February 2, 2012

Life After the 1603 Grant: The Road Ahead

In 2009, the federal government passed ARRA, and the 1603 Investment Tax Credit (ITC) cash grant program with it. The program effectively transformed what was traditionally an investment tax credit into a cash grant, awarded by the treasury, within 60 days of commercial operation. It was perhaps the single most important piece of legislation for solar in recent history that spurred huge growth in the sector, recently estimated to be 69 percent year over year. In January 2012, the 1603 ITC cash grant expired as did the ability for developers and investors to secure the cash grant in lieu of a tax credit.

So what’s next?  Well, let’s take a look.

Part I: Looking Back
Under the Emergency Economic Stabilization Act of 2008, a 30 percent tax investment credit for qualifying renewable energy projects was extended through 2016, allowing owners of solar projects to offset 30 percent of a solar system’s cost through tax credits.  So long as a system owner had enough tax liability over the course of five years, he or she would be able to deduct 30 percent of the system’s gross cost from their federal taxes.

Because most solar project companies or developers working on commercial and utility-size PV projects do not generate enough taxable profit on their balance sheets to utilize the 30 percent tax investment credit (ITC), they had to seek a financial intermediary with the necessary tax liability to buy a stake in the project company and monetize these tax credits, what is commonly referred to as “tax equity investors.”  Tax equity investors are companies with large balance sheets, traditionally banks and more recently larger corporations, which purchase tax credits to shelter otherwise taxable income, while also providing an essential financing tool for large renewable projects.

In 2007, the Solar Energy Industries Association (SEIA) estimated there were up to 28 tax equity investors, primarily financial institutions led Morgan Stanley, JP Morgan and others.  However, the collapse of Lehman Brothers and the financial crisis of 2008 effectively ended most of these companies participation in the tax equity market for renewables.   Several companies, such as AIG and Prudential, departed the tax equity market entirely because of bankruptcy or uncertainty about whether they would have sufficient taxable income.

II. The 1603 Program
In response, President Obama approved the Section 1603 Cash Grant Program (as part of the American Recovery and Reinvestment Act of 2009), to effectively stabilize renewable energy market by providing $1.9 billion in cash grants in lieu of tax credits.  Under the 1603 Program, owners of a renewable energy system could simply apply for a cash grant to cover 30 percent of the system’s cost, regardless of their tax liability.

The 1603 Program catalyzed the solar market, with approximately 80 percent of solar projects opting for the cash grant, driving growth of 104 percent between 2009 and 2010 in the United States. As of mid-August 2011, 87 percent (2,095) of the 2,410 cash grants awarded under the 1603 program were provided to solar energy projects (although only 27 percent of the nominal value if these grants). Since October of 2010, the federal government has invested over a billion dollars in solar projects through the 1603 Grant Program.

Unfortunately for the solar industry, the Section 1603 Program expired at the end of 2011, and it appears highly unlikely that it will ever be renewed.   With the expiration, interested parties without the necessary tax liability will again have to rely on tax equity investors to fully monetize the ITC.   The problem is twofold: (i) the tax equity market has not yet fully recovered and there are only an estimated 10 to 15 investors looking for tax equity deals and (ii) integrating tax equity into deal structures will significantly increase transaction costs, raise the costs of development, and potentially limit smaller deal sizes.

The result will be a bottleneck in 2012-13, where a substantial number of solar developers and other interested parties look to construct or own commercial-sized solar system, but only a select few can secure the requisite tax equity financing. This will mean a number of projects will not be developed, and those projects that do secure tax equity will see increased yields. Some projects are likely to seek safe harbor under the 1603 Program by securing five percent of the total costs of the system, but this strategy brings with it its own challenges.

So now, as we look towards the horizon, what’s next? What will happen to this 80 percent of the industry opting for the cash grant? Companies like Sungevity, Sanyo and Vivent are quickly lining up tax equity for the upcoming year, and some believe market growth will slow by up to 50 percent in the second half of 2012. Might these challenges be mitigated by solar modules priced below $1.10/watt? What creative solutions will our industry implement to meet these financing challenges?

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