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Updated: What the Proposed US Energy Tax Reforms Mean for Renewables

For those clamoring for (and against) the year-end-expiring legislation, and anyone in favor of some tax-code simplification, today the government has offered an early holiday present: proposed reform for some key areas including the production tax credit (PTC) and investment tax credit (ITC).

"Our current set of energy tax incentives is overly complex and picks winners and losers with no clear policy rationale," wrote Sen. Max Baucus (D-Mont.), chairman of the Senate Finance Committee. "We need a system of energy incentives that is more predictable, rational, and technology-neutral to increase our energy security and ensure a clean and healthy environment for future generations."

The new discussion draft (here's the short version and a longer version) proposes to swap out the "existing patchwork" of energy tax incentives with two new tax credits: one for electricity and one for transportation fuels, and both of them technology-neutral and performance-based. For the electricity one, the amount of credit would be based on "the cleanliness of the generating technology," defined as greenhouse gas emissions of a facility vs. its output. Recipients could choose to receive it as an annual production tax credit or an investment tax credit claimed upon facility operation. That single overreaching tax credit would expire once the "cleanliness" of the nation's electricity supply "increases significantly."

This single "clean electricity tax credit" would involve the following criteria:

  • A facility producing electricity that's about 25 percent cleaner than the industry average would get a tax credit, with the amount escalating depending on how big that gap is.
  • If claimed as a production tax credit, the maximum for a "zero-emissions facility" would be 2.3 cents/kWh of generation, claimed on a single facility that starts after January 1, 2017 — and effective for up to 10 years. (Goodbye, annual will they/won't they PTC extension.)
  • If claimed as an investment tax credit, the maximum is 20 percent of the cost of the investment. That's smaller than the current 30 percent ITC, but it gets extended beyond its current 2016 expiration.

The choice about consolidating tax credits, extending some and eliminating others comes down to a desire to support "areas that appear to have the largest bang-for-the-buck in reducing air pollution and enhancing energy security," while seeking to avoid "overlapping regulations and spending programs, compliance costs, and the potential for fraud or abuse," according to the proposal.

The Senate Finance Committee proposes that both the production tax credit (PTC, Section 45) and the investment tax credit (ITC, section 48), as well as the Section 25D credit for residential renewable energy use, would be extended through 2016. For fuels, three tax credits would also be extended through 2016: Section 40, 40A, and 6426 credits for transportation-grade, renewable, and alternative fuels. (A previous Baucus discussion draft in November proposed repealing an accelerated depreciation credit for renewables and two fuel production tax incentives, generally seen as a blow to renewable energy development.) Eleven other energy-related tax incentives will be repealed or allowed to expire, including the 2009-era manufacturing tax credit and several others for energy efficiency, hybrid and electric vehicles.

Comments are now being accepted by the Senate Finance Committee, which asks to receive them up to January 31, 2014. The committee even lists what it says it expects and would mull over: an alternative tax credit structure to "discourage energy production that is not clean," whether through a subsidy for clean technologies or a tax or fee on more polluting ones; making the new credits available to facilities that come online before 2016; and qualifying a facility if upgraded to reduce its emissions including carbon-capture retrofits.

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Scorecard: What's Changing and Who Wins

Putting an emphasis on kWh output is a nod to baseload plants, and they get more out of a production tax credit than intermittent generation sources. Tying output to emissions, however, does move the needle a bit more toward some concept of a "level playing field" regarding incentives. Here's what the proposed new tax rules mean for each industry segment:

The discussion draft codifies the Obama Administration's clear interest in cleaning up the nation's power sector, by aligning the tax credits to be for all power generation sources but also tying them to CO2 emissions (using data from existing power plants in 2009). You'll be seeing a lot more of this table on page 18 of the in-depth Technical Explanation document:

Possible production and ITC credit rates based on 2009 emissions estimates. Credit: Staff of the Joint Committee on Taxation

No More PTC Uncertainty: The changes to the PTC are particularly welcome. The PTC gained some breathing room with this spring's language adjustments, but understanding when a project is placed into service is simple, compared with the nuances in defining "start of construction" and related definitions, argues John Marciano, partner with Chadbourne & Park. The longer-term structure of these tax proposals is also largely favorable to renewable energy development, points out Peterson: "the longer the term of the policy, the greater the certainty, and the more the capital markets will accept making investments in such projects." Verdict: Win

Lower, but Longer ITC: The solar ITC would drop from the current 30 percent to 20 percent, which solar advocates don't like; on the other hand the ITC would be extended beyond its current 2016 expiration. (And wind projects could choose the ITC option instead for projects brought online before 2017.) Call that a wash. However, the November decision to eliminate accelerated depreciation (a topic not addressed in these new proposals) wasn't good news for solar or wind, and solar arguably deserved to keep its current ITC percentage (or even raise it) to help compensate for that loss, pointed out Peterson. Verdict: Mixed (at least for solar)

Help or Harm for Biofuels: On the fuels side, credits are currently "useless" and "not worthwhile" for anyone except the big fuels companies, said Marciano. The new proposal would provide long-term credits and help raise tax equity for building new fuel projects, which has "been a big hole in the capital stack," he said. Ironically the proposals might not be all that favorable to biofuels after all, points out Marciano. The EPA's relaxation of renewable fuel standards rather blunts the industry's drive to incorporate them, "which in turn doesn't prod the industry to grow up," he said. These tax extenders pushing out credits even further, up to $1/gallon for 10 years starting in 2017 (or a 20 percent tax credit)... but "how long can the fuel guys hang in there?" Verdict: Mixed

Can't Stop Emitting? Give It Back: The notion that a plant which fails to meet its emissions goals would have some of its tax credit "recaptured" does a few things. For one, plants can do some back-of-napkin math to see if new pollution-control systems will pencil out for a net benefit by avoiding that tax hit. On the flip side, those pollution-control technology developers and vendors might see some pressure to lower their prices. But establishing a baseline for emissions underscores a desire to support renewable energy, most especially solar and wind. Note, however, that the recapture rules only apply tot he first five year of an ITC project lifetime... and that baseline coal plants can run for 50 years. Verdict: Win

Should We Now Embrace Nuclear? Presumably happy with those new rules is the nuclear industry, whose message of high baseload output with no emissions speaks directly to the proposal's goals laid out in the above chart. Peterson points out that the Senate's companion to the Waxman-Markey proposed legislation proposed a couple of years ago also had an ITC for nuclear -- though, he adds, "it's hard to say whether anyone would pursue a new nuclear plant just because they can get a 30 percent tax credit." Verdict: Win (for nuclear proponents)

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Industry Reactions

The Solar Energy Industry Association (SEIA) has mixed feelings about the proposal, saying it appreciates the efforts to simply U.S,. tax code, but reducing the solar ITC and altering asset depreciation avenues "could jeopardize future clean energy development in the United States," the group says in a statement.

The U.S. wind energy sector, which was staring down yet another annual expiration of the PTC, now has "a sound policy option to provide domestic energy producers with stability for the years to come," votes the American Wind Energy Association (AWEA).

The proposed rules include separate metrics for transportation fuels and electricity (and within that separate measurements for biomass technologies. Overall it's "an interesting, and potentially helpful, approach to leveling the playing field among all renewables," says the Biomass Power Association (BPA). "For too long, the Internal Revenue Code has been plagued by different rates, terms, and benefits, often having the unintended consequence of favoring intermittent sources of power (solar and wind) more than baseload (biomass, waste-to-energy and hydropower). Each plays an important role and this is an important step in recognizing that fact."

At the same time, though, the BPA worries that the new rules would create regulatory uncertainty: "The use of waste wood and forest residues for energy is undeniably beneficial from a carbon perspective, and we don't need another, separate proceeding at EPA to reach that conclusion."

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What Happens Next?

Don't look for any traction on these proposals any time soon. The proposed comment period lasts until mid-January, and this proposal would then have to fight for attention amid broader tax reform among other issues, or get enough broad support to be taken up as a separate matter. Upcoming Congressional elections in 2014 promise to muddy the timeline even more. Not to mention the proposal's co-architect Baucus himself is headed for the exits, said to be the next U.S. ambassador to China. We could be looking at 2015, once the Congressional dust settles — and especially if there's any significant party shift — before any of this becomes official.

Peterson underscored that the energy tax proposal is somewhat partisan coming out of a Democrat-controlled Senate, with a president that's been trying to regulate pollution and greenhouse gases, and there's no telling what will happen and on what timeline with Republican input. Still, he noted that Senate's outlines on renewable energy policy have generally carried through, looking back through the Bush and even Clinton administrations.

Another unknown area is energy storage, which the proposal explicitly excludes from its discussion along with energy efficiency and combined heat & power. Recent IRS rulings have granted an ITC for storage costs, depending on what side of the meter it's on, Peterson pointed out. It's possible the proposals would keep those ITC rules in effect.

The recapturing provision might make spook some investors for biomass or geothermal projects, and certainly anything tied to fossil fuels, pointed out Forrest Milder, tax partner with Nixon Peabody. "Some might not know what to do with that," whether investors should be on the hook to pay for credits, if they get scaled back and lose value based on emissions performance.

Lead image: Business graph, via Shutterstock

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