A California property tax valuation of a power plant has come under scrutiny.

The California Supreme Court said in August that the State Board of Equalization erred in how it valued a 550-megawatt cogeneration facility for property tax purposes.

The board used two methods to arrive at the fair market value of the power plant.

One was replacement cost. It assumed that anyone building a similar power plant today would have to buy emission reduction credits or ERCs to cover the air emissions. Therefore, it included the cost of ERCs in the calculation of what would have to be spent to reproduce the plant since the plant cannot operate by law without them.

It also used the income method to arrive at value. In that case, it deducted the cost of ERCs from the future revenue the plant is expected to earn before converting the future revenue stream into a present value.

The state tax code allows property tax assessors to “assum[e] the presence of intangible assets or rights necessary to put the taxable property to beneficial or productive use,” but it does not allow direct taxation of intangibles. The prohibition against direct taxation dates to 1933.

The Elk Hills power plant is in Kern County near Tupman, California. The San Joaquin Valley Unified Air Pollution Control District requires any new pollution sources to buy emission reduction credits from existing sources to cover their emissions. Owners of existing power plants can free up ERCs for sale by reducing their own emissions.

The Elk Hills plant uses natural gas to produce electricity and steam for oil recovery at an Occidental Petroleum Corporation field.

The owners sued for recovery of excess property taxes paid during the period 2004 through 2008.

The state Supreme Court said the board should not have added the cost of the emissions credits to the replacement cost, since that is impermissible direct taxation of the credits, but it said the board acted properly when it subtracted the cost of credits from the revenue stream from electricity sales to arrive at the net revenue that could be earned by the power plant since that revenue cannot be earned without the credits. It said in one case, the board improperly increased the property value by the credits, while in the other case, it merely “assumed the presence” of the credits.

The case is Elk Hills Power, LLC v. Board of Equalization. The court released its decision on August 12.

Although the court declined to remove the ERCs from the income stream in this case, it said it would have removed them if they were the type of intangibles that add directly to the revenue stream. Thus, production tax credits and renewable energy credits, or RECs, to which a project is entitled should not be added to project value under either appraisal method.