Build Back Better (BBB)
The responses to these questions are based on the version of the Build Back Better bill that the Senate Finance Committee approved on December 11, 2021. The bill stalled in the Senate without the votes of Senators Manchin (D-WV) or Sinema (D-AZ).President Biden has acknowledged the bill will need to be broken into multiple bills.
Senator Manchin said, "The climate thing is one that we probably can come to an agreement much easier than anything else." This comment may have been what Senator Wyden (D-OR) was thinking of when he said "I think the climate piece offers a path forward." In contrast, Senator Boozman (R-AR) described the climate provisions as "a far left agenda" that is "opposed by every Republican in the Senate." That is a bit of an overstatement as two Senate Republicans, Murkowski (AK) and Graham (SC), have indicated they could support some form of the climate provisions Democratic leadership wants to address voting rights at the moment, and it is not clear if that effort could become a quagmire for the Senate.
1. Which components of BBB do you think would survive in a standalone climate bill?
Answer: The 30 percent investment tax credit (ITC) for energy storage seems like the most widely-supported provision because it would allow for an ITC without regard to the charging source (e.g., storage projects that are charged by coal or natural gas fired plants).
In addition, Senator Manchin is unlikely to support any bill that does not have increased tax credit for, renewable energy projects sited in or adjoining census tracts that have at least five percent of their employment in the oil and gas sector, a coal mine that closed after 1999 or a coal-fired electric plant that closed after 2009. Similarly, the expansion of tax credits for carbon capture and sequestration, in section 45Q, are likely be required by Senator Manchin as they are an opportunity for "clean coal."
Although slightly less likely than those two proposals, a long-term extension of a 30 percent ITC and a US$25 per MWh production tax credit (PTC) have a very good shot (page 3). The electric vehicle tax credit extension has opposition from Senator Grassley (R-IA) as electric cars do not use ethanol from corn grown in Iowa, and others view it as a subsidy for the wealthy. The rules around domestic content (page 7) and the rules about paying Davis-Bacon wages and employing apprentices (page 4) have more ideological opposition and are more vulnerable to being ultimately left out.
Direct pay has a fairly good chance of being included as well since the "scoring" cost is minimal as the economists that score the budgetary impact of the bill generally view a one dollar expenditure for a payment as having the same cost to the fisc as a one dollar tax credit. Therefore, excluding direct pay does little to reduce the cost of the bill.
2. Reconciliation can only be used once per year. Do you think Biden will use reconciliation for a climate change-only bill? If not, is there any chance of reaching Senate 60 votes?
Answer: President Biden would want to include the climate provisions, plus anything else that relates to raising revenue or spending that he hopes to pass in 2022. Essentially, he needs to sit down with Senators Manchin and Sinema and ask them what they want the Democrats to accomplish in 2022 related to taxes and spending and include all of those provisions in a bill with the climate provisions. From there, he has to persuade left wing of the Democratic caucus in the House to support it, despite the fact that the bill would not have many of their social spending priorities in it; fortunately, that segment of the House appears to have come to grips with that reality.
It seems unlikely that the climate change provisions could garner 60 votes. The New York Times only found two Republican Senators prepared to tepidly support the climate provisions. Senator Grassley, who considers himself the father of the production tax credit (PTC), may be able to be added if the electric vehicle tax credits were left out in order to avoid harming the ethanol industry in Iowa. Further, Senator Collins (R-ME) is historically a supporter of renewable energy, but that still leaves a climate bill six votes short of the 60 needed to overcome a filibuster without using the budget reconciliation rule.
3. Will apprentice and wage requirements (page 4) apply to both solar and wind projects raising capital using traditional tax equity, or is this something specific for electing direct pay?
Answer: Those rules would not distinguish between solar or wind; however, projects that have a capacity of less than one megawatt are excluded (page 4). The apprenticeship and prevailing wage requirements would apply whether the project's owner claims actual tax credits or applies for a direct payment. This is in contrast to the domestic content rules that only apply if the project is under direct pay or is seeking to qualify for a larger tax credit by satisfying the domestic content requirements.
4. Can you discuss the increased ITC above 30 percent (e.g., census tract, coal reclamation) under the proposed BBB text?
Answer: Qualifying projects can receive an additional 10 percent credit if located in a low-income community or on Indian land, or an additional 20 percent credit if the project is a qualifying low-income residential building project or a low-income economic benefit project. As discussed above, a 10 percent greater tax credit would be available for renewable energy projects sited in or adjoining census tracts that have at least five percent of their employment in the oil and gas sector, a coal mine that closed after 1999 or a coal-fired electric plant that closed after 2009.
5. Can you discuss incentives for clean hydrogen included in BBB?
Answer: It would provide any project producing "clean hydrogen" the choice of a PTC of up to US$3 a kilogram for 10 years on the hydrogen produced or an ITC of up to 30 percent of the cost of the electrolyzer and other equipment. Additional details are available here.
6. What is the likelihood that an ITC for biomass projects that generate renewable natural gas (e.g., jet fuel) is enacted?
Answer: BBB would not change the requirement that to be eligible for ITC that the project must generate electricity. If the project generates both electricity and natural gas, the tax basis of the project has to be allocated between those two activities and only the portion allocated to electric generation qualifies for an ITC. See WestRock VA Corp. v. U.S. (Fed. Cir. 2019).
1. Would direct pay be a refund subject to the statutory review mechanism requiring review by the Joint Committee on Tax (JCT) for refunds over US$2 million (US$5 million for C-corps)?
Answer: JCT staff in informal communication have advised that they do not plan to review direct payments.
2. Regarding the direct pay disadvantages discussed (pages 5-6), are these are only disadvantages for a taxpayer with losses? If you have taxable income, then you can offset your quarterly estimates and therefore receive the benefit immediately.
Answer: If a taxpayer has sufficient tax liability to offset with ITCs or PTCs, then there does not appear to be any reason for it to elect direct pay with the associated timing issues and additional requirements. Accordingly, the disadvantages referenced in the slides contemplate a taxpayer without sufficient tax liability to offset the tax credits.
For more on direct pay, please see this blog post.
3. What about direct pay for non-taxpayers like public power?
Answer: Certain non-taxpayers are eligible to receive a direct payment. They are any organization exempt from income tax (e.g., the Sierra Club, a university), any state or local government (including a utility owned by a local government), the Tennessee Valley Authority, any Indian tribal government and any Alaska Native Corporation. (BBB would not provide a direct payment for accelerated deprecation or otherwise relax the constraints on accelerated depreciation for partnerships that include a tax-exempt partner. These rules are referenced in the third answer under "Partnership flips" below.)
4. Is direct pay the same as the previous 1603 program that was utilized during the Obama Administration?
Answer: It is a similar policy but a different program administered by a different agency. The. previous 1603 program was administered by the Treasury, while Direct Pay would be administered by the IRS. Second, from a legal perspective the 1603 cash grant program was a cash grant rather than a deemed refund of taxes.
5. While direct pay may be less favorable, how might it impact tax equity terms and conditions?
Answer: Direct pay would create a "floor" on the tax equity market. In other words, no sponsor is going to transact with a tax equity investor if the deal is less favorable than electing direct pay. Similarly, it would allow lightly capitalized sponsors that lack the balance sheet to provide the guarantee of indemnities that tax equity investors typically require to monetize the tax credits associated with their projects.
6. In a partnership setting, assuming direct pay is elected, does the cash from the direct pay need to follow the allocation of taxable income/loss between the partners?
Answer: Receipt of the direct cash payment will be treated as tax-exempt income. That income will be part of the net income or loss that the partnership allocates. The cash from the direct payment can be distributed in a different ratio. However, if it is distributed in a different ratio than the deemed tax-exempt income is allocated, then the partner receiving most of the cash may end up with a taxable excess cash distribution.
7. Would a taxpayer be eligible for a bonus in its direct payment by having its project satisfy the domestic content rules (page 7)?
Answer: It appears that it could; however, the statutory language seems less than entirely clear. See Proposed Sections 45(b)(9), (10) and 48(a)(12), (13) in the Senate Finance Committee bill of December 11, 2021. It is possible that the drafters did not fully consider this fact pattern. For instance, it seems at best odd for Congress to both (a) condition direct pay on satisfying the domestic content rules and (b) provide a direct pay bonus satisfying those rules. It is similar to a parent saying you can only have desert if you do your homework, and if you do your homework you can have two desserts. One would hope the next iteration of the bill is clearer or there is legislative history with examples.
8. How would the increase in tax credits for satisfying the domestic content rules be calculated (page 7)?
Answer: For the PTC, it would be "increased by an amount equal to 10 percent of the amount otherwise in effect," which would mean that for instance US$25/MWh is increased to US$27.50 a MWh. See Proposed Section 45(b)(9) on page 354 in the Senate Finance Committee bill of December 11, 2021.
For the ITC, "the applicable credit rate increase" would be "10 percentage points," which would mean that for instance 30 percent is increased to 40 percent. Proposed Section 48(a)(12) on page 382 in the Senate Finance Committee bill of December 11, 2021.
It remains to be explained why the drafters of the bill opted to have different math for the PTC and the ITC with respect to the domestic content bonus.
1. Can you provide estimated cost of a one megawatt fuel cell?
Answer: All-in installed cost of a utility-scale fuel cell project is US$5,000 – US$6,000 a kilowatt. Distributed-scale fuel cells are more expensive.
2. Any thoughts on why the fuel cell ITC lacks a 10 percent "permanent" ITC, while solar has that feature? Do you think the fuel cell ITC will it be increased to 30 percent and extended beyond 2026?
Answer: There does not appear to be legislative history that answers the question expressly, but presumably it was to limit the "scoring" impact of the extension. The expansion of the fuel cell ITC is dependent on the tax credit provisions in BBB being enacted.
1. What does a GAAP income profile look like for a lessor in a sale-leaseback?
Answer: The GAAP income profile for a lessor in a sale-leaseback is generally favorable relative to that of a tax equity investor in a partnership flip transaction.
Under GAAP's ASC 842, for sales-type and direct finance leases, the lessor's financial statement reporting is generally as follows:
- The difference between the "lease receivable" and "carrying value" of the leased property recorded in the income statement.
- With respect to the receipt of rent, the deemed "interest" portion is recorded in the profit and loss statement and the "principal" portion reduces the lease receivable asset on the balance sheet.
- Similar to a loan, in each accounting period the transaction would have to be evaluated for impairment losses and any necessary impairment losses recognized as an expense for income statement purposes.
Under GAAP's ASC 842, for operating leases, the lessor's financial statement reporting is as follows:
- The lessor recognizes the lease payments as revenue in the income statement received on a straight-line basis (i.e., total the lease payments and divided by the lease term).
- The lessor records depreciation (GAAP, not tax) expense straight-line over the economic useful life of the asset.
2. Can you share more about developers "carving out" land via sale-leasebacks and getting cash out?
Answer: Land does not qualify for tax credits or accelerated depreciation, so it provides its owner no tax efficiency. Further, the cost of capital to acquire land is much lower than the cost of capital to acquire or build a project. Accordingly, the owners of renewable energy projects are different types of investors. Thus, it often makes sense for a relatively low cost capital provider that is not interested in tax benefits to own the land. This leads project companies that own land selling it and leasing it back, which can be a means of raising cash; alternatively, the project company may lease the land from the original landowner from the outset. Land finance is a growing and changing area of renewable energy finance. For more on this topic, please see this article.
3. Is the restriction on sale-leaseback to ITC projects (page 15) a de facto economic one or by tax law?
Answer: It is a function of the tax law. Section 45 is the PTC statute. Section 45(a)(2) provides that to be eligible for the PTC the electricity has to be "produced by the taxpayer" and "sold by the taxpayer to an unrelated person." In a sale-leaseback, the lessor wants the tax credit, but it is neither producing the electricity nor selling it as those are the responsibilities of the lessee, which operates the project. However, there is an exception for open-loop and closed loop biomass: "if the owner of such facility is not the producer of the electricity, the person eligible for the credit allowable under subsection (a) shall be the lessee or the operator of such facility." Section 45(d)(2)((C)(ii), (d)(3)(C).
Market for PPAs
1. Other than prices, what other characteristics of PPAs have changed making them more developer friendly?
Answer: LevelTen Energy conducted a survey among developers and observed the following terms:
(i) Upside sharing between developers and off-takers.
(ii) Delayed PPA start that allows project go merchant from completion until the PPA start date.
(iii) Certain flexibility if the project fails to reach development milestones.
2. We have seen PPAs are not particularly efficient in hedging in some severe circumstances. So, would you say the appetite for merchant projects changed?
Answer: We do not see an increased appetite for merchant projects from lender and tax equity investors. Hedging structures are changing; for instance, tax equity investors no longer want hedges that use assumed production levels pursuant to which the project company has to pay the hedge provider the market price for the assumed production levels, even if the project company is unable to produce due to weather or other unexpected events.
3. Can you speak to the difference between carbon offsets and PPA/RECs in the market?
Answer: Carbon offsets come from different kinds of projects that lower, remove or avoid emissions; RECs are generated by renewable energy projects. Voluntary market for carbon offsets in the US is small but growing. One of the key challenges in the carbon offset market is the absence of quality control / rating mechanism that would be reflected in carbon offset pricing. REC markets are more robust.
4. Regarding PPA prices, can you review what was said about the year-over-year increase on solar PPA prices?
Answer: According to a Q4 2021 report by LevelTen Energy, solar PPA rates increased by 12.1 percent year-over-year and wind PPA rates increased by 19.2 percent year-over-year.
5. How are crypto currency companies providing credit support for energy procurement from utilities?
Answer: Several approaches have been used in power procurement by cryptominers that avoid buying power from utilities: PPAs with merchant power generators, joint ventures between power producers and cryptominers and acquisition of power plants by cryptominers. For more on this topic, please see this article.
1. What would you say is motivating these partnership flip sandwich structures (page 13)? Is the cost of capital against the cash flows more attractive through this method as compared to back-leverage debt on the developer side?
Answer: A developer would need to compare the weighted average cost of capital under (i) the partnership flip sandwich structure against (ii) what can realistically be achieved in the market via a more traditional structure with sponsor equity, tax equity and back-leverage debt. The partnership flip sandwich structure might be attractive when developer has short-term cash needs or has limited access to tax equity and back-leverage, e.g., a portfolio of projects with commercial and industrial (C&I) hosts or a project in a new asset class with technology risk.
2. What level of deficit restoration obligation (DRO) do you find that tax equity investors that are not banks are comfortable with?
Answer: tax equity investors are idiosyncratic in their DRO preferences – from zero DRO to an unlimited DRO. Constraining a DRO can reduce the tax efficiency of a transaction. Generally speaking, a DRO is highly unlikely to be triggered, absent a foreclosure by a secured lender; the DRO implications of a foreclosure is one of the reasons that tax equity investors, typically, prefer back leverage (i.e., debt secured by only the managing member's interest).
3. Do you know of any examples of using a flip structure for municipal facilities?
Answer: A tax equity partnership owning solar installed on a municipal property is quite common. Typical examples include school buildings, fire stations, town landfills, policy department buildings and jails.
Having a municipality be a partner in a partnership flip is rare to unheard of due to the tax-exempt use property rules that would require it to invest through a domestic blocker corporation to avoid disqualifying up to 95.05 percent of the ITC and triggering straight-line depreciation over the class life (12 years for solar generation equipment). That percentage is the highest allocation, at any point in time, that would be allowed by the flip partnership safe harbors in Rev. Procs. 2007-65 and 2014-12, and the tax-exempt use property rules disqualify the highest percentage the tax-exempt party is theoretically entitled to, even if the tax-exempt partner is not entitled to that percentage at the outset. See Section 168(h)(6)(C); Section 50(b)(4)(D).
1. What are the tax metrics ranges, especially the return requirements, for carbon capture (section 45Q)?
Answer: There has not been a tax equity financing yet, much less a settled market. Presumably, the returns for the tax equity investor will have to be meaningfully higher than for solar (page 17) as the tax equity investor has to be motivated to learn and underwrite carbon capture projects and take risks (e.g., recapture due to sequestered carbon being released) it has not previously had to take in solar projects.
2. What does project structure look like on carbon capture? Are these SPVs anchored with tax equity with a lease back to the utility?
Answer: This is still in flux as no tax equity financing has closed yet. Also, it is unlikely to be a case of one size fits all, and not all carbon capture projects involve utilities.
3. Given how nascent of a sector carbon capture and sequestration (CCUS) is, will there be traditional project finance debt products for these kind of projects or is it too early for anyone to lend into that asset class? Additionally, in negative cash flow projects, will sponsors be able to leverage the pay as you go tax equity contributions (PAYGO) from tax equity investors?
Answer: It is still too early to talk about traditional project finance in the CCUS context. CCUS would require comprehensive financing solutions that involve both debt and tax equity. Depending on facility, CCUS economics may rely heavily on Section 45Q tax credits. To date, no tax equity financings have been closed for Section 45Q tax credits.
PAYGO structure allows tax equity investor to contribute equity over time post-COD (up to 50 percent for CCUS). PAYGO payments are typically excluded from project cash flow available for debt service (CFADS). CCUS projects are more likely to receive tax-advantaged equity investment from oil and gas, rather than banks and insurance companies.
4. If coal is being exported, is there consideration given to where the coal is exported to if a section 45Q tax credit is being applied for? If it is a country with more relaxed environmental/pollution control rules on coal burning technologies, the net impact to climate effects would be negative.
Answer: The carbon either has to be sequestered in secure geological storage, used as a tertiary injectant, used for "fixation .. through photosynthesis or chemosynthesis, such as through the growing of algae or bacteria," used in a "chemical conversion … in which such qualified carbon oxide is securely stored," or for another commercial purpose as determined by the IRS. See Section 45Q(a)(2), (f)(5).Further, there is recapture (i.e., repayment of the tax credit) if the sequestered carbon is released within five years of it being sequestered in geological storage. It does not seem like there is much opportunity to arbitrage more relaxed environmental rules in other countries; however, it possible we are not fully understanding the fact pattern.
Can projects achieve improved debt terms when debt is at project-level (i.e., senior secured) instead of back leverage (i.e., secured only by the managing member's interest in the tax equity partnership)?
Answer: The debt market for renewable energy projects is extremely competitive with more than 100 debt providers active in the US. As a result, the differences between project-level and back-levered debt terms have virtually disappeared. However, certain tax equity investors may require a higher return to invest in a project with debt at the project level, even if there is a forbearance agreement.
Could you please provide a more detailed explanation about the logistical challenge(s)? What is the bottleneck on this issue?
Answer: Many components for renewable energy projects are sourced from overseas and have experienced shipping delays due to Covid-related global supply chain disruptions.