Grid Parity

The Art of Financing Renewable Energy Projects in the U.S.

CLP Beck CEM

• Publisher: River Publishers
• Year: 2020
• ISBN:
  9781000355833
• Edition: 1
• Topic: Commerce
• Subtopic: Finance

Grid Parity provides an in-depth examination of the knowledge, insights, and techniques that are essential to success in financing renewable energy projects. An energy project finance expert with 35 years of experience in capital asset financing, the author provides a comprehensive overview of how to finance renewable energy projects in America today. He explores all components of "the deal" including tax, accounting, legal, regulatory, documentation, asset management and legislative drivers to this dynamic growth sector. Filled with case studies, the book provides a thorough examination of what it takes to compete in the green-energy marketplace.

Chapter 1

Introduction to Renewable Energy Financing

“It’s like my father once said. There are three reasons we can’t do it: The first one is we don’t have the money, and it doesn’t make a difference about the other two.”

T. Boone Pickens

EXECUTIVE SUMMARY

Grid Parity: A metric regularly used in evaluating the financial viability of renewable energy projects, which have historically been considered as too expensive. Grid parity is the point at which generating electricity from alternative energy produces power is at a cost to the user that is equal to or less than the price of purchasing power from the grid. A wholesale shift in generation from fossil fuels to clean renewable energy will take place when clean renewable energy reaches grid parity.

The purpose of this book is to provide all participants in a renewable energy project a detailed introduction on financing tools and structures including tax, accounting, legal, policy, regulatory, legislative and options for the acquisition of renewable energy systems in the U.S. The risks and benefits will be explored along with provided examples of different yield analysis methods and sample documents that will help the reader achieve a better understanding of the complexities involved in this sector of our economy. The cost-effective and creative financing of renewable energy projects will help the scaling up of renewable energy as part of a transition by the United States to a low-carbon, high-energy-efficiency economy. It is written not in a “philosophical” manner or as a “dissertation” that delves in to every possible tax, accounting or legislative detail. Rather, it is written for you, the reader who has an interest in the practical application of multiple aspects of financing renewable energy projects in the U.S.

To fully understand how financing of renewable energy projects functions, one must look at all the components of the endeavor much like an artist looks at components in their creation of artwork such as medium that will be used in the production of the art work, whether it will be done with oil or water colors, etc. To accomplish a full understanding of the components that make up a completed renewable energy project that will get financed in the market place, I have broken down the components, processes and policies into ten chapters with Chapter 7 dedicated to providing examples of how each of these ingredients are mixed and matched much like an artist would do to convey their thoughts and message to a viewer of the completed piece of artwork.

The innovative financial structures utilized in the commercial, industrial and governmental sectors of our economy today has been more revolutionary than evolutionary in nature. Many of the structures crossing over into all types of renewable energy had their originations in the wind industry. Federal tax benefits and multiple sources of revenue from rebates and incentives to help pay for the projects have dramatically transformed the market place. The installed costs of the various technologies have come down in some types of renewable energy but have remained level or actually increased in others. Some revenue sources continue to increase such as the solar renewable energy credits (SRECs) in New Jersey but continue to decline in value by program design in other states like they do under the California Solar Initiative (based on predetermined program levels that started several years ago). Yet in other states, including California, there is a great deal of talk and possible modification of incentive programs that were either cash based or performance based initiatives (PBI) to move to a feed-in tariff incentive that would completely change the economics of how a renewable energy project would be financed. Stay tuned—not a single individual component of the energy project analysis is fixed in stone. Everything from equipment costs to rebates, incentives, performance and production, tax benefits and accounting guidelines are in a state of flux and subject to change on a 30-day notice. And change they will. That is precisely why it is so important to understand both the internal and external components of renewable energy project finance structures. If one understands the components and the implications of their application in the project structure, then you can adjust as the market conditions change and the interaction of the various components play out in the financial analysis.

“Oil is much too important a commodity to be left in the hands of the Arabs.”

Henry Kissinger,

U.S. Secretary of State

(attributed, Ca. 1974)

I start with an overview of the renewable energy industry sector in Chapter 1 and then a high level view of the three pillars driving renewable energy and common structures used to implement them with an indepth discussion of the factors that contribute most to a successful project. At the end of the first chapter we will look at the general costs of all energy projects since they will need to be taken into consideration as the finance model is developed.

Chapter 2 will take an in-depth review of what the seven different renewable energy technologies (or hybrids of them) are most often used in an energy project. This chapter also will introduce the reader to basic risks inherent in the financing of each technology.

Chapter 3 introduces the historical legislative processes that have forged the industry including both federal and state law promulgations. Without the incentives produced from this process, the renewable energy sector would not exist or be able to compete with energy generated from fossil fuels. It starts with the energy policy act of 2005 (EPAct), followed by the Energy Improvement and Extension Act of 2008 (HR 1424) and ends with a detailed review of The American Recovery and Reinvestment Act of 2009 (ARRA). The reader will gain valuable insight into the principal drivers of renewable energy— tax credits and tax policy. Each of these three acts was a precursor to consecutively enacted federal laws that made every change more valuable for the sector than the previous act. A project developer, investor, lender or end user of the energy cannot possibly understand what drives renewable energy projects and the financing of those assets without a complete understanding of the legislative history providing the incentives. This chapter includes a complete review of the IRS 1603 grant program and its rules, regulations and guidance that has advanced the financial attractiveness of the industry beyond anyone’s wildest dreams. Included is a detailed inspection of the section 1705 Loan Guaranty program started under ARRA. The next section of this chapter looks at how the states have complemented the federal government program with incentives and rules of their own. The end of the chapter is devoted to looking at the regulatory compliance framework that has become such a major driver of new energy projects and how the renewable energy sector plays such an important role for companies who have mandates to meet their climate emission reduction obligations.

In Chapter 4 we will review some of the external components that need to be addressed, quantified, monetized and documented when the financial transaction is developed. These components often become the greatest source for many of the creative revenue aspects of an artful financial solution to the proposed energy project. This includes rebates, incentives, energy savings, utility rate escalation assumptions, system degradation issues, O&M and other revenue and expense components. An in-depth presentation of the IRS Section 45 energy tax credits, Clean Renewable Energy Bonds, feed-in tariffs, net metering, renewable energy credits, renewable portfolio standards in various states, white tags, greenhouse gas emissions, sustainability, carbon management, state legislation, LEED green building designs, production tax credits (IRS section 48 energy tax credits), appraised value of completed renewable energy projects, property accessed financing, and commissioning—all can play an pivotal role in the creation of financing techniques on energy projects.

Chapter 5 examines in great detail the internal components of renewable energy project finance. These components focus on the accounting and tax issues that must be addressed in all finance structures. Without a complete understanding of these factors and the proper application of them when modeling a project, would make any attempt at financing fruitless. This is an area where there are many pitfalls for the unwary project developers, equity partners, customers and lenders. There are many rules and regulations—both on the accounting and the tax side—that set forth how projects can and cannot be structured. We look extensively at the AMT implications in renewable energy project finance and analyze the impact of both FASB and the IRS rules as they dictate the proper techniques. Of great importance is the clear understanding of the “safe harbor” aspects provided by the IRS and examples are provided for how this treatment can be achieved. The chapter also looks extensively at the soon to be implemented future of accounting standards and how those changes in the corporate world could dramatically change forever the way customers view the current methods of financing renewable energy projects. The chapter ends by looking at the historical big three risk considerations of investing money in project finance—credit, collateral and capacity.

In Chapter 6, I look at the “hidden jewel” of energy project finance—energy efficiency (EE). EE is defined and analyzed. I look at different EE projects that could be implemented to complement a renewable energy generation system, consider reasons why EE is not seriously looked at, provide details how EE can play such a significant role in public sector projects and how those projects can be financed. No EE project can be undertaken without the energy audit and understanding the components of that audit and the importance they play in getting a project approved by the customer, review the tax aspects in EE projects, review CHP applications in EE, and end with the “proof of success”—measurement and verification (including best practices).

Chapter 7 will take the reader through a comprehensive financial model analysis of applying all of the components of a renewable energy project discussed in Chapters 1 through 6 into sample energy projects. This will include using current software tools to model the projects. We will look at how financial structures could be modified to artfully meet the unique requirements of developers, investors, lenders and customers. The analysis will use multiple yields, assumptions, risks and databases to model that perfect project, get it built, funded, and serviced over the systems expected life. External, internal, legislative and policy components described in prior chapters will be utilized. LCOE, IRR, NPV, pre- and after-tax results, tables and graphs will all come together to provide to provide a variety of ultimate financial solutions to a project.

“Making money is art and working is art and good business is the best art of all.”

Andy Warhol (1928 - 1987)

Chapter 8 takes the reader to the next logical step after the structuring has been completed, approved by all parties to the transaction, and now must be documented. Here again, there are many fissures that need to be bridged to meet the needs of all parties if the project is ready for construction, commissioning and final operations. Two important considerations addressed in this chapter are: (i) the at risk rules and (ii) the passive activity rules set by the IRS. New business structures known as “flip partnerships” are explored and business entity taxation is evaluated. Much of this chapter is devoted to actual project documentation—the written memorialization of what the parties have conceptually agreed too. (Appendix 1 will provide an exhaustive set of sample documents referred to in this chapter.) The chapter also includes a detailed analysis of environmental factors and environmental audits needed to complete the legal requirements of all energy projects along with documents needed to provide for the future sale of the renewable energy credits over the life of the agreement. Bankruptcy concerns are addressed, requirements for estimating fair market value of assets at contract termination, product liability issues are discussed, tax audits and options are examined, and requirements needed for the permitting and actual construction of the renewable energy project are reviewed.

Chapter 9, “Investing in Climate Change,” explores the aspects of green-house gas emissions and the role of climate change in the financing of energy projects. Concepts of carbon capture and storage, cap-and-trade markets, state and regional regulatory schemes (AB32 in California and RGGI in the Northeast) and the incentives they provide for renewable energy projects are examined.

The future of renewable energy and the opportunities and caveats they present to energy project parties are discussed in Chapter 10. Both short-term and longterm implications are examined. Economic growth implica...