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The Interview: Public Incentives Roundtable

During the recession, about the only game in town was the Treasury Department's cash grant program, known as "1603"," a reference to its section within the American Recovery and Reconstruction Act

The recession is ending and so will the Treasury cash grant program at the end of 2011, having won an extension from Congress late in 2010. Pressures are mounting in Congress and at many state capitals to cut public spending. Those pressures may put at risk multiple incentive programs for renewable energy.

Against this backdrop, three leading experts on public incentives took part in this year's Public Incentives Roundtable. An edited transcript of their conversation follows.

Roundtable participants this year included Matt Rogers, Greg Jenner and John Farrell. David Wagman moderated.

Rogers is based in San Francisco where he is a director with McKinsey & Co. During 2009 and 2010 he was senior advisor to Energy Secretary Steven Chu for Recovery Act implementation.

Jenner (left) is a partner in the tax group at the Stoel Rives law firm in Minneapolis. Before returning to the firm in 2008, he served both as acting assistant Treasury Secretary for Tax Policy and deputy assistant Secretary for Tax Policy.

Farrell is senior researcher with the Institute for Local Self Reliance, based in Minneapolis. He specializes in energy policy developments that help expand local ownership and distributed expansion of renewable energy.

The Production Tax Credit, Investment Tax Credit and Treasury grant programs have been the most high-profile forms of public incentive in recent years. How has each been most effective? Conversely, what have been key drawbacks of each?

Jenner: The Treasury Grant has been both a game-changer and a life-saver for the industry in the last couple of years. It has made things much easier than planning for the PTC or, in the case of solar, planning for the ITC, and it's a shame that it's likely to go away.

Q. How has the cash grant program made it easier?

Jenner: Cash is a lot easier to deal with than tax credits. Even though you've had to create structures even to monetize the ITC, in a way those were only bridging the construction period. The PTC is limited; you can only do one type of structure with it. You have leasing that you can do with the cash grant as well as the flip (a finance structure in which project cash flows "flip" after a period of time from benefiting investors to benefiting project owners). It's given you a number of options depending on the transaction. And dealing with cash is just easier for investors than tax credits.

Q. Has there been a particular drawback to the Treasury Grant program?

Jenner: There was a startup period when there was a lot of uncertainty and there is still some uncertainty with respect to the grant. But that uncertainty has diminished substantially. Treasury has done an absolutely fabulous job administering the program. They have stepped forward and made it easy for the industry to keep on moving smoothly.

Rogers: Both the 1603 payments and the tax credits program were among the most successful pieces under the Recovery Act for two reasons. One was that it gave clarity and confidence in how things were going to work. The other part is that it is a relatively easy to administer program compared to other types of programs that government can put in place. Once you set the rules it became straightforward as to who qualifies and it enabled money to move into the market much faster. It allowed projects to come together
with a high degree of confidence.

Farrell (left): The drawbacks are systemic rather than specific to the last few years. When you have tax credits as your primary tool for incentives for renewable energy there can be a lot of inefficiency in terms of what your ultimate goal is, which is making renewables cheaper. That's because you have to have these complex arrangements, whether it's a flip arrangement to use the production tax credit or some other structure where you have middlemen who are participating largely to help absorb the tax credit rather than being involved in developing renewable energy.

One drawback is from an incentive design philosophy: you'd want to pay for performance as the performance tax credit does rather than a cash grant up front.

Jenner: If you were starting from scratch and designing an incentive, I'm fairly certain you would not design tax incentives as the most effective or efficient. In fact, tax incentives in this type of world are very inefficient. There is a lot of efficiency loss when you have to go through these complicated legal structures. It's a boon for lawyers.

I find it somewhat remarkable that Congress makes some distinction between cash grants and tax incentives that use the same rules. It's money out the door regardless. And it doesn't matter whether it's tax money or an expenditure, it's less revenue to the government in total.

Rogers: The complement to the 1603 cash grant program was the 48C manufacturing tax credit program (an ARRA tax credit for Advanced Energy Manufacturing). Important for the overall development of the industry in the U.S. was to make sure there was enough capacity in the U.S. market to support the increased deployment of renewables and that we had the opportunity to grow both manufacturing and renewable deployment. The combination of 1603 and 48C made the U.S. significantly more competitive globally across the supply chain than had been true previously.

Jenner: The irony is that as the awardees of these 48C credits are now beginning to build their facilities, many of them are finding themselves in a similar position to renewable energy companies where they can't use the 48C credits. Once again we're faced with using fairly complicated tax structures to bring in tax equity investors so they can monetize these incentives.

Q. The recession emphasized the vulnerability of tax equity finance as the number of eligible investors dwindled. Has this form recovered in recent months as the recession has eased? Perhaps more important, how did the recession reshape this incentive?

Jenner: It's a little too soon to tell. We see statistics that show tax equity is coming back, but that can be misleading. Right now most of the tax equity deals that are being done revolve around the 1603 grant. In other words, they are providing construction bridge financing for the 1603 grant, which is immediately repaid to the tax equity investor. So it's easy money for them to invest in. We're going to have to wait and see how much real tax equity is available in a world where we only have the PTC and the ITC, but not 1603.

Farrell: The recession has illustrated that using the tax code for incentives, in the same way that we had rounds of expiring tax credits in the 1990s and early 2000s, really created a boom and bust cycle. I would agree with Greg: it's too early to tell. I'm concerned we may not be at a good place for that and that it will be more of a political decision than one that's focused on what's best for the renewable energy market.

Rogers (left): If we go back to those core principles-those about global competitiveness-are we more consistent than other countries competing for the same investment dollars? Cash is significantly better than tax equity because of the market efficiency. We're seeing tax equity trading at 70 cents on the dollar; that's a pretty inefficient way to incentivize projects when you have that kind of discount associated with a supposed benefit. The notion of making sure there's a way we can think about both the manufacturing and the demand side becomes quite important. Otherwise, you could drive up prices if you don't have the capacity in place. The flip side is also true: you could have capacity go idle if you don't have demand in place. We have to make sure Congress thinks about this in a comprehensive way.

Q. States offer a range of policies and incentives designed to encourage renewable energy adoption; everything from access laws to grants to net metering to rebates to sales tax incentives. Is there a particular policy or incentive that has been consistently effective?

Farrell: States that have mandates are the ones that are giving the market a very long-term signal that they are interested in renewable energy development. There has been, sadly, movement in some states to repeal or scale back renewable portfolio standards, though largely they've remained in place and we're now in the early years of compliance.

With the exception of California and maybe a couple of other states, the grants or rebate programs have been too inconsistent; you have either an overgenerous rebate with too-short a time period or you have a rebate or grant that's too small to be particularly effective. Ultimately the money runs out in a fairly short period of time, especially in a time of constrained state budgets.

The California Solar Initiative in part was very predictable; it set a long-term goal for the way the incentives would step down over time. It provides that good strong signal to markets about how renewable energy development is going to play out and what the players can expect in terms of pricing.

Rogers: You can have a set of mandates and you can have a set of incentives and yet a lot of projects still struggle to move forward without a more streamlined permitting and siting process. If you look at the U.S. on a competitiveness basis versus China, for example, one of the biggest differentiators is time to market for a new project, which has to do with local siting and permitting requirements. This is all about net present value and if it takes 7 to 10 years to get a project up and operational it makes the economics significantly harder to pull off.

Farrell: As you continue to see the price of modules continue to fall significantly, the burden on developers in terms of cost of permitting is rising rapidly as a percentage of the cost of a project. When we're starting to push the $5 per watt or $4 per watt threshold, permitting at the local level can be almost 20 percent of the project's price. It's going to be an increasingly significant issue.

Jenner: The attitude of the local utilities to renewables makes a huge difference. Very often that's driven by state law; sometimes they've got a gun to their head and therefore they are forced to like renewables. But other utilities that deal more readily and more easily with renewable energy. That makes a huge difference.

Q. Are we building an environment where renewable energy is permanently dependent on incentives to move forward? In other words, how do we know when incentives can be withdrawn?

Rogers: Two important parts here. One is that we should be investing in technologies where the rate of innovation is sufficiently fast so that the technology will be competitive with incumbent technology in a relatively finite period of time. You should be able to, if you will, bound the amount of incentive by time and volume to a relatively specified amount if the rate of technological innovation is fast.

If you look at the different technologies, that points to things like solar PV. So you say there's a finite amount of subsidy that's required to move down an innovation curve to drive that innovation into the market. What you don't want to do is invest in technologies that have no promise of ever becoming competitive with the incumbent technology.

The second key point is thinking about making sure that the incentives drive down the cost over time because what we observe with some of the incentives on a global basis is they had a tendency to increase the price. Take a look at some of the feed-in tariffs in Germany. One of the problems was to drive up the price of silicon on a global basis, which reduced the amount of deployment of that technology globally relative to what should have happened in a market environment. We need to make sure the incentives are such that you are able to drive down the price systematically because that has to be the goal of the incentive structure. It's not just deployment; it's deployment driving down a price consistently so we're at a price where the market can take over in a finite period of time.

Farrell: We are building an environment where we are permanently dependent on incentives in the sense that we're creating an expectation of always cheap energy. The real issue has been that we have constantly used taxpayer dollars to subsidize energy production so that it's cheaper. Americans have come to expect that electricity should be inexpensive. When we create a tax incentive or a cash incentive that chops 30 percent off the price of renewable energy, then what we're essentially saying is we want it to be cheap for us to want to deploy it.

Jenner: One of the other things that we have not yet talked about is storage technology. Some renewables are limited and the success of their deployment on a wide basis may well depend on how we develop storage capacity. It hasn't been ignored, but it hasn't been the primary focus yet, either. That very well may be an up and coming area in the use of incentives: to get that technology more up to speed with actual generation capacity.

Rogers: And storage is another area where the rate of technology innovation is quite rapid and where the opportunity to reduce cost not only for generation but also for distribution as the technology gets cheaper. The regulatory challenge is making sure we are pricing the value of storage appropriately; that it's not only time-of-use shifting but that it offers power quality and load following capabilities. The ancillary services markets need to get the price down.

Jenner: Even though our free market system has worked wonders in the past to a certain extent the lack of standardization and the lack of decentralized planning and deployment hampers us; we do suffer. If we were to figure out a way to implement a nationwide system that was fully integrated and thought through, we'd be a lot better off.

Q. Efforts are underway at the federal level and in many state legislatures to reduce public spending. The Treasury Grant program expires at the end of the year. What's the outlook for public incentives for renewables in this sort of environment?

Farrell: Not good. Unfortunately, we're seeing a very short-sighted view toward incentives for renewable energy. This is partly the result of the way we've gone about renewable energy. This is one advantage in something like the feed-in tariff; it's on the electricity system. When your public budgets go south you don't have to chop the feed-in tariff program because it's not on the public dime.

Jenner: I've pretty much written 1603 off. The realistic possibility of it being extended is not good. The likelihood is that as we start to see the approaching sunset of the ITC and the PTC that Congress, unless it is in a mood to completely do tax reform and eliminate all sorts of spending provisions through the tax code, they will probably stick around. There's enough pressure to not cut the industry off at its knees. But whether or not that's enough to sustain us going forward I don't know.

The one thing the industry would benefit from more than anything else is certainty. The industry can adapt if it knows what it has to adapt to. I would love to see Congress make up its mind: Say yea or nay. If they say nay I'm still guessing we'll have a renewables industry. It will be very different, but it would be nice to have stable policy.

Rogers: I think of this as building export industries. The challenge we face in the United States is that our demand for new capacity is relatively limited. Our demand just isn't growing that fast and so we don't need that much new capacity. And yet companies that are going to be global competitors are going to locate only if there's a local market. So if we want to be competitive globally we have to think about the renewable sector and the U.S. domestic sector as a foundation for building export industries.

We're not in the situation we were in in 1950 where we had to build out the U.S. grid; that's the situation that China's in today. We're in a situation where if we want to be competitive globally we need a domestic market in order for our companies to have a base and then compete on a global basis. That's the choice ahead of us.

The good news is the United States has a very competitive set of companies and technologies that can compete very effectively on a global basis. The challenge then is whether we create a platform from which those companies can win globally.

Captions Matt Rogers Greg Jenner John Farrell

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