The renewable energy stimulus payments rules published by US DOE on July 9th effectively knock the private equity sector out of the game by excluding consideration of projects with investors that have tax- exempt status. The government payments are themselves a ‘Plan B’ to reflect the reality that tax credits don’t really work in a recessionary market because the companies getting the tax credits need taxable earnings sufficient to make the tax credits a useful offset.
Since private equity firms are funded from tax-exempt limited partnerships or receive funding from pension funds, trusts or endowments trusts and thus don’t pay income taxes the US Treasury Department reasons these tax-exempt investors wouldn’t have been able to take advantage of tax credits so they should be eligible to participate in the alternative grant program either. The problem is even the smallest participation by a tax-exempt entity in a renewable energy project four layers up the project ownership chain is sufficient to disqualify the entire project according to the rules. The other complication is that should any of a project’s ownership lands be transferred or sold to a tax-exempt entity within five years of operation, the Treasury can demand its grant money back.
This is a big problem for renewable energy developers since private equity has been focused more intensively on the renewable energy sector than ever before smelling profits ahead from the collapse of the investment banking role in this sector. This bottom fishing is understandable since the market is demanding more renewable energy projects to feed the government’s appetite for clean energy, smart grid technology and carbon emissions reduction and the government is willing to throw money at projects to achieve its energy transformation policy goals. Investment and product tax credits that drove renewable energy project finance before the recession and credit crunch have now been replaced by government loan guarantees and outright grants to reflect the poor earnings environment. The government has replaced investment banks in energy project finance and the only thing the government wants right now is clean energy projects.
Will Investor Owned Utilities Become Renewable Energy Financiers?
Private equity still has an opportunity to fill the gaps and pick up the pieces when the government tires of playing banker. The conventional wisdom among the sector players is that this transitional period will see a typical cap structure of 55% debt, 30% US Government grants, and 15% equity to realize the renewable portfolio standards in place by 2012.
Investment will still take care of their good clients but new projects will need government direct assistance to fill the investment gap. New renewable energy projects in this market environment will almost certainly will include the long term power purchase agreements or off-take agreement in place; use of proven technology; a short path to positive cash flow and good market positioning that the tax equity players want.
But the question is whether this turn of financing events opens the door for investor owned utilities to re-enter the power generation ownership sector as the last best hope for financing for renewable projects that serve the customer needs of utilities taking advantage of the government’s largesse and the regulator’s satisfaction for their support for clean energy policy goals.