Episode #2: One Year Later: Exploring the Promising Opportunities of the IRA
Monarch Perspectives
Click here to listen and learn. Follow along with the transcript below.
Steve LeClere:
Today, we’d like to delve into some of the opportunities brought about by the Inflation Reduction Act, also known as IRA. As you know Rick, it’s been a year since the IRA was signed into law and there have already been substantial progress and interest in the programs.
Rick Chukas:
You are absolutely right, Steve. As you mentioned, there has been tremendous interest, for example, SEIA has reported that America’s solar and storage industry has announced over a hundred billion in new private sector investments since this time last year.
Steve LeClere:
Given all that investment, we thought it’d appropriate to try and gain a deeper insight into these opportunities and so we’re honored to have Bryan Didier as our guest. Bryan is a valued partner here at Monarch leading our renewable energy division. He has over 30 years of leadership experience, including nearly two decades of legal expertise in renewable energy and project finance. Bryan brings a wealth of knowledge to the table and we’re thrilled to have him. Welcome Bryan.
Bryan Didier:
Thanks, Steve. Thanks, Rick. Happy to be here and happy to talk about something that brings a lot of passion to my work and that hopefully I can share some information on that helps others out as well.
Rick Chukas:
Well, Bryan, let’s dive in head first, if you don’t mind, give us an overview of IRA. What are some of the primary changes for the renewable energy industry and how are those playing out?
Bryan Didier:
Well, I think the most exciting part is that we’ve seen a 10 year extension of the two primary tax credit programs, the production tax credit under section 45 as it will be continued under a new moniker, the investment tax credit or section 48 as it will also continue under a new guise going forward. Those two programs will be expanded to include new technologies and then there are a host of other adjunct exciting new possibilities. Some of those include production fuels, incentives related to EVs and related technology, new manufacturing credits as well. Now, under the production tax credit and the investment tax credit, those have been restructured to better incentivize use of prevailing wage and labor in the manufacturing and development facilities, but also include some additional public policy boosters or adders, if you want to call them, for investments in certain areas that we’ll talk about a little bit when we get to the adder content.
Steve LeClere:
Great, thanks Bryan. So you mentioned the two programs, the production tax credit and the investment tax credit. Can you first tackle how the production tax credit functions and maybe describe a bit of what’s new under the IRA?
Bryan Didier:
Sure. The production tax credit, as its name would imply, is based on the amount of energy that is produced by a qualifying resource. What’s new under the IRA, as I indicated, is restarting the clock on that credit that was subject to a phase down. It’s now gone back up to the highest value amount. Again, that’s subject of course to, as I mentioned earlier, using wage and labor. So using prevailing wage, creating and using a workforce that is being paid at an appropriate level and then also through use of apprentices to perform certain tasks, trying to provide forward training in improving the job base and create a new technical field for American employment as we cease or move out of some of our historical use of fossil fuels.
A couple of the other interesting new pieces are the adders, again that we’ll talk about in a minute, but also the expansion of the production tax credit to new facilities such as bringing solar into the production tax credit. So now if I’m a developer, I do the calculus on when can I monetize the credit value and then what is my production stream versus my cost stream. Do I want to try to bring all that money in upfront or does it make more sense to bring that money in over time on a high producing asset that I may be developing in a certain area that has lower power prices or a lower cost of labor, so the upfront value would be lower.
Rick Chukas:
Bryan. Okay. Continuing the theme, what then is the investment tax credit, aka ITC and how does it differ from the PTC? How was it changed by the IRA?
Bryan Didier:
Sure. So the investment tax credit is, provides a qualifying credit for the owner of renewable energy technology based on the cost of installing that qualified energy property. So that then looks at what is the investment and were incentivizing investment less incentive on the long-term production. Although, because there was a recapture component to the investment tax credit, we do need to see that property function for at least five years. Obviously many are designed for a much longer life, but we do have some measurement that we can’t just incentivize the investment of a non-functioning property, so we do require the five years. Changes by the IRA include both those adder credits, but also the concept of a lower base credit, that again, moves to the higher 30% amounts if you satisfy prevailing wage and labor requirements. Which again is paying appropriate costs for the experts that are doing the installation in those trades, but then also incentivizing a future for those trades by using qualified apprentices based on the various tasks and availability of those apprentices.
Steve LeClere:
All right, thanks Bryan. The background on the PTC and ITC is helpful and I think you’ve done a wonderful job teasing the IRA adders. And I know that that would generate a lot of interest among my clients in the affordable housing world as one of the adders relates to them. So let’s dive into it, can you give us a brief overview of what the adders are, what they do, and what the guidance that has come down looks like for those?
Bryan Didier:
We’ve been, I think, very pleasantly surprised by the rate at which guidance has been delivered by treasury with respect to the expansions of the IRA, new facets of the production tax credit, new facet of the investment tax credit, and also in particular these adder credits. So as I mentioned before, there’s a base credit under both the PTC and a base credit under the ITC. Those are each multiplied by five times by complying with the prevailing wage and apprenticeship requirements, right, the PWA rules. Now, once we get to that higher elevated credit, we get the opportunity to either multiply by an additional 10% under the PTC or stack an additional 10% credit onto the ITC, from two adders that apply to both PTC and a third that also gets added to the ITC. Those three adders are, first of all, domestic content. Domestic content is an adder that is available for using a certain percentage of American-made and manufactured components as part of the renewable energy facility.
So stepping back to public policy, what does that mean? It means that instead of maintaining a renewable energy industry that may rely on foreign sources for the materials and for manufacturing those, we’re simultaneously trying to recycle our economy by bringing that manufacturing base onshore. Second is, by incentivizing development in energy communities, that’s an additional 10% adder, again, either a multiplier to production tax credit or stacked on top of what the otherwise credit would be under the investment tax credit. If you are citing the development in three different types of energy communities. The first is a brown fields under the Environmental Protection Act that has not been remediated. So obviously, the public incentive behind that is to try to use lands that are not otherwise economically viable for development and turn them into a true source of building the independent renewable energy economy in the United States. The second is smartly targeted toward remaking what have historically been fossil fuel energy communities that now suffer from higher than normal unemployment.
If we build renewable energy in those locations, there’s a 10% adder as that is considered an energy community. So as we lessen our dependence on fossil fuels, we are trying to remake those communities with this new technology, with these jobs, and make them centers of our energy independent economy. The third that’s available only under the investment tax credit is an additional incentive for smaller wind and solar facilities that are either located in low-income communities, designated by census tract, or where the benefits of the development go into low-income persons, either by citing that renewable energy resource on the roof of low-income housing and providing the benefits to those residents, or by providing the benefits to low-income community persons either by having them participate directly in ownership, or selling electricity on the discount through a community solar type program.
Steve LeClere:
Bryan, just a quick question on the adders themselves, can they be combined or can a project only achieve one of them?
Bryan Didier:
That’s a great question. So you can have each of the domestic content adder, the energy community adder, and if you are under the ITC, you can also have the low-income community adder. They’re all considered stackable. Now, within the low-income community adder though, you only get a one adder based on either a location qualification or a benefits qualification. You couldn’t have an adder for both location and benefits qualification. So under an ITC where those are stackable, taking the 6% base rate, the five x multiplier for prevailing wage and apprenticeship gets you to 30%. Then if you had domestic content, it’s another 10%, we’re at 40. And if you had the energy community another 10% and you are at 50%. Then a location-based low-income community adder would add another 10% to get you to 60, or the alternative being, if you had all of the adders available, then you could be a 70% credit based on the off take.
So if I were a developer looking to maximize these credits, but also think about public policy goal, maybe this means that I’m now taking a solar development and looking to cite it on the rooftop of low-income housing in an area that has historically been a place where it is an energy community because there has been historic fossil fuel employment and higher than normal unemployment, and I’m using domestic content, so I’m using panels manufactured in the us. Then I’ve got myself this very robust 70% tax credits, which as you can tell from an investment tax credit really becomes the bulk of your capital stack is through this incentive.
Steve LeClere:
Great. Thanks for clarifying. That obviously adds a, no pun intended, adds a ton of value to the project if you’re able to stack those in that manner. Rick, do you want to tackle the public policy questions?
Rick Chukas:
Indeed, Steve. And Bryan, good job of building the foundation on the changes made by the IRA to PTC, ITC and then explaining adders. So from a public policy standpoint, how are the changes intended to reduce inequalities and spur economic growth?
Bryan Didier:
One common impression is that low-income communities have historically born a disproportionate burden from the sighting of energy resources. Where we’ve built coal plants or other energy centers have often been in some of the more densely populated urban areas and more affluent communities have been able to steer that development because of lobbying or other action they may take away from their neighborhoods and communities. So as we hopefully move away from some of those technologies as we displace those, if we can bring the renewable resources right to those communities, they’re suddenly getting benefits. Additionally, many of the residents of low-income communities or those persons may not be homeowners. They may not have the ability to install renewable energy facilities. Secondly, with the reuse of land, that’s a really interesting prospect. One of the thoughts out there is that really to fully become energy independent with the renewable energy economy, only need to use about 2% of the US land.
When you look at warehouse spaces or the amount of land in the US, which unfortunately has contaminated soil or other issues, we could accomplish that goal simply with using those available properties. So if we can do that, some of the concerns about spoiling our environment with the site of wind turbines, or solar farms, or other facilities elsewhere, we’re doing it places that we couldn’t use for other development. They just aren’t available for housing, commercial development, vacation spots or anything like that. So those are pretty important. Then the other is simply saying what communities have historically depended on fossil fuel. We’re moving away from that. We know that creates a burden in loss of jobs, so let’s try to replace that with a newer technology that will have long lasting benefits by creating schooling, vocational training, and then bringing source of actual job growth to those locations instead of them making them fallen away communities that have been abandoned.
Steve LeClere:
Bryan, picking up on your job growth comment and understanding that the domestic manufacturing and the apprenticeship program requirements that you’ve mentioned are clearly intended for that. If you require domestic content, that should increase domestic manufacturing of these parts because you’re creating an incentive out there in the market. Similarly, with these apprenticeship requirements, theoretically there’s going to be a supply to meet that demand in the form of these apprenticeship programs popping up. So I’m curious if you’re seeing that in the market, are solar developers or renewable energy developers writ large, targeting these communities as intended, or what are we seeing on the job growth front?
Bryan Didier:
Just because of the cycle of development, I think for a period of time there were already those projects that were under development. Thankfully, a lot of those, whether intentionally or unintentionally, were already benefiting some of these communities, but I have seen a move, and I think a lot of developers are looking forward now, there are mapping tools out there. And much like the new market tax credit program may operate, someone will look and say, “I plan to build this resource. I’m going to build this manufacturing facility. I’m going to build this renewable energy resource. Where do I cite it?” That becomes driven more by the added incentive of either citing in a low-income community or potentially citing it in the energy community. So we are starting to see those decisions made. We’re seeing a pivot on the developer side of looking specifically at those areas of land and saying, “Okay, if I can put the resource there and have a higher investment, what is my additional cost of capital perhaps for transportation, transmission of the electricity, or is it already set up an area that makes sense?”
Just like a lot of states have tried to incentivize development there with various programs, I mean this really creates a more equal national footprint for that type of siting decision. Then on the domestic manufacturing, I definitely think that we will see long-term benefits from that. We’ve been reliant and it’s been one of the challenges frankly, in the past few years on supply chains, and a lot of those supply chains being dependent on overseas markets. As we continue to onshore and become a producer in the US, it’d be wonderful if we got to a stage we were actually an exporter rather than an importer of renewable energy technology. So I think there’s a lot of parts to see that in cycling of the economy that will be really interesting in the way that the Act is designed in so many functions will have a natural offshoot of allowing those opportunities to happen. And so another one of the exciting adders is the energy community. This is available under both the production tax credit and the investment tax credit and incentivizes citing of renewable energy projects in areas that have one of three characteristics.
One is that they’re a brownfields under the Environmental Protection Agency regulations, so we’re remaking lands that don’t have any real economically viable use and using those for citing energy projects. The second is using metropolitan service areas or non-metropolitan service areas that have historically been dependent on the fossil fuel industry and now suffer from high unemployment. So we’re trying to incentivize renewable energy development and remake those economies by retraining and educated technical workforce into a new technology. Then the third is to develop areas where either a coal plant or a coal electric energy generating facility that was fueled with coal have been retired or closed within the past couple of decades depending on the qualification. Again, remaking an area that has historically been linked to fossil fuel industries to become a renewable energy hub.
Rick Chukas:
And Bryan, as a follow on to that, we’ve largely given up a lot of the manufacturing to China at this point in time. How does the IRA help cities and communities long-term, mid to long-term even promote sustainability?
Bryan Didier:
Yeah, that is a great question, Rick. Certainly the incentive to put the manufacturing in the US, there’s two prongs under the Inflation Reduction Act. One is advanced manufacturing credit, and we’re incentivizing on a credit side location of manufacturing facilities, but also by incentivizing on the development side, the use of those materials, we’re creating our own market. So that’s pretty exciting. I think communities are going to make those decisions as well just as we’ve seen local communities campaign for certain industries, I think we will see more and more smart civic leaders say, “I want to become a hub for renewable energy manufacturing,” or, “I want to become a hub for renewable energy generation. What do I do to attract those developers? How do I facilitate permitting? How do I facilitate my tax roles? How do I attract those people to bring their jobs and their technology?” And that’s the American ingenuity that has built a lot of our industries.
Steve LeClere:
Thanks, Bryan. I think the last topic we want to discuss today is the transferability option for the renewable tax credits that was created under the IRA. Can you describe generally what the transferability option is, how it’s been received, how it’s playing out in the market, and what impact, if any, it’s having on pricing for these credits?
Bryan Didier:
Sure. The transferability really is a new opportunity to find sources of the capital stack for doing renewable energy investment that is different from the traditional requirement of ownership under the standard production tax credit or investment tax credit. As I mentioned earlier, those credits flow to the owners of those resources, the tax owners of those resources. With the new transferability option under Internal Revenue Code section 6418, the owner can choose to, instead, make a one-time transfer in return for cash of the credits to another taxpayer. That removes the ownership requirement and allows someone to simply self channel their tax dollars with without being as beholden to what may be perceived as a risk of investment and instead just generate the tax credit stream instead of the ownership stream, which generates both tax credits, some cash, and some other tax economics. Perhaps a higher return, but something that requires a different accounting look and mindset and maybe more internal work and process to get comfortable with how that would sit on a balance sheet and how the overall structure works.
So it’s intended to be a simpler tool that can provide a part of the capital stack that, frankly, would price somewhat lower because there are fewer benefits returned, but also becomes available more equitably across the board to smaller projects that couldn’t withstand the traditional cost of tax equity. So under the transfer rules, the credit is attached to either the amount of electricity produced or the amount of the qualifying investments, but instead of the owners taking the credits, there is a one-time transfer and an amount that comes in as a cash component to the capital stack that can be used. And then the transferee just takes that credits on their return and is able to offset their tax burden.
Steve LeClere:
Thanks, and are you seeing an impact to pricing?
Bryan Didier:
There’s a spread between an investment tax credit and a transfer tax credit. Within the transfer tax credit themselves, there’s also a bit of a spread on pricing because the production tax credit can be timed more specifically to a typically more level stream based on the production of the asset, that can be timed exactly quarterly to the transferees estimated tax filings. There’s a real-time use component there that allows that credit to transfer to slightly higher price than perhaps the advancement tax credit, which again, is usable on the next quarterly estimated payments, but is one slug of the credit. Also, the investment tax credit is subject to the same recapture rules that we mentioned briefly earlier. Because the credit is based on the investment, the government doesn’t want to incentivize investments that don’t ultimately perform. So if that qualifying facility would go out of service before the end of five years, there is a recapture of the credit that was granted that has a step down over time of 20% per annum.
And because of the way the transfer rules are written that recapture is suffered by the transferee. So they’re taking on the risk of losing that credit, therefore, they’re going to reduce their pricing somewhat as a backstop against the fact that they’re paying for something that is immediately used, but subject to that recapture period, obviously that has some influence on the pricing. And then there is more or less of a gap of variability there depending potentially, on technological risks, the strength of the sponsor or other kind of operating parameters that may make that separation increase or decrease. I would say the spread is lower again for 2023, just based on the volume of credits. We think it’ll eventually establish somewhere two to 4%, again, dependent somewhat on the timing of when one is paying for the credits versus when one can use the credits and what that means.
Rick Chukas:
So Bryan, continuing the theme of transferability. If I’m a developer, what is the benefit of a credit transfer to me? How do I choose between transfer and traditional tax equity? And then I’d posit the same question, but from an investor standpoint, how are decisions going to be made and what factors need to be taken into consideration?
Bryan Didier:
Yeah, that’s a great question. I’ve had the pleasure talking to a lot of investors and a lot of sponsors on this very issue. People like to look at the analysis, they like to run models, they like to run comparisons. Some of it’s just very mathematical. Some of it is also in the infancy of the market trying to predict where numbers go. Certainly, for the smaller projects, if I’m a developer, the transfer may be an easier route. There’s just a cost to tax equity that is a layer of unavoidable costs to play in the area. And even though there may be a differential in the pricing, that difference of pricing is based on what would otherwise be the amount of the credit. So until you reach a certain magnitude of investments, there may not be enough added benefit from a traditional tax equity structure that prices somewhere 10% higher on the yield to make that worthwhile versus just doing a very simplistic transfer if that can be arranged. Then in addition to that one consideration for a sponsor, maybe their comfort with tax equity.
If they’ve got a lot of great existing relationships, they’re doing those larger projects where whatever that differential is meaningful to the overall capital stack, they probably stick with that structure. A sponsor who traditionally hasn’t had access to tax equity is maybe doing those smaller projects or one-offs may be more willing to just do the transfer credits. And in doing the transfer credit than, they’ve gotten that money up front, they don’t have that long-term minority partner or flipping to a minority partner eventually in their investments. They’ve got full discretion and control, and could sell out at some point without having to worry about ongoing management on behalf of the investor. Now obviously, if it’s the investment tax credit, there’s still the recapture risk that is there, but it’s still seen as less burdensome than having that minority, but we feel both markets are really going to continue to be viable. We haven’t seen sponsors say, “I would only do one.” They’re still considering, in circumstances, what is the right result for them. Turning then to the investor side, it’s also an interesting question.
Investors that have been in the market and are comfortable with tax equity are likely sticking with tax equity. They may though be willing to use transfer as a bit of an additional play to more specifically fill gaps or variability they have in a specific year because of that ability just to hone it and find that right exact fit to really measure to their discreet exposure they have from a tax perspective in any given year. There are other investors that may be new to the market and aren’t yet comfortable with the accounting piece and the internal process that would accompany having to do the investment tax credit. Therefore, they may option just to do the simpler transfer. And then of course, you’ve got the impact investments piece and whether there is a measurable difference, which I’m certain to be in a position where I would argue there is, from a sustainability approach on when you own directly or indirectly the asset that is generating the renewable energy versus simply buying a tax credit.
Nothing wrong with just using the tax credit to offset, but there certainly is a different look on your embrace of sustainability and impact investing when you are in that investment long-term and truly are a partner in the development.
Steve LeClere:
Bryan, I’m curious, you talked through kind of the cost benefit analysis a developer an investor might go through with choosing between transferability or going on a more conventional investment tax structure. Are there any other risks or pitfalls associated with the transferability option that folks should be thinking about as they approach these issues?
Bryan Didier:
Yeah, I think one thing on the transferability, we talked about the recapture risk being with the transferee on the investment tax credit. The other one, in the transfer credit, and this is again, I think a nod to public policy, and a thought that a market will be regulated by third party factors and influences, is that in the transferred credits, if the transferee were to claim a higher credit than the IRS determines would’ve been allowed to the original taxpayer who transferred the credit, then the transferee can be assessed a 20% excessive tax credit penalty. Now, that 20% tax credit penalty is obviously designed to prevent foul play in instances where there could be potential abuses. Fortunately, though for the transferee, within the rules that 20% excessive penalty isn’t payable if the transferee can prove that it had a reasonable cause for its belief of the basis of the credits.
So what that means is that while the transfers intended to be simpler, there still is a necessary part of underwriting and diligence that attenuates a transfer credit so that one can bolster against the possibility of paying that excessive credit transfer. So there still is a look to validate that the credit is available to the transferor and that the basis and documentation supporting that are correct.
Rick Chukas:
Bryan, I will say you have done a phenomenal job of providing an overview of the IRA and its impact and renewable energy industry. Is there anything that we missed or anything else that you want to touch on before we sign off here?
Bryan Didier:
No, I think we’ve hopefully provided a pretty well-rounded overview, gone in depth in a few key areas. But a lot to cover in a short period of time, and it’s a continually changing landscape. I think there is tremendous opportunity out there. All of the new types of assets are interesting to see where those go, and I think it’s much like anyone’s projection, whatever we think is going to happen in the future, we’re going to be wrong, but we’re going to be excited about what the results are.
Steve LeClere:
Well, Bryan, thanks for joining Rick and me today and explaining the IRA to us and we look forward to seeing where the new opportunities it has created will take us in ’23 and ’24. Thanks.
Bryan Didier:
Awesome. Thanks to you both. Appreciate it.
Steve LeClere:
Thanks for joining us on this episode of Monarch Perspectives. We hope you’ll follow and subscribe so you never miss an episode.
Rick Chukas:
Be sure to rate and review us wherever you get your podcast. To learn more about Monarch Private Capital, please visit monarchprivate.com.