May 1, 2009

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

Norbert Richter

More Details to Consider

The relative value of each federal credit is among the most important considerations when deciding among the PTC, ITC, and cash grant. However, there are other qualitative considerations that may affect a manager’s decision, such as those that follow, especially when the quantitative differences between the PTC and ITC are slim.

Subsidized Energy Financing. The stimulus package removed the "double-dipping" penalty for the ITC, but not for the PTC. As a result, any PTC-eligible project that can secure "subsidized energy financing" may be better off electing to take the ITC (or equivalent cash grant) rather than sticking with a diminished PTC. Prior to the stimulus bill, the values of both the ITC and the PTC were reduced proportionally (with the PTC reduction limited to a maximum of 50%) by the amount of a project’s installed costs that was financed using "subsidized energy financing" (such as government-sponsored low-interest loan programs).

Option to Elect Equivalent Cash Grant. The ARRA not only enables PTC-eligible projects to elect a 30% ITC, but it also allows projects eligible for a 30% ITC to elect a cash grant of equivalent value instead. The availability of a U.S. Treasury – backed cash source might drive some PTC-leaning projects toward the 30% cash grant option, even if the PTC promises a higher expected value.

Owner/Operator Requirement. The ITC does not require the owner and operator to be the same entity, which opens the door to a variety of leasing structures, including sale/leasebacks and inverted pass-through leases. With the exception of biomass projects, the project owner must also operate the project in order to claim the PTC.

Performance Risk. Receiving ITC or cash grants is not dependent on project performance, whereas the PTC is dependent on asset output. The certainty offered by the ITC over the performance risk inherent in the PTC — even if the PTC promises a higher expected value — may make the ITC more attractive.

Power Sale Requirement. The ITC does not impose a power sale requirement, making it a more widely applicable incentive. In order to be PTC eligible, the qualifying renewable power must be sold to an unrelated party.

Tax Credit Demand. Tax equity investors rely on having a tax base that can fully absorb all of a project’s tax benefits over the coming decade before they invest in a 10-year PTC project. Even though depreciation deductions still occur for a multi-year period, the ITC greatly reduces the need for future tax shelter because the full credit is realized in the project’s first year. This also means that to fully absorb the ITC, an investor must have a larger tax base (compared to the PTC) during the first year of the project. Should a project elect to take the 30% cash grant instead of the ITC, the importance of tax equity investors and the tax credit demand is reduced (though it may still be needed in order to maximize allowable depreciation deductions).

Liquidity. The fact that the ITC, or equivalent cash grant, is selected in the project’s first year leads to a relatively more illiquid investment. Potential buyers of the project no longer have access to the credit once the project owner realizes the ITC. Consequently, the ITC vests linearly over a five-year period, forcing the investor to hold on to the project for at least five years in order to fully realize the ITC value. With the PTC, credits are realized in real time over a 10-year period as the project generates power. The sale of a PTC project can then occur at virtually any time (ignoring the influence of depreciation recapture), whereupon any remaining PTCs transfer to the new owner.
—Norbert Richter (norbert.richter@duke.edu) is an industry consultant specializing in renewable energy project evaluation and finance.