Rationalizing Renewable Energy Finance

There is a full court press at work to get the lame duck Congress to act on policies that benefit the renewable energy industry and keep the deal flow going.  The renewable energy industry thinks it stands a better chance at getting help from the Democrat controlled lame duck Congress than the Republican dominated new Congress.

Two specific actions are seen as key to success:

  • National Clean Energy Standard (CES). The American Wind Energy Association (AWEA) has called repeatedly for adoption of a nation renewable energy standard without success.  This time it is widening the horizons modifying its plea as a “clean energy standard” and dangling in front of Republicans the idea of adding support for new nuclear power as long as the wind industry gets swept along for the ride.
  • Two Year Extension of expiring Treasury Tax Grant Program (TGP). The Solar Energy Industry Association (SEIA) is focused on the here and now seeking an extension of the provisions of the ARRA Act of 2008 that allows renewable projects to convert their investment tax credit or production tax credits into a direct loan from the US Treasury for up to 30% of the cost of the project. Those provisions are scheduled to sunset at the end of 2010 and present a clear and present danger to the renewable energy industry. SEIA claims this extension is essential to keep deal flow of solar project moving forward in the face of a still hostile project finance market.

The national CES idea is clever and offers political benefits for Republicans but likely is not achievable in the lame duck session.  Planting the CES idea now, however, positions it for consideration as part of a new—and hopefully—bipartisan energy bill next year.

The extension of the TGP program is probably essential to deal flow given the uncertainties in the project finance market.  It is about rationalizing the financing mechanisms and reducing the needless hurdles to achieve our state and—maybe someday—national energy goals.

Renewable Energy Finance Business Problem

Renewable energy projects have traditionally been supported by a combination of regulatory drivers and tax beneficial policies.  While we have no national renewable portfolio standard requiring the use of renewable energy currently twenty-four (24) states have specific RPS standards and have (5) more states have voluntary goals their regulated electric utilities are expected to meet.

Investment tax credits or production tax credits worked in a “normal” project finance market and make the renewable projects more attractive to investors who actually had tax equity against which they could use the credits.  Fast forward to the market crash and great recession bottom falling out with the number of tax equity investors in renewable energy projects that could make the ITC/PTCs work fell from about 28 to zero since the tax credits were useless for those underwater.  By late 2010 there are now about 7 or 8 tax equity investors with enough tax capacity to again invest in projects, better but still not a viable project finance market.  So the TGP has been a lifeline to keep deal flow going in this volatile period.

The other big factor favoring extension of TGP is under the tax credit provisions in place, the equipment financed by the credit could not be sold for five years.  If it is sold the government wants its money back. Under the TGP, the project can be bundled and resold as long as it remains in service. Under the TGP rules even foreclosure is considered a form of sale so TGP dramatically reduces the risk for investors in the deals.

Even under the political malpractice standard of first do no harm—unless you really mean to do so—the TGP extension seems reasonable and gives all side more time to work out longer term strategies.

What Business are We In Anyway?

The near term and real-time project financing problems raise real questions for developers of renewable energy in deciding what business they really are in.  Most want to act like developers leveraging their technology and expertise to get projects built and then sell them or bundle them to cash out and move onto the next project.  The current ITC/PTC makes this very difficult, but these renewable energy developers lack the balance sheets to compete effectively for good financing terms even in a “normal” market and doing so in the current market has been onerous even for the largest players. The TGP is facilitating this transition responsibly and that is perhaps the most compelling reason for extending it.

Like the rest of the competitive power generation business the sector has evolved into segments that require different skills, balance sheets and appetites for risk:

  • Renewable Energy Developers—the folks we’ve been talking about
  • Integrated Portfolio Managers—the NRGs and other players who assemble a portfolio of operating plants and optimize their performance in target markets.
  • Tax Equity Investors—the investment banks, private equity and other players who shop for specific investment opportunities or assets they can use to keep deal flow moving and make money in the transactions.
  • Utilities—increasingly we are seeing investor owned utilities re-entering the power plant construction and ownership sector where it is prudent to do so or where regulators believe that is the best way to accelerate the achievement of their RPS targets.  Many state prefer the purchase power agreement (PPA) procurement process which often sets up a series of transactions with middlemen driving up the costs by layering on transaction fees at each step.

Despite these project finance issues the U.S. solar energy industry is expect to reach about one gigwatt by year-end 201 in installed capacity or the equivalent to one nuclear reactor. Worldwide solar installations are expected to reach 14 gigawatts this year about fifty percent of that in Germany seduced by feed-in-tariffs that paid developers above market prices.  A similar growth bubble was caused in Spain by its feed-in-tariff but the market crashed when the government withdrew the subsidy as unsustainable.

The U.S. renewable energy policy has the Treasury Grant Program cash grants that pays 30 percent of project costs for plants under construction by Dec. 31 2010, and a loan guarantee program that covers as much as 80 percent of project costs but applicants to loan guarantees complain the government takes too long and thus only a few loan guarantees have actually been issued.

Project finance experts say many of the proposed renewable energy projects will not be built because of high financing costs, long review and permitting process approvals, and the reality that smaller, less risky projects and shorter-term loans than the 20-year terms solar plants typically need are easier to do, but utilities with RPS procurement targets to meet prefer larger utility-scale projects. And the risks of larger projects mean that even if investment banks are able to do deals their lending rates are sometimes twice the government rate.  Bankers complain that the government is causing the project finance problem by dangling low rates for jumping thru bureaucratic hoops thus diverting developers who would otherwise line up bank financing.

So what?

The big policy challenge facing Congress, the States, utilities and the renewable energy industry is finding the right mix of incentives, market rules and investor attractiveness to enable renewable energy to grow to realize its full potential without the necessity of unsustainable tax subsidies, unreasonably high transaction costs, and higher than competitive utility rates.