LONDON — On March 1, 2013, U.S. President Barack Obama issued an order, known as the sequester, which triggered automatic federal spending cuts for the remaining seven months of the fiscal year ending on 30 September, 2013.
Sequestration will affect Section 1603 of the American Recovery and Reinvestment Tax Act of 2009, more commonly known as the cash grant for the 30 percent investment tax credit (ITC). Under the program a renewable power facility owner can choose to receive a one-time grant equal to 30 percent of construction and installation costs. Eligible projects include anaerobic digesters, landfill gas, solar and wind. The facility must have been “placed in service”, or be operating and selling power at commercial rates, in 2009, 2010 or 2011 or construction must have begun in any of those years and be completed before the end of 2014.
The U.S. Department of the Treasury has announced that the sequestration percentage for cash grants will be 8.7 percent through September 30, 2013, and that the sequester will apply to cash grant applications which receive awards on or after March 1, 2013. So every cash grant awarded on or after March 1, 2013 through September 30, 2013 will be reduced by 8.7 percent, regardless of when the application was submitted.
What will this mean for renewable energy in the U.S., in 2013 and moving forward? Some have speculated that the resulting loss of revenue and jobs could herald the death of the industry. David Burton, a tax adviser at Akin Gump Strauss Heller & Feld in New York, answered some questions from REW on how the sequester will affect the industry.
Big News, or Not?
We asked Burton whether a cut of 8.7 percent really is big news for the U.S. renewable energy industry, or whether it will absorb the losses.
“The initial speculation was that the cut would only be 5.1 percent,” he said, and “then there was speculation that because the 2013 fiscal year only has seven months to go, the cut would be 9 percent. So it depends on your perspective: if you were expecting 5.1 percent you’ll be disappointed; if 9 percent this is slightly better than you would have been expecting.”
Is the industry overreacting? Said Burton, “That depends on the project. Some developers’ profit is quite slim, and this will eat into it significantly; others are richer, and for them this will be a minor pain but not significant. So it’s difficult to generalise across the whole industry.”
For wind, Burton said, projects had to be placed in service by end 2012 in order to qualify for the cash grant. Most projects that wanted the grant have already submitted their applications, and most already have grants in hand – so relatively few wind projects will be affected. “There may be some large notable ones which will be affected,” Burton said, “but overall wind will be relatively unaffected.”
There may be an indirect consequence for wind, though. According to Burton some solar developers may now decide not to take the cash grant; “instead they’ll get ITC and find a tax equity investor to monetize it”. This will drive up demand for tax equity in general, and for wind in particular.
Most, but not all, of the solar projects that have not yet claimed cash grants but plan to involve either residential or distributed generation, said Burton. “There are wide profit margins in those transactions that depend on a lot of state and local subsidies, and on how much the local utilities are motivated to pay for solar energy. So in distributed and residential solar you’re going to see a wide range,” he said. For example, he added, California “has a fair number of subsidies and is very supportive of solar, so it may be less impactful there versus other states which have fewer subsidies and are less supportive.”
Is the effect retroactive? To an extent, explained Burton. “The Treasury department has said clearly that you will be subject [to the 8.7 percent reduction] unless, prior to March 1, you had an award letter in hand.” This includes applications that have been submitted but have not yet received an award, and cases where the Treasury has asked follow-up questions and the applicants have replied, but the department hasn’t yet processed their responses. “1603 says that an application isn’t final/submitted until the responses to the follow-up questions have been accepted,” Burton clarified.
The Treasury department has stated that it has received 213,000 preliminary cash grant applications. Prior to October 1, Burton said, “the process was very preliminary”, allowing applicants change a project’s location, for example. “So a lot of people filed because they wanted the flexibility and didn’t know what they were going to do,” he said. The majority of these developers are unlikely to have award letters in hand by March 1.
The Real Consequences?
“It’s definitely bad news,” Burton believes. “As to whether it will cause people to go out of business, probably not. But it will eat into profit margins and will result in people closely evaluating whether the cash grant is a better alternative or whether they should go for tax equity.”
And it is “certainly not” going to create jobs, he said – “except for maybe at banks, which will need more underwiters for tax equity deals.” But it won’t give rise to jobs in construction, installation and maintenance, and Burton believes that developers may be forced to lay off workers in order to make up for the revenue reduction.
“Overall”, said Burton, “the U.S. renewables industry is a very resilient industry which has thrived despite peaks and valleys. 2014 in this industry is like a light year away, very far away; it’s hard to think beyond December 31 of this year. I haven’t had too many discussions about 2014, but the general atmosphere is that 2013 should be a pretty good year in terms of deal flow, capital raising, etc.”
What To Do About It?
Might it be possible for the renewables industry to persuade the Treasury department to change this policy? Burton believes anything is possible, and says a campaign for change could prove worthwhile, but he believes it’s unlikely that the Treasury will rescind the cuts because the sequester is so broadly applied. If the government changes its approach regarding renewable energy, Burton explained, it will trigger similar requests from the defense and healthcare industries, hit hardest by the cuts, and eventually from all affected sectors. “I don’t think they want to invite that type of scenario where everyone is asking for relief,” he said.
Developers have called the cash grant reductions “inequitable, unfair, harming an important part of the US economy and environmental plan,” said Burton – but, he said, he has heard from those on the ground that they will be able to absorb the cuts. “We’ll change our models and life goes on,” he quoted; “We’ll continue to do deals.”
There are additional developments taking place in the U.S. wind sector. While the production tax credit (PTC) has been extended, it has also been changed. In previous extensions the government specified that projects had to be placed in service by December 31, without specifying the year. In response to lobbying, the new rule specifies that construction must begin by December 31, 2013.
“That gives the wind industry some ability to continue to do PTC transactions beyond 2013, which gives them some optimism,” said Burton. But it is unclear at this point what “start of construction” means. According to Burton, the cash grant program defines start of construction as spending 5 percent of the total cost of the project, “even if it’s spent on parts that are sitting in a warehouse in China”.
The question for developers is whether the cash grant standard will be extended to the PTC, or whether it will instead define start of construction literally, as having work crews on the ground. Burton said the Internal Revenue Service (IRS) is in the process of resolving this question and will issue guidance soon.
Additionally, the cash grant guidance specifies that developers can apply the 5 percent to an entire project. Says Burton, “If you’re building a 100-turbine project you can buy five turbines”. He cited a revenue ruling set in place in the 1990s which defined each turbine in a wind farm as a separate unit of property. So “if IRS follows that ruling literally, you’d have to spend 5 percent for each turbine,” he said. “So the industry is hoping IRS says you can do it on a project-by-project basis.”
In addition, when reviewing recent cash grant applications the Treasury department “has been very tough on the numbers” that determine a project’s market value, Burton said, and “has been very skeptical of appraisals”. In earlier decades, he added, the IRS was “relatively deferential” towards independent appraisals from reputable consultants.
Clean Jobs Survey Cancelled
In a February e-mail to employees, the statistics unit of the U.S. Department of Labor said a clean energy survey tracking green jobs would be one of three reports cancelled because of the sequester.
While opponents of the Obama administration’s focus on renewables believe that the report would be politically biased and its cancellation is a good thing, clean energy advocates who say renewable energy industries are among the fastest-growing in the nation were disappointed by the cuts. The department released its first industry survey in 2012, finding that at least 3.1 million Americans had green jobs.
“It’s a huge loss,” said Bracken Hendricks, a senior fellow at the Center for American Progress. “This means the US will be flying blind on the growth of a very, very important sector in its economy.”
The Death of Clean Energy R&D in the U.S.?
The spending cuts will also have an adverse effect on research and development in the U.S. energy industry, says economic researcher Chris Martenson. He believes the sequester is a harbinger of “full cuts” set to go into effect in 2014, followed by flat spending for the next decade, delivering “the proverbial nail in the coffin” to U.S. energy research.
“With massive cuts, advances in solar and wind are likely to be ceded to [the U.S.’s] biggest competitor, China. The spending cuts will only further the deprivation of the current state of R&D, which will be amongst the hardest sectors hit,” Martenson said. Sequestration will affect programs at national laboratories and federally-funded research at companies and universities, according to Martenson.