On Feb. 4, 2010, U.S. Representative Earl Blumenauer (D-Ore.) introduced the Renewable Energy Expansion Act of 2010. If enacted, the legislation would extend and expand the renewable energy tax incentives contained in the American Recovery and Reinvestment Act.
While the extension of the successful cash grants program is garnering most of the attention, a less visible piece of the legislation may also have a far reaching impact on the dynamics of the solar industry in the U.S. The bill also eliminates the requirement that electric utilities “normalize” the benefits of the Investment Tax Credit (ITC) over the lifetime of the solar system. In the words of Rep. Blumenauer, the bill “eliminates an unintended consequence of the normalization rules that limited the ability of regulated utilities to develop renewable power facilities, even if the project otherwise met the prudency tests required by their public utilities commissions.” Click here to see the full bill.
To better understand the potential implications of these proposed changes, which may at first seem obscure and even unimportant, it is first necessary to provide some background on the ITC for solar and the normalization accounting rules utilities currently must apply to it.
In the Energy Policy Act of 2005 (EPAct 2005) (PDF), Congress introduced a 30 percent ITC for solar for both residential and commercial customers. The intent of the ITC was to incentivize investment in solar energy by individuals and businesses through a reduction in tax liability proportional to 30 percent of the capital costs of a solar project. While the ITC certainly increased investment in solar, one party was noticeably absent: utilities. Under EPAct 2005 utilities were not eligible to take advantage of the ITC. This changed, however, with passage of the Emergency Economic Stabilization Act of 2008. Here, Congress extended the ITC for eight years to 2016 and eliminated the prohibition that prevented regulated utilities from taking advantage of the ITC. This facilitated utility ownership of solar. As a result, the number of utilities seeking cost-recovery for new solar projects increased quickly.
Even though utilities are now eligible for the ITC, they must account for it differently than third-party solar service providers. This appears to make utility ownership more expensive. The difference in accounting is driven by a requirement for regulated utilities called “normalization.”
Normalization accounting rules require utilities to levelize the ITC benefits when setting customer rates. In other words, the tax benefits associated with the ITC must benefit all customers over the life of the project. The intent of the normalization rule is a sense of ratepayer “fairness.”
Allowing the utility to pass on (or flow through) all tax benefits to ratepayers in the period in which the benefits are incurred, at the beginning of the project, would lower rates in the early years and raise them in later years, thus “unfairly” benefiting current as compared to future ratepayers. The reasoning behind the normalization rule is that current and future ratepayers should equitably share the benefits of the ITC.
Ratepayer advocates, among others, have noted that third-party solar service providers such as SunEdison and SolarCity are not subject to normalization rules and can provide a lower levelized cost of energy to utility customers in part by capturing tax benefits immediately and then passing them on to ratepayers through a power purchase agreement with the utility. When utilities normalize the ITC, ratepayers do not receive the tax credit’s time value of money benefits. As part of Duke Energy’s filing for its proposed utility-owned solar program, testimony revealed that “the estimated cost of Duke’s program is higher than the costs associated with a number of the bids received in response to the RFP (request for proposals) due, in part, to these tax normalization requirements.”
The State of North Carolina Utilities Commission stated that if the federal tax code treats self-generation of solar energy by a public utility less favorably than the purchase of solar energy from a third party, “then prudence points in the direction of not self-generating, but instead purchasing the needed solar energy.” In its decision, the North Carolina Utilities Commission approved Duke’s solar program but capped the recoverable amount to the “effective price per megawatt-hour submitted by the third-place bidder in response to Duke’s solar RFP.”
Similarly, in response to Pacific Gas & Electric’s (PG&E) application to recover in rates the costs of its proposed 500 MW PV program, The Utility Reform Network claimed the disparity (PDF) between the cost of utility-owned generation and third-party PPAs was due, in part, to tax normalization. As of this writing, PG&E’s proposal was under final review by the California Public Utilities Commission.
As of April, the Renewable Energy Expansion Act of 2010 introduced by Rep. Blumenauer was under review by the House Committee on Ways and Means. It was unclear whether the bill will make it out of committee or to the House floor. If the legislation is eventually enacted, however, it could increase the attractiveness of utility-owned solar programs in the eyes of regulators and increase the role utilities play in the PV market.
Otherwise, state regulators may continue to question the prudence of authorizing higher costs relative to third-parties due to utility normalization accounting requirements. A further increase in utility participation in PV projects could help grow the U.S. solar market faster and further than otherwise possible. However, if utility participation increases significantly there is a chance that the solar service providers, who have been largely responsible for growing the PV market to date and who have pioneered several solar PV financing innovations, could end up losing market opportunities to utilities.
Certainly, if the requirement for utility ITC normalization is eliminated with the passage of Renewable Energy Expansion Act of 2010, we could see significant changes to the dynamics of the U.S. solar industry.
Andy Wickless is a managing consultant on renewable energy with Navigant Consulting Inc.