Five prominent renewable energy developers spoke at the CLEANPOWER 2021 conference in early June about the current state of the US tax equity market. Many developers struggled in 2020 to find tax equity, even though market volume reached $17 to $18 billion, up from $12 to $13 billion in 2019.

Tax equity is a key tool for financing US renewable energy projects. The US government offers tax credits and accelerated depreciation as an inducement to build new renewable energy facilities, but few developers can use these benefits directly. Tax equity is a form of financing against the tax benefits.

The panelists are Meghan Schultz, senior vice president for finance and capital markets at Invenergy, James Marshall, CFO of AES Clean Energy, Andrew Nourafshan, managing director for structured finance at Cypress Creek Renewables, Steve Ryder, executive vice president and CFO of Clearway Energy Group, and Vishal Kapadia, senior vice president and chief commercial officer of Ørsted Onshore. The moderator is Keith Martin with Norton Rose Fulbright in Washington.

Still Challenging?

MR. MARTIN: Meghan Schultz, have conditions in the tax equity market improved since last year?

MS. SCHULTZ: We certainly saw constraints in the tax equity market last year as banks braced for the uncertain impacts of COVID. The COVID impacts are easing this year, but there are still constraints in the market, especially as it relates to investment tax credit deals.

MR. MARTIN: How do you feel those constraints?

MS. SCHULTZ: There is a limited universe of tax equity investors. When you are marketing a transaction, some banks say they are only doing production tax credit deals. You hardly ever hear anyone say it is only doing ITC deals. Banks may only have insight into tax capacity in the current year. When you start to talk about a project that will need tax equity financing in 2022 or 2023 and that may be starting construction now, the banks are uncertain about whether they can commit. There were projects last year for which it took longer to secure tax equity or where we had fewer potential investors than we had originally anticipated.

MR. MARTIN: The ITC is what is claimed in the solar market. Because the investment tax credit is claimed entirely in the year the project is put in service, it puts more strain on tax capacity.

James Marshall, did AES Clean Energy have trouble last year raising tax equity and has the market improved this year?

MR. MARSHALL: We try to get ahead of the curve and lock up commitments for the following year to the extent possible in Q2 or Q3 of each year. We were in a good shape going into 2020. We closed all the tax equity we had anticipated.

For a good project pipeline, when you have a good relationship with your tax equity investors, the repeat business helps.

We have had a number of outreach opportunities that have come across our transom for 2021. There are a few investors looking to place additional 2021 capacity because of what happened in February in Texas. We are in the middle of placing 2022 tax equity and are feeling quite good about it.

MR. MARTIN: So you have tax equity investors approaching you trying to find 2021 projects in which to invest tax equity to replace Texas projects?

MR. MARSHALL: That's correct. We have had at least two or three approach us in the last few months.

MR. MARTIN: These are people who found themselves short because of the five-day cold snap in Texas?

MR. MARSHALL: I don't think they are explicitly saying that. My assumption is that they had some other transactions lined up that may not be so palatable any more, and they are indicating in some cases that they have meaningful capacity remaining for 2021.

MR. MARTIN: Andrew Nourafshan with Cypress Creek Renewables, was it hard to find tax equity last year, and is this year better?

MR. NOURAFSHAN: Last year was challenging. We certainly saw a slowdown, whether due to concerns about tax appetite or just needing to understand the broader economic picture before making commitments. It wasn't terribly disruptive to our ultimate execution plan, but Meghan Schultz was spot on in her assessment.

The difficulty raising tax equity last year has created a backlog of projects that got pushed from last year into this year. That has made it more difficult to start talking about 2022 and 2023 today with such a backlog of really big projects queued up for financing.

We have seen a pickup in investor interest and ability to do deals this year, but there is also greater competition for scarce tax capacity because of the backlog in deals.

MR. MARTIN: Are you financing with the major players or are you having to reach out well beyond the mainstream investors to find tax equity?

MR. NOURAFSHAN: It is a bit of both. We are always speaking with the usual suspects, and then Cypress historically has had a lot of other tax equity relationships that we continue to maintain.

MR. MARTIN: Steve Ryder, Clearway has a big pipeline of deals. How was last year? How does this year look by comparison?

MR. RYDER: We align more with what AES is doing. We have been lining up tax equity for projects hitting COD in 2022 or 2023. To Meghan's point, I think it is easier to find tax equity for wind than for solar, but it depends ultimately on the technology, the location and the sponsor.

You have a group of top-level sponsors on this call that have generally good, reputable pipelines, strong track records of execution, good relationships with the power purchasers, equipment vendors and construction contractors, and probably good post-closing sophistication, as well. The tax equity that is available tends to migrate to those sponsors.

I suspect it is still hard for smaller companies and new entrants to get the attention of the tax equity market this year.

MR. MARTIN: So this panel is not the most challenged group of sponsors.

Vishal Kapadia, the trade press is full of stories about Ørsted Onshore financing new projects, often in Texas. How was the market last year? How does it compare this year?

MR. KAPADIA: I think the market worked to our advantage. There has always been a haves and have-nots dynamic to the market. If you are a strategic with a global relationship with the large financial institutions, as we are, then you are in a much better position than if you are a fund-backed developer. This dynamic has been exacerbated by recent events like COVID and the Texas cold snap.

Unlocking ITC capacity has been more difficult for just about everybody.

It is starting to be more important to marry either broader relationship elements or, if you have the flexibility to do so, PTC wind transactions as part of a portfolio.

COVID earnings uncertainty was an overhang for much of last year. Things are in a much better place than they were last year.

MR. MARTIN: Have you seen any pause in Texas?

MR. KAPADIA: Not really. There may be more reticence and a need to look twice at the sponsor, the offtake story and the location, and people are spending more time underwriting the underlying elements of the project, but it is more of a delay as opposed to any issues in terms of unlocking the finance.

MR. MARTIN: Is the challenge with unlocking ITC tax equity solely uncertainty about tax capacity this year? Is it the fact that the entire tax benefit is claimed in one year, rather than spread over 10 years as with PTC transactions, or is it more than that?

MR. KAPADIA: The ITC is a lumpy one-year tax credit. It makes an accurate forecast of tax capacity more important.

Tax Law Uncertainty

MR. MARTIN: Going back to Meghan Schultz, are you seeing any slowdown in financings this year due to uncertainty about where the tax law will land?

MS. SCHULTZ: No. It is an incredibly busy year on the solar side. We are focused on projects that are expected to be placed in service in 2022 and 2023. Similarly, the wind side is very busy for projects that we expect to complete in the next couple years. We are financing projects based on current law. There are always negotiations around what happens if the tax laws change, but that is something that we are used to seeing in deal papers.

MR. MARTIN: Is there anyone among the five of you who sees a slowdown in financings because of tax-law uncertainty?

MR. MARSHALL: We have encountered a little bit, not so much for 2021 projects as for projects that require forecasting tax capacity in two or three years.

MR. MARTIN: Steve Ryder, the Senate Finance Committee voted in late May to increase the tax credit amounts for projects placed in service after 2022. Of course, this may never go anywhere –- it is too early to tell whether there will be an infrastructure bill this year -- but do you see anyone slowing development or construction in anticipation of a bump up in the tax credit amounts after 2022?

MR. RYDER: I remember someone telling me that, in the development business, time is never your friend.

I think developers are more inclined to get the project done rather than delay things for something that might not happen. People have signed power purchase agreements with guaranteed commercial operation dates. They may have guaranteed delivery dates for wind turbines and solar panels. For those reasons, we are not seeing any slowdown.

MR. MARTIN: What happens if the bill is enacted later this year and then you have a year to wait before the increased tax credit amounts take effect?

MR. RYDER: We will have to face that prospect at the time. Things seem too uncertain at the moment in Washington to act based on what the Biden administration or others have proposed.

MR. MARTIN: Does anyone see a slowdown in activity for standalone storage where there is no tax credit currently, but there may be one in the future? [Silence] I will take that as a no.

Let me ask another question related to the Wyden bill that cleared the Senate Finance Committee the last week in May. Catherine Wolfram, the deputy assistant Treasury secretary for climate and energy economics, said in a short talk immediately before this panel that a quid pro quo for claiming new, larger tax credits will be compliance with labor requirements.

The Wyden bill requires all construction contractors and subcontractors working on a project to pay federal Davis-Bacon wages not only during construction, but also when making repairs or improvements during the full period tax credits are claimed or are subject to recapture. Developers are worried that tax credits could be clawed back later if a contractor over whom they have little control promises but fails in fact to do this, and they are worried that the tax equity market will make them take the risk. Does any of you see anyone starting to address this in documents or is it too early?

MR. NOURAFSHAN: In terms of documents, it is too early. It is something that we are monitoring and thinking about as we formulate our plan with respect to construction contracts on projects.

MR. MARTIN: Vishal Kapadia, does this come up in any conversations with financiers?

MR. KAPADIA: Not yet. Like Andrew, we are monitoring it.

MR. MARTIN: Going back to Meghan Schultz, how is tax-change risk being handled currently in deals?

MS. SCHULTZ: I would put it in two buckets. You have the risk of a change in tax law during the period after the documents are signed through the actual funding and then for the life of the investment.

I think that sponsors and tax equity investors are used to addressing change-in-tax-law risk as it relates to tax rate change. That is easy. You can quantify and address it. The harder questions are what happens if a project suddenly becomes eligible for a refundable tax credit or something like that.

There could be a situation where you would rather not raise tax equity if Congress offers a direct-pay alternative to tax credits. The response to that may be to try to buy a little time, if the project schedule supports it, before we actually execute the tax equity transaction. I don't think investors are looking to provide much flexibility once the deal papers are signed.

MR. MARTIN: Steve Ryder, are you finding any tax equity investors willing to give you the flexibility to pull out later if Congress enacts a direct-pay alternative to tax credits?

MR. RYDER: We have had to navigate similar issues in the past with regard to state refundable tax credits, and we have found that tax equity investors have been willing to work with us. That makes me think that if we have to deal with similar issues at the federal level, sophisticated tax equity investors will have a similar mindset.

MR. MARTIN: What is a possible compromise between letting you walk and holding you to the deal?

MR. RYDER: I would rather not get into the details about what we have done at the state level versus what might happen at the federal level.

MR. MARTIN: James Marshall, Meghan Schultz said there are two buckets of tax-change risk. One is a tax change that occurs before funding and the other is what happens after. Are you seeing tax equity investors get protection for tax law changes after funding and, if so, for how long?

MR. MARSHALL: We are seeing a framework similar to what evolved the last time we were in a tax reform environment, but we are still working through this.

MR. MARTIN: The last time was 2017. Tax equity investors made it a condition precedent to each funding that the pricing model had to reflect proposed changes in tax law. There was an adjustment later if the change was not ultimately enacted by the end of 2018. However, some tax equity investors looked for longer-term protection against future tax-law changes almost as if they were lenders. Are you seeing that this year?

MR. MARSHALL: We have yet to encounter that.

MR. MARTIN: Vishal Kapadia, how do you see tax-change risk being addressed?

MR. KAPADIA: We are in a bit of a different world than we were the last time a potential change was on the horizon in that this time the risk is to the upside. There are obviously a number of details to be worked through in terms of how to be able to capture that upside if you are a sponsor and on what timetable. Our discussions about this issue have not been terribly contentious given that it is an upside case.

Other Market Shifts

MR. MARTIN: Meghan Schultz, going back to you, has anything changed about the tax equity market this year compared to 2019 or 2020, aside from the difficulty finding investors for ITC deals?

MS. SCHULTZ: Addressing change in tax laws is probably the primary topic, but I don't see any fundamental changes to the tax equity market itself.

MR. MARTIN: James Marshall, same answer?

MR. MARSHALL: Agreed. I am aligning with Meghan on this one.

MR. MARTIN: Does anyone have a different answer?

MR. RYDER: I think there is a lot more focus on sponsors this year. Events like the Texas storm and other black swan events make tax equity investors look more carefully at the ability of sponsors to navigate through and withstand such events.

MR. MARTIN: So there is a move perhaps to sponsors who are better capitalized and, if we had a panel of smaller sponsors, we might hear that raising tax equity is even more difficult than last year.

Is anyone seeing any new tax equity investors this year?

MR. KAPADIA: We are not. Our focus of late has been on utility-scale projects on the larger end of the spectrum which drives us to the investors with the ability to deploy capital at scale.

MR. MARTIN: Is anyone else seeing any new tax equity investors? We have seen 17 tax equity investors since last September who either have come back into the market or are new entrants. Many are investing alongside more experienced investors rather than on their own.

MR. NOURAFSHAN: New tax equity investors do not show up overnight. There is a long lead time of education and familiarization with the idiosyncrasies of this type of investment. There is a lag between when an investor starts looking at tax equity and when it ultimately gets comfortable signing documents and making commitments.

Last year was a disruptive year. We have had some new investors on our deals, but we are spending a lot more time focusing on cultivating new investor relationships in the hope that they bear fruit in future years as opposed to a deal that we would execute this year.

MR. MARTIN: James Marshall, tax equity last year seemed to account for about 35% of the capital stack, plus or minus 5%, for the typical solar project and 65%, plus or minus 10%, for the typical wind project. You do solely solar. Does 35% sound like the right percentage this year?

MR. MARSHALL: It does. It depends on how large an ITC the project can claim, but I don't think anything has changed.

MR. MARTIN: Meghan Schultz, you do both wind and solar. Do these figures sound right?

MS. SCHULTZ: Yes. They are in line with what we are seeing.

Current Yields

MR. MARTIN: Steve Ryder, where are you seeing current yields, and are they moving up or down?

MR. RYDER: We closed a deal earlier this year where the flip yield was sub-6%. The deal did not have a lot of risk to it. It had a long-term PPA and did not have issues like basis risk or shape risk that may be of concern to tax equity investors in other transactions. People were also comfortable with our ability as a sponsor to execute and construct the project on time.

I don't think having a flip yield in the 6% range is necessarily an outlier if you have a well-constructed project. That is where we are getting indicatives for a number of our financings coming down the line.

MR. MARTIN: In the 6% range meaning mid-6%, high 6%?

MR. RYDER: Mid-6%.

MR. MARTIN: I am guessing the deal you closed at a sub-6% flip yield was a wind project.

MR. RYDER: That's correct.

MR. MARTIN: Meghan Schultz, where are you seeing current yields?

MS. SCHULTZ: I don't think I have anything to add beyond seeing yields in the range that Steve mentioned.

MR. MARTIN: James Marshall, what about you?

MR. MARSHALL: I agree. We generally see in the 6% to 7% range, and it flexes depending on the commercial structure and the length of the power contract.

MR. MARTIN: We have been seeing 7.25% to 7.5% lately for contracted utility-scale solar projects. The fact that many of you are seeing yields in the 6% range may be a sign that you work for very experienced sponsors with longstanding bank relationships. Vishal Kapadia, where are you seeing current yields?

MR. KAPADIA: Obviously a number of factors drive the flip yield, including project location, offtake structure, overall risk profile and sponsor quality. Generally I would say they are in the 6% to 7% range, but with upward drift on the back of the events in Texas and the macro environment in terms of rising interest rates and inflation concerns.

MR. MARTIN: Andrew Nourafshan?

MR. NOURAFSHAN: This is always the question you ask your investor panels and they are coy. I don't know that I have anything else really to offer other than to underscore that project quality and offtake characteristics are the name of the game here, so flip yields vary. We have seen upward drift certainly on Texas projects since February, but it has not been dramatic. There has been a heightened focus on diligence, scrutiny of projects and underwriting the black swan event or downside cases more than any dramatic change in pricing.

Direct-Pay Alternative

MR. MARTIN: Meghan Schultz, will you still do tax equity if Congress enacts a direct-pay alternative?

MS. SCHULTZ: It depends on the project. We have solar projects ranging from 70-megawatt to over 1,000-megawatt projects, and we are in solar, onshore wind and offshore wind. It depends on the profile of the project, the timing and our ability to monetize the depreciation. We would continue to raise tax equity for some projects, but not for all.

MR. MARTIN: The direct-pay proposals in Congress would operate through the IRS and treat the tax credit as a tax overpayment that can be recovered through a refund process after the tax return is filed for the year the project is placed in service. Thus, you would not be able to file for a refund for a project that goes into service in 2023 until something like September 2024. In 2009 through 2016, people continued to raise tax equity even through the Treasury was making cash payments in lieu of tax credits under the section 1603 program. The application for a cash payment could be filed immediately after a project went into service.

You said it depends on some factors. When would you choose not to raise tax equity?

MS. SCHULTZ: We will need to see the details of the new law, but it sounds like there may be an ability to bridge the cash payment through lower-cost debt rather than tax equity.

There may also be situations where we are able to use the depreciation ourselves. This will require an evaluation of the capital structure for each project.

MR. MARTIN: That's interesting. The fact that debt can be used to bridge more cheaply than tax equity may put downward pressure on tax equity yields.

MS. SCHULTZ: You would think, although tax equity yields have proven to be pretty inelastic over the years.

MR. MARTIN: Your CEO, Michael Polsky, has been complaining about them since at least 2004. James Marshall, will you still do tax equity if there is a direct-pay alternative?

MR. MARSHALL: We have done a lot of analysis about this. The final decision will depend on the details of the direct-pay option. However, it is hard to imagine us not doing at least a mix of tax equity and electing direct pay. Moving wholly to direct pay without any tax equity seems less likely for us.

MR. MARTIN: Steve Ryder, Meghan Schultz made a good point, which is if you are going to use bridge financing, debt is cheaper, but of course, that still leaves depreciation. The tax credits are worth about 30¢ and depreciation is worth about 14¢ per dollar of capital cost of a project. That is a lot of value to leave untapped. Is there room still for tax equity in a direct-pay world?

MR. RYDER: Yes, there is. We will probably use a combination of direct payments and tax equity, depending on specific project fundamentals and when we think we might be able to use the depreciation ourselves.

The other thing is it will take some time for the market to adjust to direct payments. The tax lawyers will look at the final legislation. There will be a bunch of questions that the market will want the IRS to answer. It takes time for the IRS to issue guidance. In the meantime, the tax equity market will continue to function as it does now.

MR. MARTIN: Vishal Kapadia, how important is it that Congress enact a direct-pay alternative?

MR. KAPADIA: It is important from the standpoint of adding liquidity to the market and addressing some of the issues that we have just been talking about in terms of difficulty unlocking ITC capital for solar projects and the challenges that developers below the top tier still face raising tax equity.

MR. MARTIN: Andrew Nourafshan, will Cypress Creek still do tax equity if it has the option of taking cash?

MR. NOURAFSHAN: You will hear the same refrain from me. We do not have enough detail, nor do I think even if we had all the detail we would, with conviction, suggest one versus the other. It will end up a mix. We welcome having a broader set of liquidity options, but the details matter of how this will be implemented.

Chinese Equipment

MR. MARTIN: Meghan Schultz, Biden issued an executive order setting aside the Trump executive order that made it illegal to buy or use Chinese and other foreign adversary equipment that might harm the US power grid. It was never clear to the market what exactly that equipment is. Did Invenergy change any of its equipment procurement as a consequence of the Trump order?

MS. SCHULTZ: We did not. Like everyone else, we certainly spent time last year trying to understand what the order meant, but we decided ultimately that it did not require any changes in our equipment purchases.

MR. MARTIN: Steve Ryder, are tax equity investors or lenders showing any concern about purchases of Chinese transformers, panels, inverters or batteries or that such items, if purchased, might have to be replaced?

MR. RYDER: No, we have not heard that kind of concern from tax equity investors. When it comes to things like batteries, our view is we do not see a risk to the bulk-power system.

MR. MARTIN: Both tax equity investors and lenders push the replacement risk off on the sponsor, correct?

MR. RYDER: Depending on the transaction, yes. We do not believe the risk is significant.

MR. MARTIN: James Marshall, same answer?

MR. MARSHALL: Yes. We were asked questions when the Trump executive order first came out, but the issue seems to have died down. I agree with respect to risk allocation.

MR. MARTIN: Vishal Kapadia, the other big issue related to China of course is the Xinjiang region of western China and Uighur forced labor. Congress has been threatening to block entry of any equipment that uses material or components made in Xinjiang. Have you seen this play a role in any financing, and has it affected your equipment procurement? The solar industry issued a tracing protocol in late April.

MR. KAPADIA: We do everything we can to ensure that no forced labor is used for solar modules within our supply chain. We signed the solar industry forced-labor prevention pledge. We are following the tracing protocol. Global supply chains are not always fully transparent.

There is an incremental focus on equipment manufacturers that are relatively insulated from the issue: First Solar as an example. It may be that, depending upon how things evolve and how the tax equity market ultimately responds to the issue in terms of risk allocation, that we need to think about deferring some investments or accepting lower economics or an adverse IRR impact while we work through the concerns around forced labor and perhaps focus on equipment vendors who are less exposed to it.

It is a discussion that has come up in passing with tax equity investors. You would expect their initial positions to be to push the risk off on sponsors. There is an education process going on across the market.

MR. MARTIN: Has anyone changed solar panel suppliers for fear of Uighur issues? At least three solar panel manufacturers have acknowledged publicly that they source polysilicon from the region. Various publications have also identified four polysilicon suppliers as benefitting potentially from Uighur labor.

[Silence] I will take that as a no. It is easy in financing discussions to push these risks off on the sponsors.

Inflation

MR. MARTIN: Steve Ryder, 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. RYDER: I think everyone is thinking about inflation these days. One challenge is that a number of PPAs signed recently have flat electricity prices as opposed to having CPI adjusters. If you have such a contract, then you need to think more carefully about how the cost side of your project might be affected by inflation over the PPA contract term. This has become top of the mind lately.

MR. MARTIN: Meghan Schultz, how are you thing about inflation?

MS. SCHULTZ: We are seeing the impact of inflation through commodity price increases in the near term. They are affecting projects that we will have under construction over the next 12 months. These are projects where we may have already entered into a fixed-price build-transfer agreement or PPA. In many cases, inflation risk is on the sponsor. There is also interest-rate risk. The challenges are around all of those.

MR. MARTIN: James Marshall, how is inflation playing into what you do?

MR. MARSHALL: We are also seeing some wage inflation. The labor market is tight, in particular for the workforce we are trying to hire to build our solar facilities. We see less such pressure in the wind market. We are trying to sign up the EPC contracts earlier as a way of locking in prices.

MR. MARTIN: Vishal Kapadia, are you interested in project bonds, which of course are fixed-rate debt, as opposed to the floating-rate debt that tends to be used to finance projects?

MR. KAPADIA: We have a parent with a large balance sheet, so we probably have more options than most developers. Project bonds are just one option.

MR. MARTIN: Meghan Shultz, is there any talk at Invenergy of moving to project bonds?

MS. SCHULTZ: I am not sure they are the answer to some of the issues we are seeing. Project bonds are only suited to certain types of long-term financing. The project has to be of a certain size and have the right type of offtake agreement. We always look at them as an option, but I don't think how we look at them has changed in the current environment.

MR. KAPADIA: I think the message from all of us is costs are meaningfully escalating across the board, whether it is underlying commodities costs, pressure on the transportation side, the balance-of-plant side, insurance, recruiting. It is across the board, and then you layer that against a backdrop where interest rates are drifting up. The implication of all this is that the utility and corporate customers for the electricity, who have benefitted over the past five to seven years from continued declines in energy pricing, need to start to condition themselves to paying a bit more for electricity.

MR. MARTIN: Of course that is fine for future contracts, but if your costs are going up for existing contracts that you can't change, you are kind of stuck, right?

MR. KAPADIA: That is certainly the case in some instances. To an extent, what happens depends on the offtake counterparty and the strength of the relationship. Most offtakers are willing to be constructive, certainly in cases where it comes down to either there is a project or there is not.

MR. MARTIN: We are down to the last two minutes. Andrew Nourafshan, have you seen any changes in the willingness of lenders to do back-levered debt or in the interest rates, tenors, debt-service-coverage ratios or other terms for debt?

MR. NOURAFSHAN: Not really. The only change has been a reversion to where we were pre-COVID. There was a bit of a spike in pricing and coverage ratios early last summer. The concerns that led to that have largely been assuaged. General lender appetite remains strong, and there is a lot of appetite for projects among back-levered lenders. We are seeing pricing and sizing trending in the direction the developers want.

MR. MARTIN: Meghan Schultz, where are current spreads for back-levered debt today: 125, 137.5, 175 basis points over LIBOR?

MS. SCHULTZ: I think it depends on the profile of the project and the offtake contract. You can get something at the tighter end of that spectrum for a well-structured project.