Among the benefits afforded the renewable energy sector by the Inflation Reduction Act of 2022, the ability to monetize 11 new or expanded clean energy tax credits via direct transfer was especially interesting to developers because of its potential to eliminate costly, drawn-out tax equity transactions.
Investors were also eager to participate in the newly expanded credit landscape: power developer Invenergy sold production tax credits, or PTCs, worth $580 million to Bank of America, and Avangrid Inc. transferred wind-related PTCs worth $100 million to Vitol Inc. Recently, Ashtrom Renewable Energy sold $300 million of PTCs related to a Texas solar facility to an unnamed buyer.
Because PTCs are generated by energy produced, transactions underpinned by their value are relatively straightforward. But deals involving investment tax credits, or ITCs, which are tied to project development costs and are thus more variable, are another matter. Although the U.S. Department of Treasury and the Internal Revenue Service have issued some guidance regarding ITC transfer mechanics, remaining commercial risks have slowed real-world transactions.
The greatest such remaining risk in ITC transactions is recapture, a mechanism by which tax credits are forfeited (for example, because a project isn’t timely placed in service or is foreclosed upon). Because recapture can occur after a credit transaction closes, the risk of recapture disproportionately impacts financing parties and would-be credit buyers (who fear trading cash in the present for the promise of an uncertain future credit), not developers; thus, recapture worry has slowed ITC-based deals: financing parties worry about risks beyond their control, like construction and commissioning schedules, as well as ongoing compliance obligations. These worries can lead to onerous seller / developer indemnity obligations, aggressive investor distribution priorities, and lengthy funding schedules that can sour deals. Project entities and less-established developers are especially vulnerable to these investor fears because they lack the strong balance sheets and assets to provide confidence to financing parties wondering whether indemnity obligations can be performed.
Tax credit insurance products are slowly gaining popularity as a means of reassuring investors, but the market for them is not yet mature enough to have made pricing competitive. Another solution involves pushing project debt away from the project entity itself and instead toward a partnership sitting above the entity, minimizing the risk of project foreclosure (so long as the partnership remains intact).
Still, concerns remain, including over future tax credit audits by government authorities: tax credit buyers, who would be subject to audit, lack access to historic project information that remains with developers. Post-close, unearthing that information can be challenging. While developers can seek to allay these worries by proposing to assume control of any tax credit audit, institutional financing parties are leery of ceding audit control.
Additional guidance is anticipated (including a registration platform for tax credit-eligible projects), but much of the worry holding back large-scale energy tax credit deals is commercial, not regulatory. Anticipated future guidance can be addressed in current deals via provisions dealing with the renegotiation of commercial terms in the event of a change in law, but recapture worries persist, and parties sometimes deadlock on the allocation of that risk.
Still, the potential for directly transferrable tax credits is promising: if realized on a large scale, it could reduce the need for traditional tax equity financing (a lengthy, costly process in which an investor, often a large financial institution, funds a project in exchange for its anticipated future tax credits) in favor of direct sales of credits by developers to a larger pool of potential buyers. But that larger pool of buyers, often more interested in tax mitigation than clean energy development, lacks the historic familiarity with renewable energy projects that larger institutions have, and thus has been hesitant to jump headfirst into substantial deals.
Still, as larger deals close without issue, industry participants expect the tax credit transfer market will do what new markets tend to do as they age: settle down and function predictably along what will become market norms.
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