Solar, wind and batteries
It was certainly welcome news to the renewable energy industry to see the inclusion of tax credit program extensions in the recently-passed, bipartisan stimulus bill. Hopefully the bill soon becomes law, even if over the President’s threats to veto it.
But for many entrepreneurs and developers who are trying to introduce relatively new solutions to the market, these tax credits won’t be very useful. In fact, they can get in the way of progress. And unless this gets addressed in 2021 by Congress, this could significantly hold back innovation around climate change solutions.
I wrote recently about the opportunities for clean energy entrepreneurs around resiliency benefits. My firm invests in small-scale sustainability projects like microgrids, and so we spend a lot of time working with some of the many American entrepreneurs who are trying to sell and build these and other distributed infrastructure projects using new approaches.
Many of these innovative solutions involve integrated solar and batteries. Not only did this stimulus bill not include an energy storage tax credit, the industry still lacks clarity from the IRS about how batteries integrated into renewables-based systems may or may not qualify for the existing tax credits. Hopefully at least the incoming Administration will be able to drive the government to provide that needed clarity.
But as an investor working with many entrepreneurs and smaller project developers, I also know just how useless the existing tax credits can be for them, even for projects that would qualify. Why? Because many project developers can’t use the tax credits directly, and so in order to obtain the significant cost savings those credits would represent, they would need to source so-called “tax equity”. And most cannot.
Tax equity is an investment category that has arisen thanks to tax credit policies, where a third party totally unrelated to the project itself provides some of the project capital simply to harvest the tax benefits. It’s a no-brainer for the providers of the tax equity (they get a tidy, guaranteed return in the form of a lower overall tax bill), but only certain types of investors qualify to be able to make these investments. As one industry participant put it recently, “I'd say that if you look at the segmentation of the tax equity market, the majority of the business is done by, let's say, four or five parties.”
So mostly the benefits of tax equity investments are captured by a very few players, and of course also the investment bankers who service them. And even worse, the tax equity often isn’t even available at all. Much of the tax equity market dried up toward the end of 2020, and is already basically “sold out” going into 2021. Tax equity structures therefore introduce even more cyclicality to an industry (especially at the smaller end of the market) already suffering from cyclical sales and cash needs. Basically, when corporate tax bills go down (because of COVID-19 economic impacts, and also the reductions in the corporate tax rate), tax equity investments dry up.
Furthermore, the entrepreneurs and project developers working on smaller project pipelines often cannot access the tax equity market at all, even when it’s robust. They’re too small for the bigger tax equity investors to deal with, and the transaction costs of structuring the tax equity for smaller projects are too high. I know of one entrepreneur who’s had to resort to building his own direct network of tax equity investors and also develop a simpler set of documents. Another entrepreneur I know is having to work with his corporate customers to try to get them to provide the tax equity themselves — that’s one way to definitely slow down sales cycles! And these are the success stories of clean energy entrepreneurs who have actually figured out how to use the tax credits to help their customers. Many more cannot.
The policy solution is simple: Make the tax credits “refundable” or otherwise available in the form of a direct payment. This would mean that these smaller, innovative projects wouldn’t require tax equity at all. Congress didn’t include this in the stimulus bill, but it had been discussed.
When a direct payment approach was tried before, it unlocked a lot of market and jobs growth. A Department of Energy analysis of the Section 1603 grant program which was available from 2009-2011 showed that it led to up to 75,000 new jobs and $44 billion in total market growth.
Ostensibly Congress does want to promote innovative solutions like microgrids — after all, they did include several million dollars of funding for R&D and demonstration projects in this market. So you would think they would love for entrepreneurs and smaller project developers to be able to access these tax credit programs, especially as they’re the ones typically introducing the more innovative solutions in clean energy.
I’ve spoken with Senate staffers who get this and know how important it is to support these smaller innovators. So hopefully Congress will prioritize refundability for renewable energy tax credits in 2021. Hopefully it can get done as part of another primary piece of legislation like an infrastructure bill, rather than a climate-specific bill.
But until then, while the renewables industry will certainly benefit from the extension of the existing tax credit program, the biggest beneficiaries will continue to be a handful of large corporations and their investment bankers. And not the innovators.
