The Road Ahead

The Road Ahead

January 01, 2007

Two factors have great influence on winners and losers in the US energy market: oil prices and government policy. Private equity and hedge funds rushing to pour money into renewable energy and biofuels projects need look no farther than a chart that the American Wind Energy Association uses as part of its lobbying effort on Capitol Hill to see the role of government policy. The chart shows dizzying rates of growth in new wind farm construction during periods when production tax credits are available. Construction of such projects grinds to a halt when the credits expire. The same pattern emerges in other key sectors. Almost all segments of the US energy market are affected by government policy. A new Congress takes office in January with the Democrats in charge of both houses for the first time in 12 years.With them may come a new energy agenda. The following is a transcript of a conversation in December among four veteran energy lobbyists in Washington about what to expect in 2007 from the new Congress. The panelists are Rich Glick, director of government affairs for PPM Energy, the number two US wind developer, and a former senior policy advisor to the US energy secretary during the Clinton administration, Jonathan Weisgall, vice president for legislative and regulatory affairs for MidAmerican Energy Holdings Company, the holding company thatWarren Buffet uses to invest in the US power sector, Gene Peters, chief lobbyist for the Electric Power Supply Association, the trade association for the US independent power industry, and Joe Mikrut, a lobbyist with Capitol Tax Partners and a former lawyer with the Joint Tax Committee staff in Congress and former senior Treasury

official. The moderator is Keith Martin with Chadbourne in Washington.

Renewables

MR.MARTIN:We are talking about what the next Congress might do on energy and taxes related to energy in 2007. Let’s start with renewables. In my mind, renewables and biofuels are different things.“Renewables” refers to power projects that run on renewable energy, like wind farms or solar installations.“Biofuels” are ethanol and biodiesel. Rich Glick, Congress just extended the deadline by another year to December 2008 to place most renewable energy projects in service to qualify for production tax credits worth about 33¢ per dollar of capital cost in a typical wind farm and worth less in some other kinds of renewable energy projects. It also gave developers until December 2008 to put new solar projects in service and qualify for a 30% investment tax credit. Will Congress extend these deadlines again in 2007?

MR.GLICK:We hope so. One potential opportunity is the agenda that the new speaker of the House, Nancy Pelosi, will be trying to put through the House in the first 100 hours of the new session. She has already said that one of the items on the agenda will be elimination of a number of oil and gas tax incentives that were adopted in the Energy Policy Act of 2005, and with that comes some additional money that could be used potentially to extend the production tax credit further.

MR.MARTIN: Do you think the next extension will be for more than one year?

MR. GLICK:We hope that the credit will be extended on a longer-term basis because that would bring down the cost of wind, geothermal, biomass and other renewable energy projects. Unfortunately,we are living in a constrained budget environment that might be even more constrained if the new Democratic leaders put Congress back on the old pay-go system. If Congress returns to pay-go, it will be more difficult to get the production tax credit extended on a long-term basis.

MR.MARTIN:“Pay-go” means that Congress cannot enact new tax subsidies, or extend existing ones, unless it finds a way to pay for them either by raising other taxes or cutting spending?

MR. GLICK: Yes.

MR.MARTIN: Joe Mikrut, you are close to the tax committees. How likely is it that Congress will extend production tax credits again in 2007?

MR. MIKRUT: As Rich Glick said, the House will be trying in the first 100 hours to carve back some of the tax benefits provided to large oil companies. This could free up $3 billion in estimated revenue. A one-year extension of the production tax credits costs a little less than $3 billion. The revenues associated with the two items match up rather well. The production tax credits are popular items and are relatively easy to extend. On the other hand, there are other segments of the energy industry that were given benefits in the Energy Policy Act of 2005, but were left out of the “extenders bill” in December.They will also be seeking extensions or additional funding for their tax provisions. There are other groups that want policy changes in the existing statute — such changes would absorb revenue — and there are always “new starters.” In the end, there will be a pot of money, but it won’t be there for long. I think Congress will be looking to dedicate whatever it saves from cutting back tax benefits for the large oil companies on some combination of tax incentives for energy efficiency, renewables and alternative fuels.

MR.MARTIN:What you both have been talking about is the first 100 hours in the House. A bill must pass both houses of Congress to become law.What is the timing in the Senate?  

MR. MIKRUT:My understanding is that the 100-hour bills will not go through the House committees. Rather, the House leadership will assemble the bills, with input from the committee chairmen, and go directly to the House floor. It is relatively easy in the House to legislate quickly because of the restrictive rules on floor debate and amendments. However, once the bills get to the Senate with its more open rules, they become magnets for amendments. Thus, the Senate will be on a much slower track.Whatever tax legislation that is ultimately enacted in 2007 may emerge from the budget reconciliation process.That process usually takes at least six to nine months to play out fully.

MR.MARTIN: So we are talking late summer or early fall before anything makes it all the way through Congress, at the earliest?

MR. MIKRUT:That’s right. In the normal order of things, tax bills are taken up early in the year in the House and then sent over to the Senate, where they are debated later in the year.

MR.WEISGALL: I think one countervailing factor that may come into play is that the recently-enacted one-year extension of the production tax credit will make the extension question less urgent.That probably militates in favor of a longer-term extension, but that issue may move to a back burner because the credit has just now been extended through the end of 2008. The Democrats insist they are serious about promoting renewable energy. Renewable energy has become mainstream. You hear frequently in Washington that “green has become the new red, white and blue.”The one-year extension was terrific, but it could have a backfire effect because it will reduce some of the urgency for Congress to act quickly on yet another extension.

MR.MARTIN: The solar credit — does anyone have a feel for whether the 30% solar credit is likely to be extended at the same time?

MR.MIKRUT:The production tax credit and the solar credit have been moving in lockstep, and I expect the staffs to keep them together.My understanding is that some of the larger, concentrating solar projects are not as nimble as other renewable projects and may have a more difficult time getting siting, financing and construction done within the extra year provided by the extenders bill.They may need something more, but it will be up to the proponents of those projects to press their case in the new Congress.

MR.MARTIN: Rich Glick, you and I participated in a panel discussion at a wind finance conference in October in New York. Elizabeth Paris and John Gimigliano from the Senate and House tax writing committees were a little less optimistic than the audience hoped that the production tax credit would be extended at full value. They said there is not the money to extend the credit indefinitely. Many members, particularly on the House side, thought the subsidies were supposed to be temporary, and they are frustrated that the industry keeps returning year after year to extend them. None of the discussion so far has suggested there is any doubt the credits will be extended again; it is just a matter of timing. Are there questions about the amount or whether the credits will be extended at all given what these two key staff members said?

MR. GLICK: The production tax credit is more costly to the federal treasury each time it is extended.That’s due primarily to the success of the program. As more renewable generation gets built, more tax credits are claimed.What Elizabeth and John were saying is the program is getting too costly to survive much longer, and that is a big concern. The renewables industry believes it needs a long-term extension to spur investment in things like new factories to make wind turbines.That is what will move us to a point where we no longer need the credit; scale brings down turbine costs to a level where these projects can compete with other power plants on a more equal footing. At the same time, as the credit gets more expensive, it becomes more difficult to get through Congress.We are essentially in a Catch-22 situation. We may see Congress at some point either phase out the tax credit or reduce the value.

MR.MARTIN: It sounds like you would bet that Congress will not phase out or cut back the production tax credit in the near term, and that the deadline to complete projects will be extended at least one more time.

MR. GLICK: I think we are confident of that, but we are not confident of a long-term extension because of the fiscal constraints.

MR.MARTIN: Joe Mikrut, in your rounds on Capitol Hill, are you hearing any complaints, perhaps related to the cost of another extension?

MR. MIKRUT: No more than any of the other extenders. I think the staff is going to examine everything. These provisions that expire periodically — and I am not talking just about the energy credits but also provisions like the research and employment tax credits — have been extended almost by rote in the past. Congress has always found a way to extend the entire package, sometimes while finding a way to pay for the extension and sometimes not. It was much more difficult to extend the entire package in the last Congress. Most of the nonenergy extenders expired at the end of 2005, but were not extended until December 2006. The list of energy and nonenergy extenders has also gotten longer and there is a oneyear gap between some of their expiration dates. In general, the energy tax extenders expire at the end of 2008 while the non-energy extenders expire at the end of 2007. In addition to the extenders, a top priority for the incoming Democratic Congress will be enactment of a “patch” to spare middle class taxpayers from having to pay additional alternative minimum taxes.When you start adding up the one-year cost of all the extenders including this AMT patch, you are getting close to $100 billion.That fiscal cost has gotten everyone’s attention. The cost will force the tax-writing committees to examine all the expiring provisions. The proponents will be asked to justify why their provisions should be extended once again. The whole extenders package has become too large, too expensive, and too unwieldy, but my guess is Congress will find a way to renew most of them again.

National RPS?

MR.MARTIN: Switching gears, Gene Peters, do you think a national renewable portfolio standard will be enacted in 2007? In other words, will Congress require US utilities to supply a certain percentage of their electricity from renewable sources? Many states already do this.

MR. PETERS: The idea has tremendous support within the Democratic caucus. It has been a personal priority of the incoming chairman of the Senate Energy Committee, Jeff Bingaman (D.-New Mexico). A national RPS has had majority support in the Senate in recent years. There is an excellent alignment of the political stars on this one. Whether the Bush administration will embrace it is another matter. I don’t see a ton of really hard-core opposition in the House or Senate. I think it is a question of finding the right vehicle and trying to see whether they can navigate it through the White House.

MR.MARTIN: Are the regulated utilities putting up much of a fight against a national RPS?

MR. PETERS:My members, to be honest, are split on this one.We have not taken a position as a trade association on whether Congress should adopt a national RPS. I don’t think the utilities as a group are rolling over, but there are utilities that either are already operating in states that have very significant renewable portfolio standards and others that would rather have a common standard that applies nationally than have to grapple with different state rules.

MR.MARTIN: Jon Weisgall, what is your prediction about a national RPS?

MR.WEISGALL: I think it will be a top priority of the incoming Democrats. I don’t see a lot of opposition to it. You have a situation in the west where renewables, particularly wind, are almost the only resource that is being embraced. One of the issues may be what type of RPS will capture the 60 votes that measures need today to pass in the Senate.Will it be a pure renewables RPS, meaning primarily wind, solar, geothermal and biomass, or will we see nuclear and possibly some kind of clean coal technologies defined as renewables?

MR.MARTIN:What about hydroelectricity?

MR.WEISGALL: Small incremental additions to existing hydroelectric dams are always there.The real controversy will be whether to try to buy votes from conservatives by adding nuclear and clean coal. A national RPS may also be seen by some players as a way possibly to stave off a carbon regime or other stiffer action to combat global warming. The fact is that with nearly half the states having already enacted renewable portfolio standards, the utility industry is getting comfortable dealing with them. That’s another factor that might mitigate in favor of a federal RPS passing in 2007.

MR.MARTIN:Will this be something that is dealt within the first 100 hours in the House?

MR. PETERS: Not in the first 100 hours.

MR. GLICK: I agree with that. The Senate has voted for a national RPS on three separate occasions, only for it to die in the House where it has never actually been voted upon.The new House leaders are likely to support a national RPS. On the other hand, it is a complicated proposal. The House has not had a lot of experience with it. It is likely to have to go through the normal committee process. There is still some uncertainty in the House about whether there are the votes to move it out of the House Energy and Commerce Committee. It think it has to survive a couple hurdles before we can say it will be enacted.

MR.WEISGALL: It is not a 100-hour measure. Forgetting clean coal and nuclear for a minute, how are you going to define “renewables”? If you look at the 20 or so states that have these standards, there are already varying definitions. Part and parcel of a federal RPS will be the development of a national renewable energy credit trading program.That’s not something that you can do in 100 hours. I agree with the others: this will take time. It will go through the normal channels because of the complexity and some of the competing policy issues.

MR.MARTIN: Rich Glick, what percentage will the federal government adopt as the RPS target?

MR. GLICK: In the past, the Senate has adopted an escalating target that would require utilities eventually to supply 10% of all their retail electric sales from renewable energy. There have been other proposals for as much as 20% on a national basis. If I had to bet, I think Congress will lean more toward 10% than 20% by 2020.

MR. PETERS:The number will depend on how the word “renewables” is defined.

MR.MARTIN: If a national RPS is adopted, what happens to the state renewable energy credits that may have been purchased under long-term contracts? Are they swept away?

MR. GLICK: No, I don’t think so. I am basing my comments mostly on the legislation that passed the Senate and was sponsored by Senator Jeff Bingaman (D.-New Mexico).That measure actually had a specific provision that notes that states can have their own programs and exceed the federal requirement. To the extent a state has already adopted a program with renewable energy credits, or decides in the future to adopt such a program, the federal legislation would not hamper or do anything to impair the state credits.

Bush Budget

MR.MARTIN:Okay, new topic. The Department of Energy has been surveying people in the renewable energy industry for ideas to include in the Bush budget at the end of January. Has anyone heard what might be in the budget to promote renewables?

MR. GLICK: PPM Energy has been working with MidAmerican and a large number of other companies to persuade the administration to include a long-term extension for the production tax credit in the budget. Fifty-four Congressmen and 42 Senators recently sent letters to the President urging him to include a five-year extension in his budget.What I have heard, and this may turn out to be pure conjecture, is the administration is thinking of proposing a long-term extension for the production tax credit, but phasing out the credit over the same period. For instance, one might get full value in year one, but by the fifth year, the credit would be worth only half the value it had in the first year.

MR.WEISGALL: I think it is important to link our first two topics, because they are closely related: a production tax credit and a renewable portfolio standard. Let’s face it; an RPS is a stick. A production tax credit is a carrot. Reasonable people can differ about which is the better policy prescription. I would argue that combining the two makes a whole lot of sense.Ultimately, a production tax credit without a renewable portfolio standard works. You have an incentive to put in renewable energy.However, to have a mandate without the tools to implement it is tough.We are seeing that in California.We are seeing it in the renewable field as a whole other than wind.Wind is nimble. Biomass, incremental hydro and geothermal are more or less baseload renewables. There is a lot to be said for combining the carrot with the stick. As for what we are likely to see in the Bush budget, the production tax credit is a lot like location in real estate. It’s the first, second and third priority if you want to achieve a goal of getting renewable megawatts on the ground in any reasonable time period.

MR. PETERS: The only thing that I would add is the Bush budgets haven’t had that much impact on Capitol Hill for the last six years, and that was during a period when the Republicans were in control. This one will be even less meaningful than the ones in the past.What is more important is what signals go up to the administration from Congress.That’s why the letters that Rich Glick mentioned may be more important than what shows up in the budget.

MR.WEISGALL:We are assuming the Democrats will stay disciplined on pay-go budget rules. No one has questioned that during this conversation.

MR. MIKRUT: It’s not 100% clear. First, they have to put the pay-go rules in place, so it is a question of whether and where they sit within the first 100 hours. Congress may adopt some of its priorities before imposing a pay-go requirement. Another unknown is that even though pay-go traditionally has meant that there must be a dollar-for-dollar match between tax expenditures and revenue raisers, Congress does not necessarily have to resurrect that rule, or may phase it in over time. For example, there is growing concern in Congress about the reach of the individual alternative minimum tax. Any significant fix could cost hundreds of billions of dollars over time. Congress may make an exception from the pay-go rules to fix the AMT problem. So although the new Congress may want to bring back some form of budget discipline, it is not clear exactly what form the new pay-go rules will take.

MR.WEISGALL: The key dilemma facing the Democrats on tax benefits for renewable energy projects is how to pay for them, and renewable energy is not the only priority on the Democratic agenda. The incoming House Ways and Means chairman, Charlie Rangell (D.-N.Y.), has said that his primary goal is some form of AMT relief. Those numbers are staggering. You are looking at something like $45 billion annually.

MR. PETERS: I could not agree more. The Democratic party as a whole strongly supports renewables, but if you look at key members of Congress, Charlie Rangel’s number one, two and three priorities are AMT relief. The AMT is hitting his constituents hard right now. There is another point: the more cynical among us might say that the Republicans were not the most fiscally-conservative or disciplined party while they were in the majority, but now that they are in the minority, look for Republicans to return to those roots. We could have a very interesting situation develop where a moderate,“blue-dog” coalition of southern Democrats teams with a newly-empowered fiscally conservative and disciplined Republican minority. You could find it much more difficult than we have been suggesting to enact anything that costs money.

Global Warming

MR.MARTIN:That is a recipe for gridlock. Let me go to another big topic: carbon controls or global warming. Let me start with Jon Weisgall.Will anything happen on global warming this coming year, and if so, what?

MR.WEISGALL: The quick answer is no. I think that the Senate Environment Committee, chaired by Senator Barbara Boxer (D.-California), will start looking immediately into the possibility of some kind of mandatory carbon controls. There will be a lot of issues to address, including whether to adopt a carbon cap or a carbon-intensity form of legislation. I do not see anything being enacted in 2007. Carbon controls are more controversial than a renewable portfolio standard and, even if a bill passes the Senate, I think it is going to run into some potentially serious roadblocks in the House. You have two new incoming House chairmen — John Dingell (D.-Michigan), the incoming chairman of the House Energy and Commerce Committee who is going to look out for the automobile industry, and Nick Rahall (D.-West Virginia), the incoming chairman of the House Resources Committee and a strong supporter of the coal industry. But the potential opposition in the House is a secondary issue. This legislation will have a tough time coming out of the Senate, notwithstanding the fact that even the frontrunners for the Republican presidential nomination in 2008 — not only John McCain, but also other folks who are not even in Congress — are all supporting some form of carbon legislation. The power industry believes some form of carbonconstrained regime is coming, but I don’t think it is coming next year.

MR.MARTIN: Rich Glick, do you agree?

MR. GLICK: I agree that a consensus about what to do will be very difficult to find, especially on the House side where the key committee chairman will be very concerned about the impact of climate legislation on the industry. Having said all that, I think the irony is some utilities that burn coal, some car companies and other coal extracting companies may see this as their last best hope. If a president is elected in 2008 who is a strong supporter of stringent limits on greenhouse gas emissions and if the 2008 elections bring in another class of incoming freshmen to Congress who strongly support action on global warming — Senator Boxer, for instance, is looking for the California-type approach — it may be possible for those who oppose controls to do much worse. There is already talk within the utility industry of trying to get a deal done now when President Bush is in office.

MR.MARTIN: Rich Glick, some utilities that are planning to build new coal-fired power plants believe that it is best to rush those plants into service, figuring the plants will be exempted or “grandfathered” from any new carbon controls. Is that a reasonable bet?

MR. GLICK: It is a gamble. There is a very real possibility that when Congress does get around to adopting a greenhouse gas limit, it may not grandfather plants that were built in the last five or 10 years. Or Congress may adopt some sort of compromise approach. Utilities may see this as a slam dunk.They need to weigh the risk that they may not get everything they anticipate.

MR.MARTIN: Gene Peters, if Rich Glick and Jon Weisgall are correct, Congress is unlikely to act on global warming in 2007. Do you think such action is more likely in 2008?

MR. PETERS: In Washington we talk about each Congress as a two-year enterprise.My guess is that what Congress fails to do on this in 2007, it will also fail to do in 2008. I expect the new Congress to end up with a stalemate in a lot of areas, including a comprehensive carbon control regime. That said, what fundamentally is changing is that the dialogue on global warming is moving into a new, more serious phase. The analysis, the hearings, the attempt to work out the very significant compromises and regulatory changes that will be required to take action in this area are beginning in earnest. The political consensus needed for action is not yet there, but we are getting a lot closer to it.My members are taking the debate that is just starting in the House and Senate very seriously.We are actively trying to create our own climate change policy statement. There zero chance of action in the next two years in Congress, but the debate this year and next will shape what happens ultimately.

MR.WEISGALL: Let me add to what Gene just said. Even in the Senate, I think Gene is right. People are taking a serious look at this, but you need 60 votes to get legislation passed in the Senate. There are already a large number of very interesting proposals on climate change in the Senate, but there are so many different approaches that I wonder if the Senate can coalesce around one approach in a year. You have Senator Bingaman and the National Commission on Energy Policy. There is a McCain-Lieberman bill with an economy-wide carbon cap. Each has different target levels of reductions by different target years. Senators Boxer and Carper, Representative Waxman and some environmentalists have proposed different kinds of power-sector-only carbon caps. There are tax proposals, such as a straight Btu tax and a carbon tax on fossil-fuel plants. It will be hard to coalesce around one plan in one year. The second point I want to make is this: don’t discount the pressure from environmentalists, the nuclear industry, and possibly even technology vendors for mandatory action on carbon.

MR.MARTIN:Won’t that pressure also come eventually from power companies who are under pressure from shareholders to disclose the expected cost of future carbon controls in their annual reports and from regulators to control other pollutants besides carbon? Power companies would like to know sooner rather than later what they are required to do about carbon so that they can address it at the same time as other emissions.

MR. PETERS: I agree. One more point is worth stressing: no one is discounting the California proposal or the regional greenhouse initiative in the northeast. These are real programs that are already in place. My members are investing in power plants in these parts of the country that already have carbon controls. The plants will run for the next 20, 30 or 40 years. Carbon controls at the state level are already an important part of the equation.

Biofuels

MR.MARTIN: Switching now to a series of short topics, let me start with Joe Mikrut on ethanol and biodiesel.The current tax credits and excise tax reductions run out at the end of 2008. There has been talk about extending them as part of a farm bill. Any idea what the timing would be and how long an extension is under discussion?

MR. MIKRUT: I am not sure the Senate Finance Committee has settled on a proposal yet, but I have heard that the farm bill may be a likely vehicle.

 MR.MARTIN: The tax extenders bill that just cleared Congress allows 50% of the cost of any new plant to make cellulosic ethanol to be deducted immediately. The remaining cost would be recovered over the normal depreciation period. Joe Mikrut, any idea how that tax benefit made it into the extenders bill?

MR. MIKRUT: The Energy Policy Act of 2005 had a provision that allows a similar 50% write-off for the expansion or construction of oil refineries as an inducement to the oil companies to add to existing refinery capacity. This was a provision Congress enacted late in 2005 in response to high gasoline prices. Since cellulosic ethanol is viewed as a longrun substitute for gasoline, Congress decided to provide the same benefit to cellulosic ethanol plants.

Other Issues

MR.MARTIN:Next topic, tax credits for advanced coal and gasification projects. The Internal Revenue Service announced in November how $350 million in tax credits for gasification projects would be shared among a large number of competing applicants. The credits cover 20% of the cost of such projects.They were authorized in the Energy Policy Act in 2005. Almost all $350 million in credits went to just four projects, and no credits were allocated to coal-to-liquids projects. Joe Mikrut, have you heard any talk on Capitol Hill about either authorizing additional credits or gripes about how the allocations were handled?

MR. MIKRUT: I have heard complaints about many of the allocations. I think the IRS and Treasury had a very difficult task in trying to allocate the all the new credits authorized by the Energy Policy Act. These credits generally deal with subject matters that are foreign to most tax professionals. The Department of Energy may be in a better position to evaluate the worthiness of competing projects and allocate the credits. There has been a bit of controversy in the way the IRS and