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Renewable Energy Faces Financing Challenges with End of Federal 1603 Grant Program

The expiration of a federal grant program at the end of 2011 may make it more difficult and expensive for developers of certain kinds of renewable power projects to access private capital, a new report suggests.

That, in turn, may lead to fewer projects coming on-line.

"Our interviews with financial executives active in the renewable energy market suggest that the end of the Section 1603 Program of the American Recovery and Reinvestment Act means that financing renewable power projects is about to become more difficult," said Michael Mendelsohn, an NREL analyst who co-wrote the report "1603 Treasury Grant Expiration: Industry Insight on Financing and Market Implications," with John Harper of Birch Tree Capital, LLC.

In the United States, the renewable power sector has benefitted from federal tax incentives and the availability of institutional-scale tax equity investors able to use the tax incentives. The incentives include income tax credits — production tax credits or investment tax credits — that can reduce taxes owed by a project investor as well as reduced tax obligations resulting from accelerated depreciation of project assets.

These tax benefits can represent a powerful incentive for private investment, but realization of these benefits is hampered by the complexity of monetizing their value, the illiquid nature of the investments and uncertainty about how long tax policies will last.

Most renewable energy developers lack sufficient tax liabilities to benefit directly from the tax incentives. Instead, the developers have created partnerships and other financial structures with large financial and other companies that can make use of these incentives.

During the 2008-2009 financial crisis, tax equity investors largely withdrew from the renewable energy project financing market. The number of tax equity investors willing to make new investments decreased from about 20 to five.

"Industry experts told us that tax equity was almost unavailable for all but the largest and highest quality projects," said co-author Harper. In response, Congress enacted the Section 1603 Program.

The Section 1603 Program, which expired December 31, 2011, offered project investors a cash payment equal to and in lieu of the 30 percent federal investment tax credit. The program freed many developers from having to rely on third-party tax equity investors to monetize the tax credits.

Interviews with industry participants led the authors to conclude that the Section 1603 Program provided multiple benefits to renewable energy projects, including: 

  • Increased speed and flexibility of project finance arrangements
  • Lower transaction and financing costs 
  • Stretched supply of traditional tax equity 
  • Support for smaller and new-to-market project developers and projects using innovative energy technologies, both of which previously found it more difficult to tap tax equity markets
  • Lower developer or project cost of capital as a result of the ability to use more debt

While impacts associated with the expiration of the Section 1603 Program are uncertain, the report says industry experts predict renewable power projects again will have to rely more heavily on external tax equity investors to obtain a portion of their financing. Several potential outcomes:

  • Less-established renewable power developers, especially those with smaller projects, could have more difficulty attracting needed financial capital and completing their projects. Tax equity investors are likely to focus on established relationships with proven developers and on larger projects.
  • Development of projects relying on newer or innovative technologies that lack extensive operational track records may be slowed because many tax equity investors are seen as highly averse to technology risk. 
  • Projects relying on tax equity financing likely will be more expensive to develop because of the transaction costs and potentially higher yields required to attract tax equity capital.

Section 1603 awards made to projects in all 50 states

Through May 2012, the Section 1603 Program had awarded $11.6 billion to almost 38,000 projects that added almost 17 gigawatts (GW) of new renewable electricity capacity. Since the awards are for 30% of the projects' eligible costs, the total value of the projects supported is about $38.6 billion. Section 1603 Program awards have been made to projects in all 50 states, Puerto Rico, and Washington, D.C. These projects have used a wide range of renewable generation technologies, including geothermal (92 projects), biomass (63 projects), and hydropower, fuel cell, and other technologies (176 projects combined).

Below is a U.S. map that shows the value of Section 1603 Program awards by state.

This article was originally published on NREL Renewable Energy Finance and was republished with permission.

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