Tulsa — When it comes to federal financial incentives, proper planning is essential for renewable energy project owners and developers who seek to maximize available incentives, avoid pitfalls and realize a quicker return on investment.
Most renewable energy developers seek to benefit from one of the major federal renewable incentives: (1) grants in lieu of investment tax credits (Treasury grants or Section 1603 grants) and (2) loan guarantees from the Department of Energy (DOE) (known as Section 1703 and 1705 programs).
Why not both?
For the right project, developers can pursue parallel incentive tracks to obtain both incentives but first must work through contradictory definitions, challenging deadlines and demanding requirements associated with each program. In this field, success requires an early-stage strategic game plan to avoid a late-stage financial or regulatory quagmire.
As with virtually all sectors, renewable energy project development suffered a severe downturn during the recession and credit crisis. The $787 billion American Recovery and Reinvestment Act of 2009 (ARRA) sought to reverse this situation by injecting stimulus funds into the sector. Renewable energy received substantial attention under ARRA due to the sector’s importance to developing a clean energy economy, reinvigorating American manufacturing and creating jobs.
Under the federal system prior to ARRA, the production tax credit and investment tax credit were the principal federal incentives driving renewable energy project development. Neither of these incentives functioned effectively at the height of the credit-frozen and tax liability-starved recession. Congress enacted ARRA Section 1603, the Treasury grant, as a way to expand the use of clean and renewable energy despite diminished investor demand for tax credits and the lack of credit availability. Pursuant to Section 1603, the U.S. Department of the Treasury reimburses eligible applicants for up to 30 percent of the capital expense for specified energy property. This cash grant is payable to the project within 60 days after it is placed in service.
Due to the severity of the recession, Section 1603 was designed to be a rapid response with a short lifetime. To comply with Section 1603 requirements, a project must be placed in service or begin construction during 2009 or 2010. The last day to submit a Treasury grant application is Oct. 1, 2011, but construction must begin no later than 2010 no matter when the application is filed. For projects that begin construction in 2010, it is also necessary that the project be placed in service in time to comply with the credit termination date for the particular type of renewable energy.
The definition of “begin construction” under Section 1603 is somewhat vague and requires careful attention to detail and a complete understanding of Treasury rules. According to the Section 1603 safe harbor rules, owners can meet the begin-construction requirement when they have paid or incurred more than 5 percent of the total cost of the project (not counting certain preliminary costs). An owner can also satisfy the requirement by actual site work or even by entering a binding contract to purchase necessary equipment such as wind turbines–as long as the turbine manufacturer starts building the turbines and other Treasury requirements are met.
The Treasury has done a terrific job of administering Section 1603. Owners who submit complete applications are getting a 30 percent return on eligible capital costs within 60 days, though those who are less diligent with their applications can expect delays. Due to the success of the program, a significant number of lenders are willing to give a short-term or bridge loan to owners with projects that meet Treasury grant specifications.
Treasury grants are not a long-term incentive program, however. The grants were designed to jolt the economy by making funds available and putting people to work as part of ARRA; its sunset date is rapidly approaching. If a Treasury grant is a possibility, advisers and engineering consultants strongly recommend that owners and developers work with legal advisers to craft a compliance strategy that ensures they will qualify for the grant. Project proponents can then communicate with Treasury staff during 2010 to establish a firm placeholder and confirm that the work planned for this year is sufficient to meet the begin-construction requirement by actual site work or by meeting the 5 percent Treasury safe harbor.
There are significant efforts underway in Washington, D.C. to extend the Section 1603 program into 2011, but prospects for this occurring are uncertain enough that developers cannot rely on it. Even in the event of a program extension, there is a significant likelihood that the program will be less favorable to owners and developers due to proposals to transform the program from an immediate cash grant to a somewhat more conventional refundable tax credit.
Loan guarantees also provide an attractive financing tool for renewable energy project development. These guarantees predated ARRA and offer numerous benefits, principally by reducing the risk exposure of lenders under the program and theoretically providing greater credit liquidity. Prior to ARRA, however, these benefits proved to be illusory, with the limitations of the program preventing even a single project from utilizing DOE loan guarantees. The prior program is described by Section 1703 of Title XVII of the Energy Policy Act of 2005 (“EPAct 2005”). Section 1703 authorizes the DOE to issue loan guarantees to eligible commercial projects that “avoid, reduce, or sequester air pollutants or anthropogenic emission of greenhouse gases” and “employ new or significantly improved technologies as compared to technologies in service in the United States at the same time the guarantee is issued. The first challenge raised by this program was the innovation requirement, which precluded the funding of mature technologies. Unfortunately, such maturity is a standard prerequisite for project finance. In addition, the 1703 program suffered from the credit subsidy cost requirement, which effectively required applicants to self-insure project risk by making an administrative fee payment to DOE to cover the risk of payment default or delinquency.
Under ARRA, Congress invigorated the DOE loan-guarantee program by establishing a temporary program under Section 1705 that authorized DOE to make loan guarantees to certain renewable energy systems, electric transmission systems and leading-edge biofuels projects that commence construction no later than Sept. 30, 2011. In contrast to the Section 1703 program, 1705 projects do not have to employ innovative technologies. In addition, ARRA provided $6 billion (reduced to $4 billion when the Cash for Clunkers program was funded through a funding diversion) in appropriations to support up to $32 billion in loan guarantees, including authorization to cover the credit subsidy cost of eligible projects.
The most important deadline for renewable energy developers under 1705 is that they must start construction by Sept. 30, 2011. The definition of “construction starts” under DOE 1703 or 1705 is different from the Treasury 1603 grants definition. For 1703 and 1705 applicants, starting construction is defined as actually commencing construction at the site with no alternative compliance or safe harbor expenditure options available. Thus, to stay within the attractive funding zone of ARRA for loan guarantees, projects must be able to complete all conditions precedent (including additional requirements that arise from obtaining a DOE loan guarantee) and literally start construction by Sept. 30, 2011. If a project fails to meet this deadline, even if a conditional commitment from DOE has been received, the project is precluded from receiving ARRA funding. For some solicitations, including the Financial Institution Partnership Program (FIPP), such tardiness is fatal and the entire solicitation becomes inoperative after the deadline.
Double-dipping and Traps
The independent value of both Treasury grants and loan guarantees is clear. However, the smart play is to recognize the interaction of the incentives and their requirements on the same project. This planning is best done thoroughly and realistically at as early a stage as possible in project development. In this manner, a critical path timeline can be developed and timing challenges can be immediately addressed. In some projects, difficult decisions regarding project milestones, financing and environmental work can be made early rather than at a later stage when there will be more severe cost implications.
The first nettlesome aspect of the conflicting requirements is compliance with the National Environmental Policy Act (NEPA). Most owners and developers are familiar with NEPA, as the statute establishes a stringent set of procedural requirements for projects that have a federal nexus and involve a department’s exercise of decision-making discretion. DOE loan-guarantee incentives establish a federal nexus and involve discretionary qualification review that requires NEPA compliance. Notably, Treasury grants in lieu of tax credits do not, analogous to qualification for tax credits without the requirement of federal decision-making involvement. Thus, a project that has no other federal nexus can comply with the begin-construction requirements of a Treasury grant-in-lieu without having to comply with NEPA. A project seeking a DOE loan guarantee, however, will need to satisfy NEPA.
There are three primary levels of sufficient NEPA compliance depending on project attributes:
- Categorical exclusion or exemption (CE/CX)
- Environmental Assessment (EA)
- Environmental Impact Statement (EIS)
To date, CE/CX’s have been quite rare in projects applying for loan guarantees. While agencies develop their own exemptions, elevated NEPA compliance is favored with the preparation of an EA as a minimum. The EA process typically takes three to six months to complete, on average. Upon completion, two outcomes are possible. The preferred and best-case scenario is a “finding of no significant impact” (also known as “FONSI”). Assuming all other program requirements have been met, construction activities could commence soon after issuance of the FONSI, as NEPA has then been satisfied. However, a conclusion that the underlying project is likely to have significant environmental impacts will require more extensive project review in the form of an EIS, which can take an additional year or more to complete.
The challenge under the DOE loan-guarantee program is that many projects were already under development prior to the passage of ARRA.
Quite prudently, the environmental consultants for these projects made their assessments of whether there was a federal nexus to trigger NEPA before the DOE loan garantee program under ARRA existed. In some situations, the project then moved forward without a NEPA compliance component because it had been determined that NEPA did not need to be satisfied. Projects that later decide to pursue a loan guarantee are often left behind schedule on NEPA compliance because the trigger came late in the timeline. Thus, these projects are now struggling to satisfy NEPA and still meet the ARRA loan-guarantee deadline on Sept. 30, 2011.
The second nettlesome challenge arises from the NEPA requirements themselves. For projects that must satisfy NEPA, work on the site cannot begin until the necessary NEPA process is completed. Therefore, a delay to satisfy NEPA could affect a project’s ability to meet the begin construction requirements unless funding is sought through a grant-in-lieu under Section 1603. While the begin-construction safe harbor may provide a solution on the Treasury grant side, it is not available to solve the loan guarantee challenge. Even with a safe harbor, the loan guarantee project will still need to get all the way through NEPA in order to complete construction and go into service. This placed-in-service date must predate the credit termination date of the Treasury grant program. In addition, this date actually triggers the payment to the project owners and developers.
The foregoing discussion outlines the pitfalls and potential solutions to these incentives as they exist today. As previously noted, Congress is considering an extension of the Treasury grant program to put it more in line with loan guarantee deadlines. Congress could also convert the program to a refundable tax credit instead of its current grant-like structure, which would potentially delay the return of funds to the next tax year. The DOE is also working to streamline and speed up the FIPP application and approval process that specifically supports commercial energy-related projects. Owners and developers will need to monitor legal developments in this area carefully to ensure success in their projects.
Blair Loftis is the national director of alternative and renewable energy for Kleinfelder. He can be reached at BLoftis@kleinfelder.com. Graham Noyes is an attorney specializing in energy and telecommunications at Stoel Rives LLP. He can be reached at firstname.lastname@example.org. Lisa Dickson, an area manager with Kleinfelder/S E A, also contributed to this article.