Tax Reform: New Uncertainties for Big Wind (political risks for a political business model)

“Wind projects most at risk by the new tax bill are those that negotiated their finance package in the last two years based on a 35 percent corporate tax rate. Renegotiating these agreements, if possible, could result in higher debt assumed for the project, higher prices for the electricity sold, and pressure to lower build costs … to put the financial viability of the project at risk.”

As previously cited, the wind industry is reliant on tax-equity investors willing to accept tax credits in return for funding significant percentages of their project costs. Tax-equity financing is complex; altering one or more elements of an investment package could undermine the success of a wind project.

Despite Congress’ decision to leave the wind PTC phase-out unchanged in the final tax bill, other changes in the law might upset plans for some projects.

Wind projects most at risk by the new tax bill are those that negotiated their finance package in the last two years based on a 35 precent corporate tax rate. Renegotiating these agreements, if possible, could result in higher debt assumed for the project, higher prices for the electricity sold (PPAs), and pressure to lower build costs. [1] Any one of these changes could put the financial viability of the project at risk.

This post briefly discusses two key changes in the tax code and how they might impact wind projects that opt for the PTC.

1. Tax Change: Corporate rate drop from 35% to 21%

Direct Impact: The PTC is still slated to phase out altogether after 2019.[2] Its after-tax value does not change, however, the lower corporate rate will directly reduce the value of the depreciation. At 35%, depreciation is worth about 26¢ per dollar of project capital cost. At a 21% corporate rate, depreciation is worth less. [3]

Potential change to financing: To make up for the shortfall in tax equity, investors could add more equity. Doing so increases investor risk and also extends the timeframe for when an investor can cash out (‘flip’) assuming other aspects of the deal remain constant. The other, more likely option for addressing the shortfall, would be to increase debt. Conventional financing is risk averse so project owners will have to meet stricter debt service requirements. In either scenario, the final negotiation might involve increasing the price of the electricity sold and also reducing build costs.

2. Tax Change: BEAT or Base Erosion Anti-Abuse Tax

Direct Impact: The law retains the Senate version of BEAT but now protects up to 80% of renewable energy and low-income housing tax credits from potentially being clawed. (The original Senate language only allowed for the R&D tax credit to be protected in its entirety.) This leaves up to 20% of the energy tax credits subject to claw back in any given year through to 2025. After 2025, which is less than the 10-year horizon for the PTC on new projects, up to 100% of all tax credits including renewable energy credits will be subject to claw backs. Whether a multinational entity is subject to the BEAT tax in any given year cannot be known until the end of the subject year. Uncertainty in wind financing and the impact of BEAT could cause projects to be placed on hold until new finance models are run to assess whether a project is still financially viable.

Potential change to financing: There are several approaches tax equity investors might take to avoid losing some of the PTCs generated by a wind project. For one, they could limit their investments in wind to 80% of projected tax credits. This would address PTCs produced through to 2025 but beyond that investors still risk 100% of the PTCs being subject to claw. Another option is to institute a pay-go scheme where the decision to further invest is made yearly based on the BEAT calculation.

To largely avoid the BEAT risk, wind projects could also opt for ITC financing as opposed to the PTC since the full credit is realized in the project’s first year. However, assuming the ITC requires investors have a larger tax base in the first year in order to absorb the credits. This approach could work for some projects but with increasing capacity factors and lower project costs, advancing with the ITC is likely to leave substantial tax credits unrealized.

Notes

1. Finance agreements and power purchase contracts for wind energy facilities that were written in the last 1-2 years may include clauses that allow for the renegotiation of terms in anticipation of the tax code changes. At this point, there is no way to know the degree to which signed agreements will be renegotiated.
2. The PTC phase-out was preserved in the final tax bill. For projects that began construction in 2017, the PTC is valued at 1.9¢/kwh (80% of 2.4¢/kwh); projects starting in 2018 will earn just 1.4¢/kwh (60% of 2.4¢/kwh).
3. With a 40% reduction in the corporate tax rate (35% down to 21%), we are likely to see a reduced appetite for tax-equity investing. Since the PTC is slated to phase-out altogether after 2019, it’s not clear new investors will be interested in entering the market.

References

Marathon Capital, U.S. Federal Corporate Tax Reform – Potential Impact on U.S. Renewable Energy Financing, https://www.marathon-cap.com/news/u-s-federal-corporate-tax-reform-potential-impact-on-u-s-renewable-energy-financing, January 13, 2017

Martin, K., Final US tax bill: effect on project finance market http://www.nortonrosefulbright.com/knowledge/publications/160375/final-us-tax-bill-effect-on-project-finance-market,  December 16, 2017

Palliser, H., Tax Equity Flip in a US Partnership – Financial Modelling Considerations, http://blog.corality.com/financial-modelling/financial-modelling-tax-equity-flip-us-partnership-renewable-energy,  September 22, 2015

Schwabe, P. et.al., Wind Energy Finance in the United States: Current Practice and Opportunities, https://www.nrel.gov/docs/fy17osti/68227.pdf,  August 2017