil companies, from strategics and from pension funds looking to invest directly. Ja Kao said this is pushing down returns in the solar sector. What effect is this having on discount rates used to price assets in other sectors?

MR. SAXENA: There is an interesting op-ed piece in the Wall Street Journal today that is worth reading about the electric-truck manufacturer Lordstown and the whole stock buyout and resignations of the CEO and the CFO. The SPAC phenomenon, especially as it relates to clean energy and electric vehicles, is way over-bought. (For more details on SPACs, see "SPACs Gain in Popularity" in the October 2020 NewsWire.)

We can't compete with SPACs, and I don't think anybody can in buying these companies. We will soon find out whether the valuations SPACs are placing on companies hold. We have already seen some spectacular failures.

The good news is that the SPACs are playing in a sort of quasi-tech sector rather than dealing with hard assets. It is not the same playing field, at least so far.

MR. MARTIN: Martin Torres, what are current discount rates for bidding on assets?

MR. TORRES: It depends on the market segment. They are more competitive for contracted utility-scale solar projects.

MR. MARTIN: Where are they for that type of asset?

MR. TORRES: They are in the 6% to 7% range, depending on what assumptions people are making. It is always tricky to isolate an equity return because somebody's 6% could be somebody else's 9%. It really depends on what kind of assumptions you are making around a project.

We look at equity returns on a relative basis. Utility-scale solar is at the most competitive end of the spectrum, and distributed solar—commercial and industrial and residential—are at the other end of the spectrum. Wind falls in-between, depending on the offtake arrangements.

MR. MARTIN: As a sponsor, you would earn a higher return in the distributed end of the market?

MR. TORRES: For sure.

MR. MARTIN: And that return is in the high single digits?

MR. TORRES: I think you can see returns in the distributed solar sector that are north of high single digits.

MR. MARTIN: Low teens?

MR. TORRES: Low double digits, yes.

MR. MARTIN: If you are sitting on assets today, is this the time to sell, especially if you think tax rates will increase next year?

MR. TORRES: That is a complicated question to answer. It depends on your overall investment strategy. If it is to earn a maximum return for having capital deployed for a short period of time, the answer could be yes. If your objective is to keep capital deployed for an extended period of time, then the answer is not necessarily yes because then you have to look at the reinvestment universe.

If you are anywhere close to needing or wanting to sell assets, this is a good market for that. If you are going to have to redeploy that capital in the same sector, then you have to take a much more nuanced view and consider the investment opportunities at the time.

MR. MARTIN: It is like selling your house today in a hot market, but then not being able to buy a new place to live.


MR. MARTIN: Let me go back to Anand Dandapani. There has been an uptick in the last two months in inflation. Are inflation concerns starting to affect the market and, if so, how?

MR. DANDAPANI: Not the tax equity market. We are not seeing pressure on yields due to inflation. However, the overall return on a project might be affected. Spiraling costs have the potential to affect sponsor returns significantly.

MR. MARTIN: Gaurav Raniwala, same answer?

MR. RANIWALA: Yes. From a tax equity perspective, inflation concerns are not really affecting pricing because the underlying Treasury yields are not really changing.

However, on the industrial side of our business, we are not immune to the commodity-side pressures that are being faced by manufacturers everywhere. Our teams are working constantly on different ways to minimize cost and examine what commodities they use. Renewables are going to grow, given where government policy is headed, but this could be a sharp bump in the road that the industry will have to work through.

MR. SAXENA: The cost of solar panels, for the first time in a decade, has gone up. We are seeing similar pressure on wind turbines. We are building a big transmission project, and we see this pressure on copper, steel and lumber.

Tax equity will not fund more, so this is not a tax equity problem. If the project cost goes up by 20%, the additional cost will come out of the cash equity. The returns will get stressed if power prices have already been locked in.

This is a challenge the industry will face, not just in renewables, but also across the board over the next 12 to 24 months before the supply chains normalize.

MR. RANIWALA: We have seen sponsors try to renegotiate the electricity prices to make projects work during periods like this. It is in everyone's interest to do so if they want to see these projects built.

MR. MARTIN: Let me ask two more questions quickly, if we have time.

Pressure is mounting to block entry of solar panels that use materials from the Xinjiang region in western China. The Solar Energy Industries Association issued a tracing protocol in April that it recommends solar companies adopt when buying solar panels. Are concerns in this area affecting the choice of solar panel suppliers, and how is the risk that a withhold release order will be issued by US Customs to block panels with any connection to Xinjiang from entry being handled in financings?

MR. DANDAPANI: We are monitoring this, but as you will probably appreciate, we think of this more as a sponsor risk. When it comes time to invest tax equity, the project is already close to completion and the panels are in the United States.

MR. MARTIN: This seems like one of a number of items that are turning out to be sponsor risks this year. It is not just this, but also change-in-law risk in Texas, escalating casualty insurance premiums, and so on.

Himanshu Saxena, what effect has the Texas cold snap had on the ability to finance projects in Texas?

MR. SAXENA: It depends on the type of project. If you have a Texas project with a busbar PPA with a creditworthy utility, there has not been any effect. If you are trying to raise tax equity for a wind project with a fixed-shape hedge, that has gotten really hard.

MR. RANIWALA: Sponsors are probably not interested in doing a fixed-shape hedge today, given recent experience. It is not just the tax equity who have run away from them.

MR. MARTIN: Last question. Casualty insurance premiums for solar projects have increased by as much as 400% in the last two years. Some sponsors have notified tax equity investors and lenders that they cannot find insurance at an affordable price. To what extent are climate-related issues like this affecting the ability to finance projects in places like California, that are at risk for wildfires, or along the southeastern coast and the Texas Gulf coast that are susceptible to freak weather events?

MR. DANDAPANI: We see these issues on pretty much every project. We need to understand what insurance we are getting, what cash provisions can be made to ensure payment of premiums and, if we are not getting the full coverage we normally expect, what happens if there is a casualty and the cash reserves are not enough to get us to our yield.