May 1, 2009

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

Norbert Richter

Good News for Renewables

The ARRA has several finance-based provisions that renewable stakeholders can now consider. These changes will influence how financing decisions are made on both qualitative and quantitative issues. The key changes include these:

• The PTC in-service deadline is extended through 2012 for wind projects and through 2013 for open- and closed-loop biomass, geothermal, municipal solid waste, qualified hydroelectric, and marine hydrokinetic facilities.

• Project financiers may now elect the ITC in lieu of the PTC. The ARRA allows PTC-qualified facilities installed in 2009 through 2013 (2009 through 2012 in the case of wind) to elect a 30% ITC in lieu of the PTC. If the ITC is chosen, the election is irrevocable and requires the depreciable basis of the property to be reduced by one-half the amount of the ITC.

• Project financiers may also elect a cash grant in lieu of the ITC. This new program provides grants that cover up to 30% of the cost basis of qualified renewable energy projects that are in service in 2009 – 2010 or that commence construction during 2009 – 2010 and are in service prior to 2013 for wind, 2017 for solar, and 2014 for other qualified technologies. The grant is excluded from gross income, and the depreciable basis of the property must be reduced by one-half of the grant amount.

• The ITC-subsidized energy financing penalty is removed, allowing projects that elect the ITC to also utilize "subsidized energy financing" (such as tax-exempt bonds or low-interest loan programs) without suffering a corresponding tax credit basis reduction. This provision also applies to the new cash grant option.

• Bonus depreciation of 50% is extended (that is, the ability to write off 50% of the depreciable basis in the first year, with the remaining basis depreciated as normal, according to the applicable schedules) to qualified renewable energy projects acquired and placed in service in 2009.

• The loss carrryback period is extended from two to five years for small businesses (those with average annual gross receipts of $15 million or less over the most recent three-year period). This carryback extension can only be applied to a single tax year, which must either begin or end in 2008.

• ITC dollar caps are removed, eliminating the preexisting maximum dollar caps on residential small wind, solar hot water, and geothermal heat pump ITCs. The dollar cap on the commercial small wind 30% ITC is also eliminated, and credits may be claimed against the Alternative Minimum Tax.

• The existing loan guarantee programs to cover commercial projects are expanded to include support of up to $60 billion to $100 billion in loans, depending on the risk profiles of the underlying projects.

• Clean renewable energy bonds (CREB) get more funding: $1.6 billion in new CREBs is added for eligible technologies owned by governmental and tribal entities, municipal utilities, and cooperatives. Combined with the $800 million of new CREB funding added in October 2008, new CREB funding totals $2.4 billion.

Pick Your Poison

Cash flow model studies funded by the Department of Energy have been developed to help quantify the benefit of PTC and ITC incentives. Given installed project costs and expected capacity factors — along with assumed federal and state tax rates — the models calculate the present value of the ITC, PTC, and cash grant at nominal discount rates of 5%, 7.5%, and 10%. Depending on the project type and constraints, your tradeoff choice between the federal incentives may be clear or marginal.

For example, a wind project that uses a discount rate of 7.5%, costs $2,000/kW installed, and with an expected capacity factor of 30% results in a 1.3% net value advantage for using the ITC instead of the PTC. Using the same assumptions, but with a project cost of $1,700/kW and an expected capacity factor of 40%, yields a 10.4% increased value for the PTC.

Generally, wind projects with lower installed costs and higher capacity factors find that the PTC provides greater benefit than the ITC. Because a higher capacity factor results in more production, the PTC seems to have higher project value for projects that can operate near the plant’s rated output for more hours each year.

Consider another example of an open-loop biomass project, the same discount rate, a capacity factor between 60% and 90%, and a project installed cost ranging from $3,000/kW to $5,000/kW. Using these parameters and several other assumptions (depreciation schedules and PTC applicability to biomass projects), calculations show that the ITC produces more financial benefits for the project than the PTC.