Stimulus With Bottlenecks

Stimulus With Bottlenecks

March 06, 2023 | By Keith Martin in Washington, DC

The Inflation Reduction Act is stimulating demand at the same time that developers are running into multiple bottlenecks. Some of the bottlenecks are consequences of the war in Ukraine. Others are long-standing problems like grid congestion or issues that started with COVID and have not gone away.

Five veteran market observers talked at the Infocast projects & money conference in New Orleans in late January about how the market has changed in the past year and what opportunities they see in the Inflation Reduction Act.

The panelists are Gabriel Alonso, CEO of 547 Energy and former CEO of EDP Renewables North America, Laura Beane, president of Vestas North America and former CEO of Avangrid Renewables, Tom Buttgenbach, CEO of Avantus, formerly known as 8minute Solar, Justin DeAngelis, co-head of sustainable infrastructure investments for Denham Capital, and Himanshu Saxena, CEO of Lotus Infrastructure Partners, formerly known as Starwood Energy Group. The moderator is Keith Martin with Norton Rose Fulbright in Washington.

What Has Changed

MR. MARTIN: Gabriel Alonso, apart from the Inflation Reduction Act, what has changed since this same conference last year?

MR. ALONSO: There is more supply-chain and trade uncertainty than a year ago. Interest rates have also increased over the last 12 months. Natural gas prices increased significantly. Gas prices have collapsed lately, but high gas prices were a basic reality for most of 2022.

The interconnection queue process has worsened over the last 12 months, which is making it more difficult to bring projects across the finish line.

Projects cost more today to build. Electricity prices under wholesale power contracts have changed over the last 12 months.

MR. MARTIN: That is quite a list. I hope the Inflation Reduction Act offsets it.

MR. DEANGELIS: Add to that list a war in Ukraine and rising global tensions.

What hasn't changed is continuing strong investor appetite for sustainable infrastructure. That is a global phenomenon. The Inflation Reduction Act is drawing capital into the US. Even with the macroeconomic headwinds, this is still a fundamentally good market. We might not have said that 10 or 15 years ago when solar and wind were relatively expensive, but today, they compete with other sources of power on economic terms and not just for their environmental benefits.

MR. BUTTGENBACH: We saw last year a material change that is shifting attitudes in the market. There was a heat wave in California, but the lights did not go out. Four gigawatts of energy storage supported the grid in California. Without those four gigawatts, we would have had blackouts.

People have come to the realization that technology — energy storage in this case — is playing a fundamental role in grid stability. Renewables and energy storage are no longer merely a nice to have, a good thing for the environment, but they also play a fundamental role in supplying energy and grid stability.

MR. MARTIN: You made the point at a conference last June that energy storage in its current iteration is like a Model T Ford. You said you don't want to be locked into contracts requiring you to maintain the existing technology for 20 years. That is the other side of technology: it keeps evolving.

Himanshu Saxena, what has changed?

MR. SAXENA: Justin mentioned the war. I think we need to talk about how it has affected the energy transition. We can talk about ESG and reducing carbon emissions all day, but affordability and security of energy supply are growing concerns.

Before the war, there was not a lot of discussion about the risks that countries take when they rely on a single country for their energy supply. We see the equivalent in our own market where everybody was pushing to go 100% green 100% of the time. That conversation has shifted quite materially over the course of last year.

People are starting to be more realistic about how long it will take to go through the energy transition. We saw Germany build a regasification terminal in six months. Germany is signing 20-year contracts to buy LNG. The discussion about going off gas has slowed significantly.

The question we have to ask ourselves as investors is whether this is a near-term phenomenon or a change that will affect the next 20 years. We invest in gas, we invest in renewables, we have battery storage, we have RNG, we have R&D, we have transmission, we have hydrogen, we have ammonia. We have a little bit of everything.

We are seeing a lot more new opportunities in natural gas, sometimes paired with carbon capture and sequestration, than we ever did before. It has become clear that the US is now the energy superpower and the provider of the last resort for the world.

MR. MARTIN: Is the energy transition accelerating or will it take longer than expected?

MR. SAXENA: It is not going to happen as fast as people think. It takes 10 years to build a new transmission line. Coal and gas currently supply about 80% of our electricity. How do you move from 80% to 0% in the next 10 years?

MR. MARTIN: Laura Beane, what has changed?

MS. BEANE: All three of the major wind turbine manufacturers are reporting financial losses. GE just reported earnings before interest and taxes of minus 13%. Siemens Gamesa just announced a special provision that took its EBIT to more than minus 30%. Vestas is saying it will be in the 0% to minus 5% range. This is a fundamental shift that should be cause for concern.

MR. MARTIN: How is it possible with increasing demand for the things you make that the manufacturers are losing money?

MS. BEANE: It is counterintuitive. A lot of things led us to this point. The supply-chain crisis was the final push. We saw shipping costs skyrocket. All of us had firm commitments that we had to honor, and the costs were so much higher than what we had baked in. There is also an element of blame that belongs on the manufacturers. We all participated in a race to the bottom. We kept on delivering larger and larger turbines at lower prices. It reached an unsustainable point, both for the developers and then now clearly for us.

Supply Chains

MR. MARTIN: Gabriel Alonso, one item on your list is continuing supply-chain difficulties. The Wall Street Journal reported this week that it now takes 70 weeks to get high-voltage equipment, up from 30 weeks before. Do you see any relief ahead?

MR. ALONSO: We are starting to see some positive signals, but not yet a major improvement.

MR. MARTIN: What is causing the supply-chain problems? Is it labor shortages or something else? The ports have cleared on the West Coast.

MS. BEANE: Vessel availability and delays have been the largest contributing factors for us. We are starting to see an improvement. Part of that is due to lessons learned. We are fortunate to be a very large customer for the shipping companies. We have been able to leverage our global supply chain and our buying power to get more favorable contract terms.

MR. MARTIN: So not labor shortages, but lack of ships.

MR. DEANGELIS: I have a question for Gabriel and Laura. Has the market adjusted so that delays are now baked into project schedules or are projects coming in behind schedule due to unforeseen delays?

MS. BEANE: Total lead times have increased. The projects are not necessarily late because people are assuming longer construction schedules. There has been a general recalibration.

MR. MARTIN: Tom Buttgenbach, you order a lot of solar panels. How long does it take to get them today?

MR. BUTTGENBACH: Thirty days on the ocean.

It feels like it was long ago, but the threat of anti-circumvention duties just last year caused massive supply-chain disruptions and delayed projects. We started construction on some, but it was a nightmare contracting around logistics issues and dealing with cost overruns.

What we saw in the last year was a massive, massive disruption. Himanshu, you mentioned the topic. I think it will lead to an acceleration of the energy transition. The entire global economy has been disrupted and the energy markets have fundamentally changed in the last year. This is a huge opportunity. There is crazy stuff like increasing demand for LNG. Does that make sense long term? No. Does it make sense that Germany is restarting its coal plants? No. None of that makes any sense, but that is what happens when you have a massive disruption.

I would not want to have a 20-year LNG contract. That is a really bad idea. People are doing it because they are feeling the pinch to deal with energy shortages on a global scale. For the first time in a long time, the world has realized that energy is highly volatile.

Once my solar plant is built, I can guarantee you the price for 30 years.

MR. MARTIN: You have a free fuel.

MR. BUTTGENBACH: It is a little rougher road building it, but I can guarantee the price for 30 years. Not a single fossil fuel plant can do that. That is a fundamental change.

MR. ALONSO: One fundamental change over the last 18 months is that we have moved from a global view of the supply chain of the different components to a much more domestic approach. The IRA has many features, but supporting domestic manufacturing is a key one. Europe is planning to follow soon.

Various countries have seen not only the constraints that can come from a global supply when there are disruptions like a war, but also the massive opportunity for local employment and growth. The shift will not be immediate, but supply chains will look very different in a few years.

MR. MARTIN: Laura Beane, if someone orders wind turbines today, how long does it take to get them?

MS. BEANE: For us, it depends on where the components are being sourced because we have factories all across the globe. For a project in North America, the range is anywhere from eight to 15 months.

MR. MARTIN: How long does it take to get batteries today?

MR. BUTTGENBACH: Two to three years.

Grid Congestion

MR. MARTIN: Gabriel Alonso, another change, you said, is you can't connect new projects to the grid. The National Renewable Energy Laboratory reported a year ago that it takes 3.7 years on average to interconnect. There is a formal moratorium in place in PJM on new interconnections. Other RTOs have similar policies informally in place. What is the current wait time? Is it still 3.7 years or has it grown longer?

MR. ALONSO: I think it is longer than 3.7 years. It varies by ISO. If developers today are not planning on a period to go through the interconnection process of at least four or five years, then they are not being realistic. Another challenge is you have no visibility as to how long it will take to get through the entire study process and sign an interconnection agreement after getting into the queue.

MR. MARTIN: There were 8,100 projects lined up to connect to the grid at the end of 2021. The Federal Energy Regulatory Commission and PJM have offered proposals to try to clear the queue. One thought is to let people connect on a first-ready, first-served basis rather than first-in-line, first-served. How important a change is this?

MR. BUTTGENBACH: It should help. This is the same system that California uses. It is a bit more rational.

Another issue is the cost of interconnecting to the grid has increased quite substantially, not only in MISO but also in PJM and CAISO. The cost of deposits is increasing. A developer trying to build a 500-megawatt wind farm is now being asked to post a $40 million development security to secure the interconnection rights. It has become a game that the smaller developers will find hard to play.

MS. BEANE: The proposals are a good start, but we really need more focus on grid modernization and shortening the timelines. Is anyone else tired of talking about this? I have been in this industry since 1995. Transmission bottlenecks have been the root cause of all of the delays and challenges during most of that period, and yet here we are still talking about them.

MR. BUTTGENBACH: I hate to bring up technology again, but there are solutions.

First, you can't shut down a gas plant with a 65% capacity factor and replace it with a solar farm with a 25% to 30% capacity factor. That is not going to work, which is where technology comes in. With energy storage, we are well on our way to building solar power plants with 60%, 70% and 80% capacity factors. They are true substitutes, and that makes a huge difference to the customers as well as to the cost, because the interconnection cost per megawatt hour delivered goes down significantly.

Second, there are new technologies available. We did an analysis for the California market. We could add 75 gigawatts of capacity to the California grid for about $12 billion. That's the equivalent of 32 times Diablo Canyon's capacity.

How is that possible? The answer is modern conductors that can carry three times the energy at the same weight. That means you can replace the existing gas capacity using the existing transmission towers. You don't need any environmental impact studies. We can upgrade key existing lines for a third of the cost and in a tenth of the time. It is a simple solution that can be deployed nationwide.

MR. MARTIN: Himanshu Saxena, you started construction recently on a 3,200-megawatt Ten West Link transmission line from Southern California to central Arizona. How long did it take to get to the point where you could start construction? How much of the capacity is contracted? What percentage of the cost will be covered by lenders?

MR. SAXENA: I was in my 20s when we started this. [Laughter] Look, we won that award in 2014, and it is not a complicated project. It is 125-mile line. It doesn't affect anything environmentally sensitive, so it is pretty simple. It is a point-to-point connection of Arizona into California.

We have 8,000 megawatts of interconnection requests today in Arizona for a line with a capacity of 3,200 megawatts, so we are already starting to talk about a second circuit.

The thing that makes me concerned is we talk about all the renewables that need to be put on the grid for the energy transition, but if it takes eight years and $100 million in development-stage spending to develop a transmission line that is only 125 miles, how are we going to rebuild the grid across the whole country? How much time and money is that is going to take?

Seventy percent of our line goes over a BLM right of way. Delays to get a federal permit, to get past COVID and sort out supply-chain issues added to the challenges.

The line will be a regulated asset. The California ISO will have full access to it. At the groundbreaking last week, we had the vice president of the United States, the US energy secretary, the US interior secretary and the governor of Arizona. After the groundbreaking, we talked in the back room with the energy secretary and she said, "I understand that this is very painful for developers. It shouldn't take eight years." They are all trying to make it better.

Permitting reform is something that has been introduced several times in Congress and has been killed. When you have two states, the federal government, local communities and, in certain cases, Tribes of First Nation, it just becomes really difficult. Permitting took four years longer than it should have, but what can you do? This is the same experience we see across the board in developing transmission.

MR. MARTIN: Audience, if you are interested in this topic, Russell Gold, a Wall Street Journal reporter, wrote an excellent book called Superpower about the difficulties Michael Skelly had developing transmission. Another excellent book called California Burning by Wall Street Journal reporter Katherine Blunt explains how we got the utility regulatory regime in California that Tom Buttgenbach mentioned.

Gabriel Alonso, you look about to say something.

MR. ALONSO: We have two fundamental problems here. We have been talking about transmission bottlenecks, as Laura mentioned, for more than a decade. I first joined EDP Renewables 15 years ago, and this was already identified as a fundamental problem.

It takes two to four years to develop and build wind and solar projects, but it takes more than a decade to build the transmission infrastructure required to accommodate them.

Then there are the barriers to enter the interconnection queue. The grid operators are short staffed. They lack the staff to implement new reforms. PJM has already announced that it is six months behind the schedule it presented to FERC.

In Europe, they have approached this in two different ways. In some countries, a project must be fully permitted, and only then can it get into the queue. Examples are Germany and Greece. In other countries like Spain, the developer must post security of €40,000 to €50,000 per megawatt. If you do not build the project within five years, you lose the security.

Equipment Prices

MR. MARTIN: So the key in Europe is not letting people into the queue or pushing them out quickly.

Let me get two other points in here quickly, and then we will move to the Inflation Reduction Act.

Solar panel prices appear to be falling. Roth Capital Partners reported last week that they are about 23¢ a watt on average. It said prices will come down another 10% this month on top of a 10% to 20% drop last month. Is that consistent with what you are seeing?


MR. MARTIN: Where would you put current panel prices?

MR. BUTTGENBACH: We are looking for panels in the high 30¢ to low 40¢ range.

MR. MARTIN: Does anyone have a different experience?

MR. ALONSO: No. Polysilicon spot prices have gone from $35 to $21 a kilogram, and that will eventually trickle down into wafers, but panels that can clear US Customs are still scarce. The benefit of lower solar panel prices may surface in markets where you don't have this type of restriction, but the benefit is not being felt in the United States.

MR. MARTIN: Axios, a digital news source that is read by many policymakers in Washington, reported that new construction of solar projects has essentially ground to a halt because of Customs detentions of panels imports on forced-labor grounds. Customs told Axios it has detained 2,600 shipments of goods worth $806 million on forced-labor grounds since October. How significant are Customs detentions at this point?

MS. BEANE: We have had several customers tell us recently that they are pivoting resources that would have been allocated to solar to try to expedite wind development.

MR. ALONSO: I don't think Customs detentions are the most important metric. More important are the virtual detentions, meaning the deterrent for solar panel manufacturers to produce for the US market. They are diverting cargoes to other markets. What you need to look into is the number of projects that are not proceeding, or are stalled because they are not receiving panels, not because the panels have been detained, but because they are not even manufactured.

Inflation Reduction Act

MR. MARTIN: Let's move across the panel, short answers, broad question, where are you finding opportunities in the Inflation Reduction Act?

MR. DEANGELIS: The opportunities are in the medium term. The hydrogen tax credit has made green hydrogen more interesting than it was. We had been looking at Europe as the first spot for it, and the US has now leapfrogged Europe.

MR. SAXENA: We are seeing an uplift for many of our projects, from renewable natural gas to sustainable aviation fuel, carbon capture, all types of renewables. Our entire portfolio is benefiting from the IRA.

MR. MARTIN: Except for transmission.

MR. SAXENA: People talk about why transmission was left out of the bill, and it is because while cost matters, it is not the primary explanation for why more transmission is not being built. If a new transmission line makes sense, it makes sense with or without a 30% investment tax credit, at least that is my experience. The problem is you cannot get it permitted.

MS. BEANE: The IRA provides long-term certainty that should create a very robust market for wind. We are anticipating 125 gigawatts of new wind by 2030, which is significant for us. The new section 45X tax credits for manufacturing wind, solar and storage components are also important and helpful for the industry.

MR. BUTTGENBACH: We were closely involved with Congress working on some of these provisions, and we are eager to see how the IRS interprets them. Things like the bonus tax credit for projects in energy communities, more detail around when a coal-fired generating unit is considered to have been retired and the calculations for the domestic content bonus credit will all be important. We are excited about bringing the supply chain to the US, onshoring more jobs and working with suppliers to build factories in the US.

MR. ALONSO: Solar manufacturing in the US is the area where we are seeing a lot of momentum based on the number of investment opportunities we are being shown. We have been hearing from lots of companies trying to manufacture different components here in the US.

MR. MARTIN: Tax credits for generating renewable electricity could reach as high as 70% of the cost of new projects, but they come with fine print. The fine print is that mechanics and laborers working on the projects not only during construction, but also on alterations and repairs for the next five to 10 years after projects are in operation, must be paid the same wages that are paid on federal construction jobs. How significant an issue is this?

MR. BUTTGENBACH: Most of our projects in the southwest are already under project labor agreements, so the cost delta is minimal.

MR. SAXENA: Monitoring is the bigger issue. The effect on cost is not material.

MR. MARTIN: Some developers say it is not additional costs during construction that are the issue, but rather having to pay such wages for the next 10 years on O&M-type work. Do you agree?

MS. BEANE: I think we really need further guidance to understand how large of an impact this will have.

MR. MARTIN: A bonus tax credit can be claimed for using domestic content if the steel and iron construction materials used in the project are 100% US-made, and the other components are at least 40% US-made initially, increasing to 55% over time. Do you see anybody able to qualify for this in the near term? If yes, on which types of projects?

MS. BEANE: Again, without guidance, it is impossible to give a definitive answer. Wind has strong a US manufacturing footprint relative to some of the other technologies.

MR. MARTIN: Is anyone expecting to qualify currently?

MR. D'ANGELIS: We do not see any qualified projects.

MR. BUTTGENBACH: Waiting for guidance.

US Manufacturing

MR. MARTIN: Many manufacturers are considering moving manufacturing to the United States because the US government is now offering a tax credit for making wind, solar and storage components and, not only that, it will also pay the tax credit value in cash for the first five years. Laura Beane, what percentage of the cost of a typical wind turbine do you expect the tax credits to cover?

MS. BEANE: The benefits are 5¢ a watt on the nacelle, 3¢ a watt on the tower and 2¢ a watt for making blades, so you can do your own math based on the prices that you are seeing for turbines. I see it largely as leveling the playing field with lower-cost imports. We were largely phasing out our US manufacturing footprint. Our larger, newest turbines have not been manufactured in the US simply because it is so much higher cost to manufacture here. These incentives are critical for keeping manufacturing in the United States.

MR. MARTIN: This could be an important source of cash flow for Vestas and other manufacturers to the extent they manufacture in the United States.

MS. BEANE: Definitely helpful, but remember a large upfront capital investment is required, and we need volume certainty to make such commitments. This is particularly relevant in offshore wind. The capital investments are very significant, and the way the industry is going about it, with each state wanting its own factories rather than talking about a regional approach, is very inefficient and will likely slow the growth of the industry.

MR. ALONSO: What about concrete towers for wind turbines? They allow developers to move away from exposure to steel, which is a volatile element. And concrete is manufactured locally, really locally. Moreover, such towers can be made by the wind turbine manufacturer or by the balance-of-plant construction contractor.

Will the IRA disincentivize or incentivize use of concrete towers, especially as people are thinking about using taller and taller towers? We have seen a shift to concrete in other markets like Brazil and parts of Europe.

MS. BEANE: We are definitely seeing concrete usage in Brazil. In North America, it has not penciled economically. In Germany, we are using concrete for the bottom tower sections as a way to allow taller towers. It is something that will continue to evolve as technology improves and costs fall.

Greater Volatility

MR. BUTTGENBACH: Tying all of the topics we have been discussing together, it is not just about cost, it is also about volatility.

We are planning projects today for four, five, six and seven years in the future. In order to get full capacity deliverability status in CAISO, I need to have a PPA. How do I commit to a PPA for a project five years out? I need to predict what I will pay in five years for solar panels. I don't know whether we will be importing panels from southeast Asia or buying domestically-made panels by then. The Auxin petition created volatility. It is good to encourage companies to manufacture in the US. Even if it ends up being a few percent higher in cost, the numbers work. I just need that certainty. I can't take the risk of the deal blowing up because of some new crazy import restriction.

MR. MARTIN: Isn't this a question of who bears the risk? Perhaps you can have a PPA in which you pass through some risks, like changing commodity prices.

MR. ALONSO: Three years ago, if you could sign a PPA at current prices for a project that would start delivering electricity five years in the future. Everybody would consider that PPA an asset. Solar panels or wind turbines will only get cheaper.

MR. MARTIN: Nobody wants to do that today.

MR. ALONSO: Correct. Now it's the opposite. The uncertainty around supply-chain cost and timetables mean that a PPA is no longer an asset. You cannot commit to the future electricity price for the reasons that Tom mentioned.

MR. MARTIN: That may explain why it seems easier than ever before to get a PPA today.

MR. SAXENA: That point is really critical. If we are developing a project five years out, I don't know what price PPA I can sign today. It used to be easier.

You don't have to look that far out in advance to find problems. Look at the offshore wind companies. Many of them are trying to renegotiate PPAs. The two off the Massachusetts coast cannot deliver electricity at the originally agreed price of $48 a megawatt hour escalating over time to $72.

 The challenge for developers is how to get long-term price certainty or have PPAs that pass commodity price risk to the customers. Last year, 20 gigawatts of PPAs were signed by corporations. Are corporations willing to take on unlimited cost overrun risk? No. Maybe a little bit of cost increase can be passed through to them, but if there is a new administration in 2024, another trade war and a 25¢ tariff on the solar panels, how would you make that work? And 2024 is just next year.

There is a lot more volatility and uncertainty in the market for developers than I have seen in the last 15 years.

MR. BUTTGENBACH: That's right. For me, the most significant part of the IRA is the 10 years of stability. We have been completely dependent on southeast Asia for solar panels. Bringing manufacturing back to the US will help with supply-chain uncertainty and price stability.

Competing Incentives

MR. MARTIN: The Inflation Reduction Act has had a giant suction effect. It is drawing capital and manufacturing facilities into the US. What happens if Canada and Europe match these subsidies? Canada has already taken steps to do so.

MR. DEANGELIS: I don't think the IRA has as material an impact as implied by that statement. Fund managers with trillions of dollars in investment capital are looking for infrastructure projects around the globe. There is a lot of money that wants to come into the US because of an actual or perceived level of stability. Even though we just talked about instability, it is all relative.

MS. BEANE: The world has changed. There is an energy crisis whose duration is hard to predict that I have not seen before. The energy prices we have seen in Europe over the last 18 months are staggering. The more investment, the better. I would welcome mirror incentives across all the regions.

MR. MARTIN: Will they drive up the price of things like batteries and solar panels because they contribute to greater demand for these items?

MR. ALONSO: I think the disruption will be minimal. Panel manufacturers have the ability to increase manufacturing capacity. There are barriers to enter the wind industry. There could be periods when there is way too much demand for the supply. The reason we are seeing the collapse in polysilicon prices, for example, is because the amount of new polysilicon manufacturing capacity added in the last six to 10 months.

MR. D'ANGELIS: How about minerals? In the near term, there are shortages of key minerals like lithium, but in the medium to long term, the supply grows to meet demand.

We have another arm at Denham Capital that does minerals investments. It is astounding how much underinvestment there has been in exploration for rare-earth minerals that are needed for the energy transition. This is leading to short-term dislocation.

MR. MARTIN: Let's close out the IRA discussion with this. The IRA creates incentives to invest in a long list of new sectors. Tell me which single sector will receive the strongest push as a result of the IRA: hydrogen, standalone storage, biogas, sustainable aviation fuel, carbon capture, critical minerals, EV charging infrastructure or small, modular nuclear reactors? If you had to pick one, which will see the most new investment?

MR. ALONSO: Are you asking for absolute tailwind or incremental tailwind?

MR. MARTIN: They were all already advancing on their own. Incremental.

MR. ALONSO: If it is purely incremental, then green hydrogen.

MR. SAXENA: I think it depends on the guidance, honestly, because if the guidance comes out a certain way, the tailwinds that we are talking about for hydrogen will not exist. The biggest question is how closely in time purchased renewable electricity or renewable energy credits need to be matched with hydrogen production. If it is done on an hourly or daily basis, we are dead. If it is done on an annual basis, we are in play. The whole hydrogen thing is highly, highly dependent on how IRS comes out in the guidance.

If the guidance is favorable, then hydrogen. If not, it is carbon capture in my opinion.


MR. BUTTGENBACH: I agree, but it is all small stuff in the larger context.

MR. MARTIN: Small stuff compared to solar and storage?

MR. ALONSO: Yes, exactly. That's why on an absolute basis, it is solar, storage and wind.


MR. MARTIN: The Inflation Reduction Act allows tax credits to be sold to other companies for cash instead of doing complicated tax equity transactions. Will you be sellers, have you received any offers and, if so, at what discount?

MR. SAXENA: There is a whole system in place for people to trade low-income housing tax credits. Our real estate business does that. Folks are telling us that there is unlimited demand for tax credits. We expect pricing in the 95¢ to 96¢ range per dollar of tax credit. If you sell a 10-year strip, that number is close to 90¢. Folks are setting up investment funds to buy tax credits. They are coming up with various structures. I expect a lot of financial innovation around how to trade tax credits.

MR. MARTIN: The price will probably increase toward the end of the year as companies have a better fix on their tax capacities.

MR. SAXENA: I think the fact that you can carry forward these tax credits 20 years and roll back three years is beneficial because it reduces the risk of tax credits being stranded. If you are a buyer and you don't know whether you will have enough tax capacity in 2024, there is the option of using the tax credits in a later year.

MS. BEANE: In the projects on which we are working currently, nobody is talking about transferability. Everybody is still laser focused on securing tax equity.

MR. BUTTGENBACH: That's because selling credits still leaves the tax depreciation unused.

MR. MARTIN: The depreciation is worth about 14¢ per dollar of capital cost.

MR. BUTTGENBACH: Right. I don't think people are willing to forego that much value, and from what we understand, the tax equity market is unlikely to be interested in depreciation-only transactions in the near term.

MR. SAXENA: If you look at these decisions as made around single projects, I agree. However, on a portfolio basis, the depreciation can be used to shelter gain from project sales and, in that sense, transferability is better than tax equity.

Inflation Effects

MR. MARTIN: Where else is inflation having an effect besides pushing up construction costs?

MR. ALONSO: Talent. Labor costs. Companies have budgets for how much they can afford to pay employees, and that has changed dramatically over the last 12 months.

MR. SAXENA: There is a valuation topic that hasn't quite sunk in yet. If you have a 20-year contracted asset and you built it to a 7.5% return and your cost of debt now, because of inflation and rising interest rates, is close to 7%, where is the margin for equity over debt? We have not had to deal with this yet because a lot of investors are still total-return investors.

If inflation persists, a lot of these bond-like cash flows that have been created from older assets will go down in value. When rates go up, bond values go down. There is a risk of a general resetting of valuations over time if interest rates remain high. That will affect portfolio values across the board for contracted assets with stable cash flows.

MR. BUTTGENBACH: I agree with that, but you have a countervailing effect, which is that the optimistic merchant assumptions that people have been using for post-contracted revenues are much more likely now to be realized. We used to laugh at Ventyx curves. They may end up being true.

MR. MARTIN: People are asking what discount rates are being used in appraisals. They used to be 6% to 6.5% to discount after-tax cash flows to arrive at a fair market value. What is the appropriate discount rate today?

MR. BUTTGENBACH: It depends on whether we are buying or selling.

MR. DEANGELIS: The equity markets don't seem to have directly reset the way the credit markets have. You would think with base rates up 200 basis points, logic and reason would tell you that discount rates for equity valuations should increase as well, but we are not seeing that.

MR. BUTTGENBACH: That's partly because you still have a lot of infrastructure funds for whom the only thing that matters is the hurdle rate.

MR. DEANGELIS: That is a rational economic behavior. It is also the issue. Financial models that used to be over 20 years are now over 40 years to make the numbers work.

MR. BUTTGENBACH: It is how the general partner makes money.

MR. ALONSO: You also have a supply-and-demand issue. There is so much capital trying to enter into a space that is full of bottlenecks. There is more uncertainty to develop and execute on projects, not just in the US, but also in other regions outside the US. We are also not seeing the same level of discipline on the equity front as we saw in the past.

MR. SAXENA: You could also argue the other way around, which is that the equity returns used to be way too high. When real interest rates were zero, why was the discount rate 6% to 6.5% for a solar plant with a 25-year PPA?

MR. DEANGELIS: Equity returns are never too high. Should equity returns be 50 basis points higher for somebody who just took a whole bunch of risks putting the project together? I didn't go to Harvard, but you know my second-grade MBA tells me that is not enough premium.

MR. MARTIN: Himanshu Saxena, you complained at past conferences that the equity has to wait 15 to 20 years just to get its capital back, let alone a return.

MR. SAXENA: I don't complain.

MR. DEANGELIS: That's not true. [Laughter]

MR. SAXENA: A little bit of complaining is good for the soul. If you sign a 20-year PPA, chances are that you will still not have gotten your capital back by the end of the PPA. You are still relying on the post-contract value of the assets to earn a return. That pattern has not changed.

MR. BUTTGENBACH: You are relying too much on debt.

MR. SAXENA: The capital structure has maybe 25% debt, 60% tax equity and 15% true equity. However, the tax equity in a partnership flip structure is a kind of mezzanine debt.

Audience Questions

MR. MARTIN: Let's try to fit in a few audience questions as we wrap up. Himanshu, what guidance are you looking for on hydrogen? You said one thing you are looking for is what is the measuring period for using renewable energy credits and VPPAs to offset dirty grid electricity so that the hydrogen qualifies as clean.

MR. SAXENA: Do you need to be directly connected to the wind or solar project that is the power source to run electrolyzers? That is question number one.

If you are not directly connected to it, can you buy grid electricity and use RECs from, or a VPPA with, the wind farm to offset the emissions from the grid electricity? If so, how closely do hydrogen output and the wind output have to match in time?

What happens if the wind farm is not operating? What if its capacity is only 40%? Do you have to shut your electrolyzers down? Do you have to do it in real time? How do you deal with the unpredictability of wind and solar versus the need for a downstream customer for the hydrogen to have a predictable supply?

The guidance is critical to sorting out these questions. Guidance that says you have to match in real time is not a practical outcome.

MR. MARTIN: Other issues are whether you have to match geographically and whether there an additionality concept. You can find all of these discussed in a paper on the web by searching for "hydrogen tax credits Norton Rose."

Another audience question: tax-exempt and state or local government entities, rural electric cooperatives, Indian tribes and the Tennessee Valley Authority can get direct cash payments in lieu of tax credits on projects they own. Are you seeing structures where people are trying to work such entities into their deals in order to convert the tax credits to 100¢ on the dollar?

MR. DEANGELIS: Working on it.

MR. MARTIN: Any details?

MR. DEANGELIS: Working on it. We have a lot of relationships with tax-exempt investors. We are trying to figure out a way to optimize the capital structure.

MR. MARTIN: This will be our last audience question. How much time should developers assume it will take to work out an investment from a private equity fund. How long does it take to work through the process?

MR. SAXENA: We have all the money for all of you in this room for good projects.

MR. DEANGELIS: I agree with the Himanshu's statement, except our money is better.

MR. MARTIN: Lower return? From whose perspective? [Laughter]

MR. SAXENA: Capital is a commodity at the end of the day. The challenges we talked about make it very important for developers to align themselves with the right partners. There will inevitably be delays and cost overruns. You don't want to be partnered with someone who at the first sign of trouble wonders what he or she is doing in the deal. Developers should focus less on 50 basis points more in yield and more on the track record of the potential partner in developing projects. Does the partner know what it is doing?

MR. DEANGELIS: One thousand percent agree with that. These are not M&A deals. They are long-term partnerships.