Below are selected insights from the Infocast Wind Finance conference last week in San Diego.
First, as an indicator of the overall interest in wind finance, the conference had twice as many registrants as last year. The largest driver for that change is likely the extension of the production tax credit for projects that start construction before 2020.
However, the extension is not a panacea for the wind industry. Starting with projects that begin construction next year the tax credits for wind projects ratchet down 20 percent a year.1 One financial advisor noted that he was not sure that new wind projects would be economical to construct once the tax credit ratcheted down by 40 to 60 percent if natural gas is only $2 per BTU.
Depth of the Tax Equity Market
Executives from banks that invest in tax equity stated that, in 2015, there were 40 to 42 wind tax equity transactions for approximately 5,700 megawatts. This resulted in approximately $6.4 billion of tax equity investment in wind in 2015.
A bank executive advised that were was $5 billion in tax equity invested in solar in 2015. A financial advisor stated that another $2 billion was invested in solar joint ventures by Southern and Dominion. In those transactions, Southern or Dominion is allocated 99 percent of the investment tax credit, but also shares in a larger portion of the cash distributions than in a typical tax equity deal. So, with this additional $2 million, the solar tax equity market was larger than the wind tax equity market in 2015.
The tax equity market for 2016 was projected to be similar to the 2015 market.
The number of tax equity investors in the market was estimated to be 30. The tax equity investors fall into three camps: those that invest in only wind, those that invest in wind and solar, and those that invest in only solar.
There are more tax equity investors that will invest in only solar than that will invest in only wind. This is because the solar investment tax credit is realized in the first year of the project, while the wind production tax credit is realized over a 10-year period.2 Some tax equity investors are skeptical that they will have a tax appetite for the next 10 years, so they opt to invest in only solar. Other tax equity investors do not like the highly concentrated nature of the tax benefit in solar arising in the first year and prefer the more steady 10-year stream from wind.
As demonstrated by the above discussion, one banker described tax equity investors as “highly idiosyncratic.” For that reason, the banker stated that he preferred to lead transactions with fewer tax equity investors, because the idiosyncrasies of each tax equity investor often compound in the structuring and terms and conditions to the detriment of the developer. The chief financial officer (CFO) of a large developer concurred that he preferred that tax equity investors “take bigger tickets,” so there are few of them in any single transaction.
Supply and Demand for Tax Equity
One banker noted that, two or three years ago, the tax equity market would have been thrilled to have the number of tax equity investors as are participating in today’s market. However, renewables and, in particular, solar, have been growing faster than the tax equity market can add investors. Thus, the demand for tax equity continues to outstrip the supply.
A banker noted that the returns demanded by tax equity investors have declined slightly in recent months. A developer noted that the after-tax returns continue to exceed what is merited by the risk borne by tax equity investors.
A CFO of a large developer expressed hope that, with the tax credit extension, more tax equity investors will enter the market. Contrary to natural expectations, the executives from the banks that make tax equity investments also stated a hope that more tax equity investors would enter the market. The reason that the executives are receptive to additional competition is that many of the current investors have reached their exposure limits for certain segments of the market. For instance, many of the traditional players have limited ability to make incremental investments in Texas.
A financial advisor noted that the largest tax equity investor in 2015 was Berkshire Hathaway Renewables, which invested $1 billion. The advisor did not provide a breakdown between wind and solar. The financial advisor noted that the newest entrant to the market is Allianz. Allianz co-invested in an EDF transaction with Bank of America. The financial advisor pointed out that many regional banks view tax equity as “project finance,” and project finance remains a “dirty word” to them, due to losses suffered in past years unrelated to renewables. Therefore, regional banks continue to be underrepresented in the tax equity market.
One banker noted that a downside with new market entrants is that execution risk is higher with smaller new investors.
Syndication of Tax Equity
One financial advisor noted that it almost impossible for a tax equity investor after its funds a wind production tax credit project to sell a portion of its investment without recognizing a loss for generally accepted accounting principles purposes, unless the buyer is willing to accept a lower yield than the seller. The advisor noted there is no reason for the buyer to accept such a lower yield, because the buyer could merely invest in a new project and earn a higher return.
Transfers and YieldCos
The tax equity investors noted that transfer provisions in tax equity documents are requiring attention and negotiations. Developers want to ensure that the transfer provisions can accommodate a transfer to a yieldco or the sale of the developer’s interest to another developer. One banker noted that his institution was open to preapproved streamlined transfer provisions, so long as the transferee did not have the right to change the operations and maintenance provider.
In terms of yieldcos, a banker noted that the recent decline in the stock prices of yieldcos “has not had much impact on our tax equity deals.” Nonetheless, some institutions are concerned about transfers to yieldcos whose “stock performance has been less than sterling.”
In terms of portfolio performance, an executive from one large tax equity investor described his bank’s portfolio as “a tale of two cities.” For the first five years of tax equity investments, wind production underperformed. This resulted in fewer production tax credits being realized, so the bank was entitled to larger cash distributions, in some instances, all of the cash distributions. However, investments originated in 2008 or later have, on average performed, closer to expectations; therefore, the tax equity investor is not entitled to large cash distributions.
It was noted that 3,200 megawatts of power purchase agreements (PPAs) were executed by corporations last year, as opposed to utilities. Examples of corporations that have signed renewable energy PPAs are Apple and Amazon. The projects associated with those PPAs will need tax equity and other forms of financing in 2016 and 2017. One banker predicted this that trend would accelerate. The corporate PPA phenomenon necessitates tax equity investors that are typically used to underwriting PPAs with regulated utilities to underwrite corporate offtakers in wide ranges of businesses.
2 Although, the owner of a wind project can elect to claim the investment tax credit, rather than the production tax credit and avoid the question of 10 years of tax appetite, today’s high-efficiency turbines often cause developers to prefer that their tax equity investors claim the production tax credit.