Renewable Project Finance Options: ITC, PTC, or Cash Grant?

Norbert Richter

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Dozens of institutional investors in U.S. renewable energy projects pulled out of the market when the nation’s liquidity reserves dried up late last year. Some left the renewable market sector in search of more lucrative investment opportunities. Others found themselves unable to take advantage of the attractive tax credits because they themselves lacked profits against which to use the credits. The American Recovery and Reinvestment Act of 2009, approved February 13, changed the investor ground rules — again.

The American Recovery and Reinvestment Act of 2009 (ARRA) gives investors, owners, operators, and financiers a choice of government credits that may help push forward renewable projects that otherwise might be turned down. The purpose of this article is to provide a summary of the ARRA as it affects federal support for renewable energy projects as well as an explanation of how the renewable investment rules of the road have changed with the stimulus incentive package.

Large insurance companies and investment banks that engage with project developers provide the bulk of renewable energy project financing. The ARRA offers to those financiers a number of very useful incentives for renewable energy projects that can be tailored to individual project needs. By using complex financial models and structures that are designed to leverage the federal government’s support for renewable technologies, investors can use accelerated depreciation and tax credits to offset tax liabilities. Now, with the expanded variety of production tax credits (PTC), investment tax credits (ITC), and cash grants to choose from, investors must consider the benefits of each incentive for their respective projects (see sidebar).

Renewable Project Tax Credit Options

The American Recovery and Reinvestment Act of 2009 (ARRA) gives developers of renewable power generation projects the option to select an investment tax credit, a production tax credit, or a cash grant. Previously, there was no cash grant option, the tax credits were directly linked to particular technologies, and renewal was always problematic. The rules have changed.

The production tax credit (PTC) was originally authorized by the Energy Policy Act of 1992 to provide a 10-year, inflation-adjusted tax credit based on the energy produced by qualified wind, closed- and open-loop geothermal, biomass, and small hydroelectric projects, among other technologies. The PTC has been renewed several times since the original legislation. Generally, wind and closed-loop geothermal projects received the entire credit of $21/MWh (as of 2008) and other eligible technologies received half the credit. The PTC rules also continue to require that electricity sales be to an unrelated party, and limitations related to eligibility with other public sector grants, tax-exempt bonds, and other federal tax credits remain. The ARRA extends the credit for wind projects placed in service prior to the end of 2012 and for other technologies through 2013.

The investment tax credit (ITC) continues to provide a tax credit for commercial energy projects such as solar, fuel cell, and small wind up to 30% of the project’s qualifying costs and for other geothermal, microturbine, and combined heat and power projects up to 10% of the project’s qualifying costs. The ITC for fuel cells and microturbines has a cap; the others do not. Also, the ITC must be taken in the year that the project enters commercial operation, but it vests over a five-year period. If the project is sold within the first five years of operation, the Internal Revenue Service will recapture a portion of the credit.

What’s new is that the ARRA extends the credit for projects placed in service prior to the end of 2016, although credits for geothermal projects have no expiration date. The solar tax credit is currently slated to drop to 10% at the end of 2016.

Perhaps the most significant new element is that those eligible for either the PTC or ITC may elect to receive a cash grant of equivalent value. The grant is excluded from gross income of the company, and the depreciable basis of the property must be reduced by one-half of the grant amount. Generally, the PTC or ITC make more economic sense for companies that can use the entire credit.

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