This article comes from a Chadbourne newsletter edited by Keith Martin.
Two prominent tax equity investors, whose banks accounted for roughly 30% of the big-ticket US renewable energy tax equity market in 2015, and two wind developers talked to a packed room in October in New York about the current state of play in tax equity. The discussion took place at the annual finance conference organized by the American Wind Energy Association.
- The panelists are:
John Eber, managing director and head of energy investments for P.Morgan,
- Jack Cargas, managing director, Bank of America Merrill Lynch,
- Dan Elkort, executive vice president and general counsel of Pattern Energy, and
- Martin Torres, managing director at BlackRock and formerly on the tax equity desk at Morgan Stanley.
The moderator is Keith Martin with Chadbourne in Washington.
MARTIN: Most wind companies have been focused on starting construction of as many projects as possible before year end to qualify for tax credits at the full rate. Those who can afford to incur at least 5% of the project cost have already arranged to do so. Now is the time of year when companies who lack the money to incur 5% of the cost start thinking about limited physical work at the site on turbine foundations or roads or at the factory on step-up transformers. They want to be in a position to raise tax equity later. What advice do you have for them?
The physical work test
CARGAS: The physical work test is challenging to satisfy as there are some grey areas around interpretation of the test. The more work completed before the construction-start deadline, the better. It is important that sponsors keep detailed records, including construction logs and time-stamped photographs, and hopefully have those records verified by an independent expert. We will invest in projects that relied on the physical work test.
EBER: Projects that rely on the physical work test could be more difficult to finance. There will be investors who will not want to take the risk on such projects. I would encourage developers not to be thinking about doing the least amount possible and thinking in the opposite direction, either incurring at least 5% of the project cost or going as far as they can on initial physical work so that they are well beyond what they think might be necessary.
MARTIN: This is the fourth time that the wind industry has faced a deadline to start construction. What lessons should be drawn from the last three times?
ELKORT: We have observed over the four successive extensions that the tax equity market has gotten tighter, the thresholds for establishing start of construction required by tax equity have gotten higher, and the terms of tax equity financing have gotten tougher.
The start-of-construction requirement has not changed, but if you approach starting construction like you did four or five years ago, I think you will meet a relatively unresponsive tax equity market.
I would flip the question that you asked Jack Cargas and John Eber to you, Keith. On some level, the tax equity market responds to the opinions of tax counsel. When we started looking into this in terms of how much physical work we needed to do, we reached out to a couple tax equity counsels and got a sense of how much work they would require in order to write an opinion that construction started in time. So rather than asking them, I think we should ask you: What do you require to give an opinion?
MARTIN: If we are talking about work at the project site, we like at least 10% of the turbine foundations dug to at least six feet. They must be used in the project. You should be far enough along in your planning that you have an idea what turbines will be used and how they will be positioned so that the turbine foundations do not have to be re-dug. Alternatively, we like to see at least a mile of turbine string roads finished to the permanent surface. It is even better if you can do both.
Let me ask another question related to this. The production tax credit will phase out after this year. If you start construction this year, you get the full PTC. It phases down in amount over the next three years 2017 through 2019. The following question is for our tax equity investors: when the PTC starts phasing down, do you think wind companies will be able to compete for your attention with the solar companies who will still have full tax credits?
CARGAS: I think there will continue to be investor appetite for transactions that allow for a single investment of a large amount of capital while spreading the use of tax capacity over 10 years. Therefore, my view is the tax equity market will remain interested in wind projects despite the decreasing importance of PTCs to the economics.
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Filed Under: Financing, News, Policy