Section 1603 of the American Recovery and Reinvestment Act was designed to attract private investors to renewables projects by offering investors a cash 
reimbursement equal to and in lieu of the 30% federal Investment Tax Credit. According to a recent NREL report, the program has awarded $11.6 billion to around 38,000 projects – which have received $38.6 billion in total investment – and has supported the installation of 16.9 GWs in new renewable capacity. To put that in context, in 2007 third-party tax equity financing provided about $6.7 billion to renewable project developers. In 2009, in the heart of the financial crisis, that number, according to USPREF, dropped to $2.1 billion.
That drop in financing helped inspire the creation of the 1603 Program, and renewable developers fear that with the end of the Program – the application period for which ends on September 30th, 2012 – a similar drop in renewables financing may take place.
The NREL report gives some credence to these fears, collecting renewables industry insiders’ analyses of the impact of the 1603 Program’s expiration. Many of the report’s contributors expect reduced renewable project development, as developers’ options for obtaining funding are narrowed. The report anticipates three primary consequences of the Program’s expiration: industry consolidation “as well-funded developers acquire smaller firms”; reduced investment for innovative projects; and a slowing of new investment as projects become more expensive to develop and developer returns decrease.
The Senate Finance Committee appears unlikely to extend Section 1603 when the mark-ups are finalized this week.
Are tax incentives the most effective way to spur project development? Do the returns on these renewables projects, in terms of capacity installed and jobs created, justify the cost of the program? Should it be the role of government to support industries through these types of programs?
Tax credits could be way of moving forward. However, with all of the labs fighting for their existence and the lack of any long-term sustainable energy plan in the U.S., the unsure future dictates that real alternative energy business growth is not going to happen. The question should really be: When is the U.S. (i.e. the dysfunctional Congress and the DOE) going to do their job and come up with a viable long term energy plan? (i.e. “Winning the Energy Wars, A Sustainable Energy Plan for America’s Future”).
The 1603 program was designed to reduce the need for a project developer to find an investor with taxable income to utilize the tax credits (Investment Tax Credits or Production Tax Credits) for renewable energy projects by providing cash grants in lieu of the credits. The challenge was that the tax investor market (typically financial institutions that will invest cash and earn a return not in cash, but in the form of tax benefits) essentially dried up in 2008 during the financial crisis.
As framed the program was always meant to be a bridge to time when tax equity was available again to support these projects. The working theory being, that the private market could better vet good and bad deals than the Government, so once there was available liquidity that role of project selector should return to the tax equity community. Think of it this way – if you have a set of program criteria, anyone meeting that criteria gets an award, and no matter how hard you work to get that criteria tight, there will be projects that are not optimal that move forward. If instead every developer needs to find a financing partner, who will share in the project risk (by earning a return on the tax-based investment) then only very good projects will get built because the investors represent a dynamic filter for projects and will only invest in really good projects.
With all of that said there are two problems with the end of the grant program.
The first is that the tax equity market is not fully functional again – improving, but the pool of potential investors and the pool of available capital both remain extremely limited. While money has begun to flow, tax equity availability remains the single biggest constraint on development of non-wind assets (the looming sunset of the PTC is a much more serious constraint for the wind industry). Despite efforts to draw in new tax equity investors the market has been slow to redevelop. There are fixes, but all require legislative action.
The second problem with the program expiration is that tax equity is a terrible way to support small projects. Tax equity deals are complex and transaction costs are high. That causes two problems 1) it hurts project economics – on a $500,000 project paying $100,000 in fees to lawyers and accountants simply won’t work; 2) it dramatically limits the pool of investors since most generally won’t manage this size deal flow. Extending 1603 for small projects, say under $1,000,000, would have made an enormous amount of sense, but was never seriously discussed. Developers targeting the small project size must become nimble, and find ways to leverage a portfolio of projects to help manage costs and attract investors.
If a developer has a track record, careful planning, outstanding project economics, adequate scale, access to good advisors and a well-populated rolodex it can get tax equity financing and projects are getting built without the help of the 1603 Program. However, a developer missing one of those pieces will struggle to get project financing in this post-1603 world.
It’s probably pointless to say so, again, but: A 20-year national feed-in tariff would be so much simpler and effective, as most of the rest of the developed world has already proven. That’s what real federal energy leadership would look like, not more short-term twiddling of the tax code.
Good commentary though, Eli.
Chris — You are absolutely right. There is that no question a long-term, easy to use, stable program that provided clear price signals would have a much more significant impact. Bingaman’s national renewable energy standard (and even the watered down clean energy standard) was an attempt at this kind of certainty and stability. The place that we see consistent limits on investment (both at the project level and at the technology level) is the inability of investors to manage the risk of policy uncertainty.