Tax equity financing for renewable energy healthy, but with risks: CohnReznick
The market for renewable energy tax equity deals is healthy with good deal flow and an expanding pool of investors that could help mitigate the political risks facing tax equity investments, according to the latest industry survey from CohnReznick.
Citing J.P. Morgan data, the report noted that 2016 was a robust year for tax equity deals, even though aggregate funding amounts declined in year-over-year comparisons because many deals were rushed to market in 2015 in anticipation of the expiration of the production tax credit (PTC) for wind power projects and the investment tax credit (ITC) for solar power projects.
New classes of tax equity investors, such as regional banks and insurance companies, continued to enter the market in 2016, indicating there could be the potential for those investors to make up for the shortage of investors with tax appetite for projects that are not utility scale or do not have investment grade offtakers.
The CohnReznick report cited J.P. Morgan data that $11 billion of tax equity financing was raised for renewable energy projects in 2016. The decline from the $13 billion raised in 2015 stemmed from developers rushing deals to market at the end of 2015 out of concerns that the PTC and ITC would not be renewed by Congress.
The report noted that the 2016 total was still above the $10 billion of tax equity financing in 2014 and the $6.5 billion invested in 2013.
Despite the robust numbers, the report says there is still a shortage of tax equity investors — known as “tax appetite” in the industry — who have sufficient income to have a need for tax credits and who are comfortable with the risks associated with renewable energy projects. That is particularly the case, the report says, for distributed generation, residential and merchant projects.
The report identifies new classes of tax equity investors, such as regional banks and insurance companies, that can fill that gap.
Political risk is an important component of the market for tax equity, but the report says there is “a relatively level of certainty” regarding the PTC and ITC.
The PTC was extended in December 2015 through to 2020, but the level of benefits will be gradually reduced. The solar ITC, worth 30% of the invested capital, was also extended for projects that begin construction by year end 2019 and are in service by 2024. Projects that start construction in 2020 will receive a 26% credit, those starting in 2021 will receive a 22% credit, and those starting construction in 2022 are eligible for a 10% credit.
A more potent political risk to the PTC and ITC is the prospect of tax reform, the report says. Proposals that would reduce the corporate tax rates to 15% from 35% could reduce the appetite for tax equity financing for renewable projects.
That effect is already being felt on wind projects where some sponsors are adding in benefits to make up for the prospect that future tax rates could be lower. The effect is less apparent in solar projects because the payout of the ITC is not stretched out over several years.
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