With the end of the year approaching, the annual Congressional debate over extending a variety of expiring federal tax credits and other benefits is gearing up again. Few of these measures are as high-profile as the payroll tax cut, but each has a vocal constituency, including renewable energy. The American Wind Energy Association (AWEA) has launched a major effort seeking inclusion of the Production Tax Credit (PTC) for wind power in this year's "tax extenders" package. That might seem premature, since the PTC won't expire until the end of 2012, until you realize that eligibility for the stimulus-funded Treasury renewable energy grants for which many wind project developers have opted over the PTC ends in a few weeks with little chance of a further extension. However, before simply tacking another year (or four!) onto a tax credit that began nearly 20 years ago, Congress should answer two basic questions: Is this still the most effective way to promote renewables like wind, and does wind power now require subsidies at all?
I don't blame AWEA for tackling this issue early, since the US wind industry has experienced significant volatility when previous PTC expirations went down to the wire, and in several cases lapsed for up to a year. At the same time, taxpayers deserve a more compelling rationale for continuing to subsidize wind power than the one now being offered. The "green jobs" argument is wearing thin, post-Solyndra, and it has become increasingly evident that helping to create a market for renewable energy technologies is a necessary but not sufficient condition to establishing a sustainable, globally competitive renewable energy manufacturing industry. Although more of the wind power value chain is now produced in the US than previously, too much of each wind subsidy dollar still goes offshore for this to be deemed an efficient way to boost to US jobs and manufacturing without reform.
In order to address the first question I posed, concerning the continued suitability of the PTC, it's important to understand how it works and how it compares to other renewable energy incentives. The current PTC provides wind project owners (or the parties to whom the tax benefit has been sold via a "tax equity swap") with an income tax credit of 2.2 cents per kilowatt-hour (kWh) of electricity actually generated and sold from the completed facility. Based on recent estimates of the levelized cost of electricity from unsubsidized wind power, that's over 20% of a typical wind farm's production cost. It's also equivalent to more than half of this year's average wellhead price of natural gas--a far larger subsidy per BTU than the controversial tax benefits currently provided to oil & gas firms.
The best thing about the PTC is that it is entirely outcome-based. You only receive the benefit when your project is completed, brought online, and as power is sold to customers. Mess up any of those steps and you get zilch. Put your project in a location with poor wind resource or limited access to transmission, and you won't get nearly as much tax benefit. So from that standpoint--ignoring the green jobs angle that arose mainly from expediency when the financial crisis and recession hit--we are getting what we pay for: actual low-emission energy. The structure of the PTC has cash-flow implications that are viewed as a problem by many wind developers but might be regarded as a useful feature by taxpayers. Smaller developers, in particular, have greater difficulty financing projects when the incentive must be deferred until after start-up, or they may lack sufficient taxable income to take full advantage of the credit. They complain about the need to transact swaps with bankers and other investors to realize the subsidy sooner, at a cost. But perhaps it's not such a bad thing for companies that small to have to convince an experienced third party that their project is really viable.
There are many alternatives to the PTC, including the 30% Investment Tax Credit (ITC), the same one received by solar and other technologies. The stimulus bill extended the ITC as an option for wind and allowed the Treasury Department to pay it as a cash grant, rather than waiting for subsequent tax filings. This certainly put money in the hands of wind developers much quicker--$7.6 billion since 2009 including $3.3 billion so far this year--and it has the added benefit of automatically scaling down as the cost of the technology falls. The solar feed-in tariffs favored in Europe didn't have such a feature, with the result that countries have had to cut them numerous times, but only after the fat tariffs gave birth to a huge export-oriented solar manufacturing industry in Asia. Similar competition is now emerging in the wind industry.
The main problem with the ITC is that when viewed from an outcomes perspective, which really gets to the question of effectiveness, the outcome being promoted is construction, rather than energy production. You would get the same tax credit for a project with the best wind resource as for one with the worst. (This has also led to a lot of solar installations in places that would never otherwise have been considered.) So of the two main policy tools the federal government has used to subsidize renewable electricity, the PTC is probably more cost-effective in delivering the result we should really want, which is more renewable energy. As it is, even with rapid growth over the last decade, wind accounted for just 2.8% of our power generation this year through August.
That brings us to the bigger question of whether wind should be subsidized at all after the current PTC term expires. I get emails practically every day from folks who have serious concerns about the health and environmental impacts of power, as well as its cost- and emissions-reduction effectiveness. Even if we ascribed all of these concerns to NIMBYism, it doesn't change the fact that the wind PTC, complete with annual inflation adjustment, is providing the same level of incentive as it did when the technology was much less mature and cost many times what it does today; AWEA cites wind costs having fallen by 90% since 1980. Other factors have also changed in the last twenty years. A majority of US states--and most of those with attractive wind resources--now have in place Renewable Portfolio Standards requiring utilities to include increasing proportions of renewable power in their supply. These mandates create a similar redundancy as the one between the ethanol blenders credit, which is also due to expire 12/31/11, and the biofuel mandates of the federal Renewable Fuels Standard. In the absence of the PTC, the state RPS system should provide a safety net--and more--for the industry.
There are two other key factors missing from AWEA's arguments for extending the PTC. The first is the economy, which is the main reason that US electricity demand has not been growing at a rate that would support large generating capacity expansions of any kind. New wind installations have been anemic for the last two years, in spite of last year's extension of the Treasury grants. Moreover, wind must now compete with the explosion of domestic natural gas production from shale, which when used in combined cycle gas turbines produces cheaper electricity than wind, with low emissions of the air pollutants that are of the greatest concern to most Americans, while still beating coal-fired power hands down on greenhouse gases.
Where all this leaves us depends on your priorities. If your main focus is on reducing greenhouse gas emissions and you see renewable power as a key strategy, then in the absence of a price on carbon you might support extending the PTC for at least a little longer. If you are concerned about climate change but more worried in the short term about the deficit, then letting the PTC lapse next year and relying on state RPS quotas to put a floor under wind looks reasonable. If boosting US cleantech manufacturing is your aim, you should prefer a more direct incentive than the PTC. And if your main worry is oil imports, then the PTC is irrelevant, since the US gets less than 1% of its electricity from burning oil, and most of that in remote and back-up power roles that wind can't easily fill. On balance, if after considering all the alternatives the Congress decides to extend the Production Tax Credit, it should be for an explicitly final period, at no more than the 1.1 cent/kWh rate that technologies like marine, hydropower and waste-to-energy now receive, and without the annual inflation adjustment that undermines the incentive to continue reducing costs.
Showing posts with label investment tax credit. Show all posts
Showing posts with label investment tax credit. Show all posts
Friday, December 09, 2011
Monday, September 26, 2011
Drawing Conclusions from Solyndra
When the energy portions of the 2009 stimulus were announced I remarked to a colleague that I wouldn't be surprised if its billions in incentives led to a future scandal or two. In fact, I was thinking more along the lines of fraudulent diversions from the Treasury's renewable energy grant program, which has handed out $8.7 billion since its inception. That program had its own day in the spotlight when it turned out that a significant portion of the initial disbursements were going either to non-US companies or to pay for equipment made outside the US, undermining its green jobs rationale. However, I wouldn't have guessed that the biggest scandal would erupt from the ostensibly lower-risk loan guarantee program of the Department of Energy. The prospect that a tussle over a small cut to that program, for which eligibility is due to end in a few days, nearly set up another government shutdown crisis seems even stranger.
Whatever happens to the loan guarantee program, the decision to lend over $500 million to Solyndra looks bad, and not just in retrospect, with the firm in bankruptcy. The market environment that Solyndra was betting on was already shifting in late 2008--months before its loan was approved. The global bottleneck in the supply of polysilicon, the key raw material for the crystalline silicon photovoltaic modules with which Solyndra's unique CIGS modules competed, was easing as new polysilicon capacity was coming on line, more was under construction, and polysilicon prices were falling. Someone at the DOE should accept responsibility--and the consequences--for ignoring or missing that signal and concluding that it was a good time for Solyndra to double its capacity and fixed costs.
As tempting as it might be to dwell on Solyndra's failure, that should not be our primary concern right now. If laws are found to have been broken or influence improperly used, there will be ample time to address that. Nor should we dwell on the fate of the other projects for which $10 billion in loans or loan guarantees have already been concluded. Many of those projects involve generating renewable power and selling it under long-term agreements that will ensure a profit, with little additional risk. Instead, oversight should focus urgently on those projects that are still under consideration or have received only conditional approvals to date.
One of the applications that apparently got caught in the fallout from Solyndra was a project of Solar City Corp. to install up to 371 MW of rooftop solar panels at military facilities across the US. Solar City was seeking a partial (presumably 80%) guarantee of up to $344 million in loans to carry out these projects. This is precisely the sort of initiative necessary to deliver on the military's goals to increase its use of renewable energy. I heard a lot more about that at an Air Force energy briefing at the Pentagon earlier this month and will write about that session when I receive the responses to the follow-up questions I sent in.
The military faces two major obstacles in achieving its energy objectives, and projects like Solar City's would help overcome both. First, energy generation assets are expensive and would compete with military hardware procurement and other budget priorities. Having someone else make those investments and charge the services for power that they'd otherwise have to buy from a utility is as useful for the military as it is for homeowners who can't afford the up-front costs of rooftop solar. The other aspect with which the project helps is that the economics of rooftop solar still depend on federal and state incentives that the Department of Defense can't access directly. In this case, Solar City would buy and install the hardware and collects the tax credits and other incentives that allow them to charge the military a competitive price for power. With time running out on its application, the company has apparently decided to pursue a scaled-down version of the project with only commercial financing.
As for any remaining applications, if the DOE can't convince itself that they are sound before the clock runs out at the end of the month, then it must either turn them down or ask the Congress for more time. Whatever call the DOE makes it had better be prepared for the scrutiny and second-guessing they are bound to receive. The Solyndra debacle has arguably done as much harm to US renewable energy policy as the Enron scandal did to energy trading. Another Solyndra might just put an end to the whole proposition of financing green energy with public funds in the US.
Note: Posting updated to reflect the current status of Solar City's project.
Whatever happens to the loan guarantee program, the decision to lend over $500 million to Solyndra looks bad, and not just in retrospect, with the firm in bankruptcy. The market environment that Solyndra was betting on was already shifting in late 2008--months before its loan was approved. The global bottleneck in the supply of polysilicon, the key raw material for the crystalline silicon photovoltaic modules with which Solyndra's unique CIGS modules competed, was easing as new polysilicon capacity was coming on line, more was under construction, and polysilicon prices were falling. Someone at the DOE should accept responsibility--and the consequences--for ignoring or missing that signal and concluding that it was a good time for Solyndra to double its capacity and fixed costs.
As tempting as it might be to dwell on Solyndra's failure, that should not be our primary concern right now. If laws are found to have been broken or influence improperly used, there will be ample time to address that. Nor should we dwell on the fate of the other projects for which $10 billion in loans or loan guarantees have already been concluded. Many of those projects involve generating renewable power and selling it under long-term agreements that will ensure a profit, with little additional risk. Instead, oversight should focus urgently on those projects that are still under consideration or have received only conditional approvals to date.
One of the applications that apparently got caught in the fallout from Solyndra was a project of Solar City Corp. to install up to 371 MW of rooftop solar panels at military facilities across the US. Solar City was seeking a partial (presumably 80%) guarantee of up to $344 million in loans to carry out these projects. This is precisely the sort of initiative necessary to deliver on the military's goals to increase its use of renewable energy. I heard a lot more about that at an Air Force energy briefing at the Pentagon earlier this month and will write about that session when I receive the responses to the follow-up questions I sent in.
The military faces two major obstacles in achieving its energy objectives, and projects like Solar City's would help overcome both. First, energy generation assets are expensive and would compete with military hardware procurement and other budget priorities. Having someone else make those investments and charge the services for power that they'd otherwise have to buy from a utility is as useful for the military as it is for homeowners who can't afford the up-front costs of rooftop solar. The other aspect with which the project helps is that the economics of rooftop solar still depend on federal and state incentives that the Department of Defense can't access directly. In this case, Solar City would buy and install the hardware and collects the tax credits and other incentives that allow them to charge the military a competitive price for power. With time running out on its application, the company has apparently decided to pursue a scaled-down version of the project with only commercial financing.
As for any remaining applications, if the DOE can't convince itself that they are sound before the clock runs out at the end of the month, then it must either turn them down or ask the Congress for more time. Whatever call the DOE makes it had better be prepared for the scrutiny and second-guessing they are bound to receive. The Solyndra debacle has arguably done as much harm to US renewable energy policy as the Enron scandal did to energy trading. Another Solyndra might just put an end to the whole proposition of financing green energy with public funds in the US.
Note: Posting updated to reflect the current status of Solar City's project.
Thursday, August 04, 2011
US Renewables Need A Fallback Plan
When I described some of the energy implications of the debt limit crisis last month, the most serious ones were associated with a default by the US government in the event the debt ceiling wasn't extended. That risk has been resolved, for now. But that doesn't mean that everything looks rosy, especially for renewables. Renewable energy technologies and projects are far more dependent on government assistance and policies than conventional energy. The fate of a wide range of federal energy incentives looks highly uncertain, and the impact of that uncertainty is matched by doubts about the health of the US economy and its growth prospects. With the pace of growth already slowing in some renewable energy sectors, any manufacturers or project developers that aren't thinking seriously about how they would manage without federal incentives could be setting themselves up to become roadkill.
Understanding why requires taking a closer look at the debt ceiling bill that Congress passed in the context of the federal budget baseline--never mind that the US Congress has not enacted a budget in more than two years. In April the Congressional Budget Office (CBO) published its assessment of what the economy would look like under the budget submitted by President Obama in February, as well as under the laws already on the books. The latter comprises the "March CBO Baseline" that was mentioned frequently during the debt limit talks and that formed the basis for comparing different proposals. (See Table 1-5 of the CBO report.) Without factoring in this week's debt limit agreement, the CBO projected a cumulative deficit for fiscal years 2012-21 of $6.7 trillion. That figure is important for several reasons.
First, it serves as a reminder that even after the $917 billion of cuts agreed up front and the $1.2-1.5 trillion of future cuts to be determined later this year, the US debt would still grow by more than $4 trillion over the next decade, mainly through increases in mandatory, or non-discretionary spending--entitlements and other untouchables. That won't change even under the deal done by the Senate and House this week; all of its pre-programmed cuts are to discretionary spending, the category into which most federal spending on renewable energy would fall.
But even that $4 trillion figure looks optimistic. As I understand it the CBO baseline assumes that next January 1 all of the Bush-era tax cuts will expire on schedule, resulting in substantial increases in taxes on both ordinary income and dividend income. And that's not just for those earning more than $200,000 per year, or whatever the threshold of "wealthy" is determined to be; it's for everyone. Nor would the Alternative Minimum Tax, which has been biting a growing number of middle class families every year, be indexed as proposed. It also assumes that the Social Security payroll tax will revert to its normal level of 6.2%, up from this year's 4.2%. Barring a dramatic improvement in the economy between now and the end of the year, it seems unlikely that all of those tax increases will be allowed to take effect. That means that the government's revenue through 2021 is likely to be significantly lower than the CBO forecast, because both growth and tax rates are likely to be lower. That translates into bigger deficits and more pressure for deficit reduction.
So the environment for continued support for renewables will be one in which the government's projected deficits continue as far as the eye can see, even after painful cuts, while its ability to continue borrowing on that scale looks suspect. With the main focus of budget cuts falling on the category that includes cash support for renewables, how likely is it that the Congress would extend the Treasury renewable energy cash grant program when it expires on December 31, 2011, or add new appropriations for the Department of Energy's Loan Guarantee Program? And if the Congressional super-committee's proposals include tax reform that would eliminate many "tax expenditures"--tax credits and deductions--then a host of programs such as the solar investment tax credit, the wind, biomass and geothermal energy production tax credit, various biofuel tax credits, and the electric vehicle purchase tax credit, could end up on the cutting block. In the coming scramble to avoid the budget knife, renewables will be competing with better-established programs with broader and more influential constituencies.
It has always been a risky proposition to build companies and industries, the economics of which depended on substantial government subsidies. Some folks could be on the verge of finding out just how risky. If we go down that path, it will probably also result in awkward questions being asked about some of the decisions made by the stewards of these government programs. They should be; I've never understood what kind of due diligence could have resulted in hundreds of millions of dollars in grants or "loans" going to to clean energy and automotive startups with minimal track records, when private investors weren't willing to bet on those risks at that scale. From a national energy policy and strategy perspective, our focus should not be on saving individual companies--no TARP for renewables, I suspect--but on preserving key capabilities essential to ensuring a long-term competitive US position in the global clean energy market.
What would that entail? First, as government funding for renewables becomes constrained it should be focused on R&D at the expense of deployment. Not only would the available money go much farther, but it would also create more options for the future. The next step should be to ensure that whatever the government does spend on deployment should go to projects that are close to being viable without help, or in the case of the military that enhance combat capabilities. That means, for example, focusing solar development assistance on sunny places like the southwest--preferably in proximity to existing transmission infrastructure--and putting an end to paying people to install utility and rooftop solar in places that receive less than about 5 "peak sun hours" (kWh/m2) per day, on average. Again, the money would go farther, and we'd be shoring up nearly viable operations, instead of trying to command the tide not to overwhelm the marginal ones. And finally, as I suggested last week, a greater emphasis on exports to developing country markets, where energy demand is growing at impressive rates and where renewables are becoming increasingly popular, would increase export earnings and employment while participating in volume-related unit cost reductions. And looking beyond renewable energy, the US government has a bird's nest on the ground in the form of the potential lease bid and royalty income from the substantial oil and gas resources that have been placed off limits for various reasons. Tapping those looks like a much smarter source of revenue--not to mention job creation--than selling off the Strategic Petroleum Reserve bit by bit.
If that sounds like a recipe for putting the US cleantech industry on life support after years of robust government-supported growth, then that's consistent with the severity of the fallback plan that could become necessary. The need for this would depend on the priorities set by the special Congressional deficit reduction committee established by the debt ceiling bill, and by the Congress as a whole, along with the subsequent efforts that will be necessary to prevent our long-term debt from growing beyond our ability to service it. Nor would it be quite the starvation diet it might appear, as long as states kept their renewable portfolio standards in place. This isn't a scenario the cleantech industry would willingly choose, but it's one that it can't ignore.
Understanding why requires taking a closer look at the debt ceiling bill that Congress passed in the context of the federal budget baseline--never mind that the US Congress has not enacted a budget in more than two years. In April the Congressional Budget Office (CBO) published its assessment of what the economy would look like under the budget submitted by President Obama in February, as well as under the laws already on the books. The latter comprises the "March CBO Baseline" that was mentioned frequently during the debt limit talks and that formed the basis for comparing different proposals. (See Table 1-5 of the CBO report.) Without factoring in this week's debt limit agreement, the CBO projected a cumulative deficit for fiscal years 2012-21 of $6.7 trillion. That figure is important for several reasons.
First, it serves as a reminder that even after the $917 billion of cuts agreed up front and the $1.2-1.5 trillion of future cuts to be determined later this year, the US debt would still grow by more than $4 trillion over the next decade, mainly through increases in mandatory, or non-discretionary spending--entitlements and other untouchables. That won't change even under the deal done by the Senate and House this week; all of its pre-programmed cuts are to discretionary spending, the category into which most federal spending on renewable energy would fall.
But even that $4 trillion figure looks optimistic. As I understand it the CBO baseline assumes that next January 1 all of the Bush-era tax cuts will expire on schedule, resulting in substantial increases in taxes on both ordinary income and dividend income. And that's not just for those earning more than $200,000 per year, or whatever the threshold of "wealthy" is determined to be; it's for everyone. Nor would the Alternative Minimum Tax, which has been biting a growing number of middle class families every year, be indexed as proposed. It also assumes that the Social Security payroll tax will revert to its normal level of 6.2%, up from this year's 4.2%. Barring a dramatic improvement in the economy between now and the end of the year, it seems unlikely that all of those tax increases will be allowed to take effect. That means that the government's revenue through 2021 is likely to be significantly lower than the CBO forecast, because both growth and tax rates are likely to be lower. That translates into bigger deficits and more pressure for deficit reduction.
So the environment for continued support for renewables will be one in which the government's projected deficits continue as far as the eye can see, even after painful cuts, while its ability to continue borrowing on that scale looks suspect. With the main focus of budget cuts falling on the category that includes cash support for renewables, how likely is it that the Congress would extend the Treasury renewable energy cash grant program when it expires on December 31, 2011, or add new appropriations for the Department of Energy's Loan Guarantee Program? And if the Congressional super-committee's proposals include tax reform that would eliminate many "tax expenditures"--tax credits and deductions--then a host of programs such as the solar investment tax credit, the wind, biomass and geothermal energy production tax credit, various biofuel tax credits, and the electric vehicle purchase tax credit, could end up on the cutting block. In the coming scramble to avoid the budget knife, renewables will be competing with better-established programs with broader and more influential constituencies.
It has always been a risky proposition to build companies and industries, the economics of which depended on substantial government subsidies. Some folks could be on the verge of finding out just how risky. If we go down that path, it will probably also result in awkward questions being asked about some of the decisions made by the stewards of these government programs. They should be; I've never understood what kind of due diligence could have resulted in hundreds of millions of dollars in grants or "loans" going to to clean energy and automotive startups with minimal track records, when private investors weren't willing to bet on those risks at that scale. From a national energy policy and strategy perspective, our focus should not be on saving individual companies--no TARP for renewables, I suspect--but on preserving key capabilities essential to ensuring a long-term competitive US position in the global clean energy market.
What would that entail? First, as government funding for renewables becomes constrained it should be focused on R&D at the expense of deployment. Not only would the available money go much farther, but it would also create more options for the future. The next step should be to ensure that whatever the government does spend on deployment should go to projects that are close to being viable without help, or in the case of the military that enhance combat capabilities. That means, for example, focusing solar development assistance on sunny places like the southwest--preferably in proximity to existing transmission infrastructure--and putting an end to paying people to install utility and rooftop solar in places that receive less than about 5 "peak sun hours" (kWh/m2) per day, on average. Again, the money would go farther, and we'd be shoring up nearly viable operations, instead of trying to command the tide not to overwhelm the marginal ones. And finally, as I suggested last week, a greater emphasis on exports to developing country markets, where energy demand is growing at impressive rates and where renewables are becoming increasingly popular, would increase export earnings and employment while participating in volume-related unit cost reductions. And looking beyond renewable energy, the US government has a bird's nest on the ground in the form of the potential lease bid and royalty income from the substantial oil and gas resources that have been placed off limits for various reasons. Tapping those looks like a much smarter source of revenue--not to mention job creation--than selling off the Strategic Petroleum Reserve bit by bit.
If that sounds like a recipe for putting the US cleantech industry on life support after years of robust government-supported growth, then that's consistent with the severity of the fallback plan that could become necessary. The need for this would depend on the priorities set by the special Congressional deficit reduction committee established by the debt ceiling bill, and by the Congress as a whole, along with the subsequent efforts that will be necessary to prevent our long-term debt from growing beyond our ability to service it. Nor would it be quite the starvation diet it might appear, as long as states kept their renewable portfolio standards in place. This isn't a scenario the cleantech industry would willingly choose, but it's one that it can't ignore.
Friday, November 19, 2010
Energy Implications of Tax Reform
I've been thinking about the implications for energy of a major deficit reduction effort along the lines suggested by the co-chairs of the President's fiscal responsibility and reform commission. Our present approach to providing incentives for various energy sources and technologies, new and old, is embedded in a tax code and taxation philosophy that might not survive the upheaval required to bring the US deficit and resulting federal debt back into a manageable range. This goes far beyond the comparatively minor question of extending expiring grants and tax credits that I discussed the other day; under the most stringent of the proposals from Mr. Bowles and Senator Simpson, such things wouldn't even exist. It's not clear how the Administration or Congress would promote favored energy technologies and strategies without these well-established but costly tools.
Start with renewable energy. We currently promote renewable fuels and electricity generation with a combination of mandates--policies such as the federal Renewable Fuels Standard (RFS) and state Renewable Portfolio Standards--and subsidy payments. Until last year's stimulus bill established the Treasury renewable energy grants, for which eligibility is due to expire in a few weeks, most of those subsidy payments have come in the form of reductions in federal taxes, via either an investment tax credit (ITC) based on the cost of a project or a production tax credit (PTC) for actual energy generated. Both of these measures, which have had a checkered history of expirations and extensions, fall into the broad category of "tax expenditures". The Zero Option proposed by Messrs. Bowles and Simpson would permanently eliminate over $1 trillion of such tax expenditures, in exchange for much lower tax rates.
Even if the renewable energy tax credits were reloaded into a streamlined tax code under the "Wyden-Gregg-style" reform presented as Option 2 from the co-chairs, the value of those credits would be reduced--or at least rendered harder to extract--because the corporate tax rate would be reduced from the current 35% to 26%. That means that a higher proportion of companies would likely not pay large enough taxes to take full advantage of the renewable energy tax credits--or have as much appetite for others' credits via "tax equity" swaps. Compounding that, the likelihood of enacting cash grants to get around this restriction would probably be much lower in an environment in which entire herds of sacred cows were being slaughtered in the cause of averting a looming national deficit and debt crisis.
In the absence of such tax credits, renewable energy developers and manufacturers would be forced to rely even more on state-level mandates or a proposed federal renewable electricity standard. The first test of such a mandates-only approach might come in a few weeks, if the ethanol blenders' credit is allowed to expire, while the annual RFS mandate continues to ratchet up. Or companies might simply conclude that without generous tax subsidies for renewable energy deployment here, their best opportunities would be found in markets that are growing much faster than ours, based on actual energy demand, rather than better incentives. Developing Asia comes to mind. That shift might not be the worst outcome, in terms of both the US trade deficit and global emissions reductions.
Conventional energy firms wouldn't escape unscathed, either. They stand to lose significant tax expenditures as well, in the form of oil & gas depletion allowances, the Section 199 manufacturing deduction, and other benefits. However, the oil and gas industry has been paying an effective corporate tax rate above 40% even after all these credits and deductions. A drop to 26% might more than offset the loss of the other benefits, while more importantly bridging the competitive gap between US firms and foreign competitors that operate under lower tax rates and a territorial tax system, rather than being taxed on worldwide earnings, as US companies are today. Bowles/Simpson also proposed increasing the federal gasoline tax by 15¢ per gallon to restore the Highway Trust Fund to solvency. That's a worthy goal, but as I've pointed out previously the Highway fund faces complex challenges as the US car fleet becomes steadily more fuel efficient and increasingly moves away from liquid fuels taxed at the pump. Raising the gas tax is a stop-gap measure, at best, on the way to a different means of collecting road taxes.
With regard to climate policy, tax reform that eliminated tax credits or reduced their value would also tend to nudge the debate back in the direction of putting an explicit price on carbon, either via cap & trade or with an outright tax. Might that prospect suddenly look more attractive as an adjunct to a fairer and simpler income tax system, than it seemed when it would have come as a further complication to an already enormously convoluted tax system that is widely viewed as unfair by both liberals and conservatives? My guess is not, without something else that motivates us to tackle climate change on a much more urgent basis.
Now let's come back to reality. The proposals of the commission's co-chairs have already received a frosty reception or outright hostility from both sides of the aisle, and they haven't yet gotten the buy-in of the rest of their team; the final report requires the consent of 14 of the 18 members. Their ideas must also compete with a growing number of deficit-reduction alternatives, including a widely-reported plan from another bi-partisan group, plus at least one solo proposal from another member of the President's commission. The chances are low for any of these proposals to gain enough traction to be enacted without first being significantly watered down. However, it is starting to look just as risky to assume that the present tax system--and its cornucopia of energy incentives--will continue unchanged indefinitely. A quick glance at the US debt clock ought to make that abundantly clear.
Start with renewable energy. We currently promote renewable fuels and electricity generation with a combination of mandates--policies such as the federal Renewable Fuels Standard (RFS) and state Renewable Portfolio Standards--and subsidy payments. Until last year's stimulus bill established the Treasury renewable energy grants, for which eligibility is due to expire in a few weeks, most of those subsidy payments have come in the form of reductions in federal taxes, via either an investment tax credit (ITC) based on the cost of a project or a production tax credit (PTC) for actual energy generated. Both of these measures, which have had a checkered history of expirations and extensions, fall into the broad category of "tax expenditures". The Zero Option proposed by Messrs. Bowles and Simpson would permanently eliminate over $1 trillion of such tax expenditures, in exchange for much lower tax rates.
Even if the renewable energy tax credits were reloaded into a streamlined tax code under the "Wyden-Gregg-style" reform presented as Option 2 from the co-chairs, the value of those credits would be reduced--or at least rendered harder to extract--because the corporate tax rate would be reduced from the current 35% to 26%. That means that a higher proportion of companies would likely not pay large enough taxes to take full advantage of the renewable energy tax credits--or have as much appetite for others' credits via "tax equity" swaps. Compounding that, the likelihood of enacting cash grants to get around this restriction would probably be much lower in an environment in which entire herds of sacred cows were being slaughtered in the cause of averting a looming national deficit and debt crisis.
In the absence of such tax credits, renewable energy developers and manufacturers would be forced to rely even more on state-level mandates or a proposed federal renewable electricity standard. The first test of such a mandates-only approach might come in a few weeks, if the ethanol blenders' credit is allowed to expire, while the annual RFS mandate continues to ratchet up. Or companies might simply conclude that without generous tax subsidies for renewable energy deployment here, their best opportunities would be found in markets that are growing much faster than ours, based on actual energy demand, rather than better incentives. Developing Asia comes to mind. That shift might not be the worst outcome, in terms of both the US trade deficit and global emissions reductions.
Conventional energy firms wouldn't escape unscathed, either. They stand to lose significant tax expenditures as well, in the form of oil & gas depletion allowances, the Section 199 manufacturing deduction, and other benefits. However, the oil and gas industry has been paying an effective corporate tax rate above 40% even after all these credits and deductions. A drop to 26% might more than offset the loss of the other benefits, while more importantly bridging the competitive gap between US firms and foreign competitors that operate under lower tax rates and a territorial tax system, rather than being taxed on worldwide earnings, as US companies are today. Bowles/Simpson also proposed increasing the federal gasoline tax by 15¢ per gallon to restore the Highway Trust Fund to solvency. That's a worthy goal, but as I've pointed out previously the Highway fund faces complex challenges as the US car fleet becomes steadily more fuel efficient and increasingly moves away from liquid fuels taxed at the pump. Raising the gas tax is a stop-gap measure, at best, on the way to a different means of collecting road taxes.
With regard to climate policy, tax reform that eliminated tax credits or reduced their value would also tend to nudge the debate back in the direction of putting an explicit price on carbon, either via cap & trade or with an outright tax. Might that prospect suddenly look more attractive as an adjunct to a fairer and simpler income tax system, than it seemed when it would have come as a further complication to an already enormously convoluted tax system that is widely viewed as unfair by both liberals and conservatives? My guess is not, without something else that motivates us to tackle climate change on a much more urgent basis.
Now let's come back to reality. The proposals of the commission's co-chairs have already received a frosty reception or outright hostility from both sides of the aisle, and they haven't yet gotten the buy-in of the rest of their team; the final report requires the consent of 14 of the 18 members. Their ideas must also compete with a growing number of deficit-reduction alternatives, including a widely-reported plan from another bi-partisan group, plus at least one solo proposal from another member of the President's commission. The chances are low for any of these proposals to gain enough traction to be enacted without first being significantly watered down. However, it is starting to look just as risky to assume that the present tax system--and its cornucopia of energy incentives--will continue unchanged indefinitely. A quick glance at the US debt clock ought to make that abundantly clear.
Monday, November 15, 2010
Extend or Reform?
As the US Congress returns from its election recess to take up its "lame duck" session, one of many crucial pending items it will likely take up is the so-called "extenders" package: key tax provisions that are due to expire at the end of the year, unless extended by legislative action. From an energy perspective, this includes both the expiring ethanol blenders credit and the Treasury renewable energy grants issued in lieu of the investment tax credit (ITC) for renewables. Both incentives face a much more uncertain reception when the new Congress is sworn in next January, so the lame duck might just be their last gasp.
For the ethanol credit, that is as it should be; if 32 years of federal subsidies haven't made corn ethanol competitive with gasoline--particularly when its use is now mandatory--then nothing will. The situation for the renewable energy grants is more complicated. This is a relatively new benefit that, as I've noted in previous postings, was instituted as part of last year's American Recovery and Reinvestment Act--a.k.a. the stimulus--to substitute for a class of market transactions ("tax equity") that renewable energy developers could no longer access as a result of the financial crisis. Bridging that gap became all but essential for smaller companies without enough taxable earnings to take full advantage of the tax credit on their own, or lacking adequate working capital to afford to wait until their next tax filing to recoup the applicable ITC portion of the cost of a project.
If that situation still obtained, justifying the extension of the grants for another year or two would be easy. In the meantime, however, much has changed. Although not yet functioning at the same pace as before the financial crisis, the tax equity market is recovering. Banks and insurance companies have announced a growing number of tax equity deals in the last few months. This market might revive even faster if it weren't competing with essentially free money from the Treasury.
The other aspect of the situation that has changed is the growing dominance of large players in renewable energy project development, particularly for wind. Contrary to the perception that the Treasury grants mainly benefited small companies, more than half of the $5.4 billion in grants awarded to date went to just three companies, all of them large and profitable enough to have waited until tax time to collect their ITC benefits--though I don't doubt that getting cash up front improved the economics of their projects. For example, EDP Renovaveis, through its Horizon Wind Energy subsidiary, collected around $565 million in grants in the first half of 2010, after receiving "in excess of 685 million dollars" in 2009. Meanwhile, between its 3Q2010 earnings presentation and its 2009 full-year presentation Iberdrola Renovables claimed approximately $983 million in US renewable energy grants. NextEra Energy (the renamed parent company of Florida Power & Light) booked $556 million in grants in the first 9 months of 2010, on top of $100 million last year. All of this was entirely appropriate under the provisions of the stimulus, but it doesn't quite fit the picture of an emergency measure intended to help small, struggling firms.
Some have argued that in any case the grants are merely a matter of timing for the government: paying eligible developers cash now, or paying them the same amount later, via reduced taxes. That would only be true if every project that was eligible for a grant could (or should) proceed without one. Sparing wind farms, solar installations and other projects from the discipline of rigorous review by private investors risks allowing weaker projects to proceed, when they should either be rethought or cancelled. That was an unavoidable risk in early 2009, when the renewable energy industry was in peril of imploding, but overlooking it seems less justifiable today.
The Treasury renewable energy grants were instituted as an extreme step at an unprecedented time. It's hard to imagine that anyone intended them to become a permanent entitlement to replace the existing renewable energy tax credits, which were simultaneously extended through the end of 2012 for wind power and 2013 for most other technologies. However, if this program is to be extended for now, it ought to be reformed to exclude beneficiaries for which it constitutes merely a convenience, rather than a necessity. That would mean either capping the maximum payout for any recipient at something less than $100 million, or imposing a corporate income threshold. I'll be watching this issue with great interest between now and the end of the year.
For the ethanol credit, that is as it should be; if 32 years of federal subsidies haven't made corn ethanol competitive with gasoline--particularly when its use is now mandatory--then nothing will. The situation for the renewable energy grants is more complicated. This is a relatively new benefit that, as I've noted in previous postings, was instituted as part of last year's American Recovery and Reinvestment Act--a.k.a. the stimulus--to substitute for a class of market transactions ("tax equity") that renewable energy developers could no longer access as a result of the financial crisis. Bridging that gap became all but essential for smaller companies without enough taxable earnings to take full advantage of the tax credit on their own, or lacking adequate working capital to afford to wait until their next tax filing to recoup the applicable ITC portion of the cost of a project.
If that situation still obtained, justifying the extension of the grants for another year or two would be easy. In the meantime, however, much has changed. Although not yet functioning at the same pace as before the financial crisis, the tax equity market is recovering. Banks and insurance companies have announced a growing number of tax equity deals in the last few months. This market might revive even faster if it weren't competing with essentially free money from the Treasury.
The other aspect of the situation that has changed is the growing dominance of large players in renewable energy project development, particularly for wind. Contrary to the perception that the Treasury grants mainly benefited small companies, more than half of the $5.4 billion in grants awarded to date went to just three companies, all of them large and profitable enough to have waited until tax time to collect their ITC benefits--though I don't doubt that getting cash up front improved the economics of their projects. For example, EDP Renovaveis, through its Horizon Wind Energy subsidiary, collected around $565 million in grants in the first half of 2010, after receiving "in excess of 685 million dollars" in 2009. Meanwhile, between its 3Q2010 earnings presentation and its 2009 full-year presentation Iberdrola Renovables claimed approximately $983 million in US renewable energy grants. NextEra Energy (the renamed parent company of Florida Power & Light) booked $556 million in grants in the first 9 months of 2010, on top of $100 million last year. All of this was entirely appropriate under the provisions of the stimulus, but it doesn't quite fit the picture of an emergency measure intended to help small, struggling firms.
Some have argued that in any case the grants are merely a matter of timing for the government: paying eligible developers cash now, or paying them the same amount later, via reduced taxes. That would only be true if every project that was eligible for a grant could (or should) proceed without one. Sparing wind farms, solar installations and other projects from the discipline of rigorous review by private investors risks allowing weaker projects to proceed, when they should either be rethought or cancelled. That was an unavoidable risk in early 2009, when the renewable energy industry was in peril of imploding, but overlooking it seems less justifiable today.
The Treasury renewable energy grants were instituted as an extreme step at an unprecedented time. It's hard to imagine that anyone intended them to become a permanent entitlement to replace the existing renewable energy tax credits, which were simultaneously extended through the end of 2012 for wind power and 2013 for most other technologies. However, if this program is to be extended for now, it ought to be reformed to exclude beneficiaries for which it constitutes merely a convenience, rather than a necessity. That would mean either capping the maximum payout for any recipient at something less than $100 million, or imposing a corporate income threshold. I'll be watching this issue with great interest between now and the end of the year.
Friday, November 05, 2010
A Wind Bubble?
New US wind turbine installations have slowed significantly this year, compared to 2009, and the decline is having consequences. Among other fallout, Suzlon is mothballing a four-year-old wind turbine factory in Minnesota and laying off the remaining 110 workers, due to a lack of new orders. While the industry pins most of the blame for the slowdown on insufficiently aggressive federal energy policies, it suddenly occurred to me to wonder whether wind power, like housing, might have been caught up in an investment bubble that has finally popped, somewhat belatedly.
The idea of a wind bubble goes against all conventional wisdom, including the importance of expanding electricity generation from low-emission sources in order to mitigate climate change; the desire to build a vibrant "new energy" economy in the US for energy security and competitive reasons; and the persistent mantra of the green jobs that are supposed to turn the economy around. Yet every bubble must have a compelling, plausible narrative, or it would never take off.
When you examine the charts of annual and quarterly US wind turbine installations on pages 2 and 3 of the "Third Quarter 2010 Market Report" from the American Wind Energy Association, there are at least two ways to look at them. The customary perspective would attribute the dramatic increase in wind installations beginning in 2006, which set records in each of the next three years, to the rapid scaling up of an industry that many envision supplying 20% of US electricity generation within two decades, up from its current level of around 2%. This growth has been supported by a variety of incentives and mandates, including the federal renewable production tax credit (PTC), the stimulus grants, and state renewable portfolio standards. But in this scenario it's hard to explain why installations would have fallen off so much this year, when all of these benefits are still in place, other than the imminent expiration of eligibility for the stimulus grants--which in another year might have been expected to trigger a mad rush for projects to get in under the wire, as we saw in 2008 when the PTC was due to expire at year end. How can we attribute this year's drop in installations to the absence of a policy--either a national renewable electricity standard or a comprehensive climate bill--that we've never had?
So turn this picture around and ask why wind might have been in a bubble, and why that bubble might have only popped now, roughly two years after the other bubbles for stocks, housing and possibly oil prices. Aside from the policies promoting wind and other renewables, which have not changed, wind power developers would have looked at two other indicators: credit and demand. Wind projects are capital intensive, and in the run-up to the financial crisis they benefited from the same kind of cheap and readily available credit as other businesses and homeowners did. At the same time, between 2000 and 2007 US demand for electricity was growing at about 1.3% per year. That might not seem like much, but at the scale of the US power sector, that translated into the need to add around 7,000 MW of new generating capacity each year. If all of that was from wind turbines, the required nameplate capacity would approach 20,000 MW, because of wind's lower average output per MW. Wind was also becoming a preferred technology, despite its intermittency, because coal was falling out of favor for environmental reasons and the price of natural gas, the fuel for the dominant incremental generation technology for the last 20 years, had spiked and become very volatile.
If wind was indeed being carried along either by its own bubble or by the froth from the other bubbles fueling the economy in the middle of the decade, why has it only now run out of steam, rather than popping in 2008 or 2009? After all, electricity demand growth evaporated when the financial crisis and recession hit, and demand has not yet recovered to its 2007 peak. For 2008, perhaps the dash to complete projects before the expected expiration of the PTC--it wasn't extended until October of that year--provides sufficient explanation. As for 2009, the charts show that installations did fall dramatically until the implementation of the Treasury stimulus grant program, which injected $1.7 B into wind projects last year and another $2.9 B this year. Moreover, the stimulus grants were more valuable to wind developers than the PTC they formerly received. That isn't just because developers got the money up front, rather than having to wait until a project started up and produced electricity, but also because the grants were based on the 30% investment tax credit (ITC). Using NREL's simplified calculator for the levelized cost of electricity, at a typical cost of around $2,200/kW of capacity the ITC could be worth at least 20% more than the 2.2¢/kWh PTC. In other words, just as the wind market was collapsing last year, the government increased its incentives and accelerated them into up-front cash. That might have been enough to keep a bubble going for a while longer.
Of course there's no way to know whether this scenario is more accurate than the standard explanation for what has happened to the US wind market this year. Nor does it doom wind power to the doldrums even after the economy resumes growing and creating jobs at a healthier rate, and electricity demand picks up. However, if there is a grain of truth in this view, then it might alter our perspective on providing more aggressive support for the wind industry based on the notion that installations should still be running at 10,000 MW per year or more, as they were in 2009, rather than at the lower rate of around 5,000 MW we see today.
The idea of a wind bubble goes against all conventional wisdom, including the importance of expanding electricity generation from low-emission sources in order to mitigate climate change; the desire to build a vibrant "new energy" economy in the US for energy security and competitive reasons; and the persistent mantra of the green jobs that are supposed to turn the economy around. Yet every bubble must have a compelling, plausible narrative, or it would never take off.
When you examine the charts of annual and quarterly US wind turbine installations on pages 2 and 3 of the "Third Quarter 2010 Market Report" from the American Wind Energy Association, there are at least two ways to look at them. The customary perspective would attribute the dramatic increase in wind installations beginning in 2006, which set records in each of the next three years, to the rapid scaling up of an industry that many envision supplying 20% of US electricity generation within two decades, up from its current level of around 2%. This growth has been supported by a variety of incentives and mandates, including the federal renewable production tax credit (PTC), the stimulus grants, and state renewable portfolio standards. But in this scenario it's hard to explain why installations would have fallen off so much this year, when all of these benefits are still in place, other than the imminent expiration of eligibility for the stimulus grants--which in another year might have been expected to trigger a mad rush for projects to get in under the wire, as we saw in 2008 when the PTC was due to expire at year end. How can we attribute this year's drop in installations to the absence of a policy--either a national renewable electricity standard or a comprehensive climate bill--that we've never had?
So turn this picture around and ask why wind might have been in a bubble, and why that bubble might have only popped now, roughly two years after the other bubbles for stocks, housing and possibly oil prices. Aside from the policies promoting wind and other renewables, which have not changed, wind power developers would have looked at two other indicators: credit and demand. Wind projects are capital intensive, and in the run-up to the financial crisis they benefited from the same kind of cheap and readily available credit as other businesses and homeowners did. At the same time, between 2000 and 2007 US demand for electricity was growing at about 1.3% per year. That might not seem like much, but at the scale of the US power sector, that translated into the need to add around 7,000 MW of new generating capacity each year. If all of that was from wind turbines, the required nameplate capacity would approach 20,000 MW, because of wind's lower average output per MW. Wind was also becoming a preferred technology, despite its intermittency, because coal was falling out of favor for environmental reasons and the price of natural gas, the fuel for the dominant incremental generation technology for the last 20 years, had spiked and become very volatile.
If wind was indeed being carried along either by its own bubble or by the froth from the other bubbles fueling the economy in the middle of the decade, why has it only now run out of steam, rather than popping in 2008 or 2009? After all, electricity demand growth evaporated when the financial crisis and recession hit, and demand has not yet recovered to its 2007 peak. For 2008, perhaps the dash to complete projects before the expected expiration of the PTC--it wasn't extended until October of that year--provides sufficient explanation. As for 2009, the charts show that installations did fall dramatically until the implementation of the Treasury stimulus grant program, which injected $1.7 B into wind projects last year and another $2.9 B this year. Moreover, the stimulus grants were more valuable to wind developers than the PTC they formerly received. That isn't just because developers got the money up front, rather than having to wait until a project started up and produced electricity, but also because the grants were based on the 30% investment tax credit (ITC). Using NREL's simplified calculator for the levelized cost of electricity, at a typical cost of around $2,200/kW of capacity the ITC could be worth at least 20% more than the 2.2¢/kWh PTC. In other words, just as the wind market was collapsing last year, the government increased its incentives and accelerated them into up-front cash. That might have been enough to keep a bubble going for a while longer.
Of course there's no way to know whether this scenario is more accurate than the standard explanation for what has happened to the US wind market this year. Nor does it doom wind power to the doldrums even after the economy resumes growing and creating jobs at a healthier rate, and electricity demand picks up. However, if there is a grain of truth in this view, then it might alter our perspective on providing more aggressive support for the wind industry based on the notion that installations should still be running at 10,000 MW per year or more, as they were in 2009, rather than at the lower rate of around 5,000 MW we see today.
Monday, September 13, 2010
Post-Stimulus Transition for Renewable Energy
One of the largest uncertainties affecting the US renewable energy sector is how it will make the transition from the special subsidies provided under last year's stimulus bill (American Recovery and Reinvestment Act of 2009) back to the "normal" incentives available prior to the financial crisis and recession. The key element of this concerns the Treasury renewable energy grant program, which has stood in for the "tax equity" market that stalled around the time Lehman Brothers went under. Eligibility for the grants expires at the end of this year, and companies that have benefited from them are calling for an extension into 2011 or beyond. That looks like a long-shot at this point. However, another proposal not specifically aimed at renewable energy could provide exactly the sort of transition support the industry requires, while also beginning the necessary task of treating this sector more like others.
As of the Treasury Department's most recent update, renewable energy projects have received a total of $5.2 billion under the "1603" grant program, with more than 85% going to large-scale wind farms. Solar electric and thermal projects received $330 million, or about 6%, trailed by geothermal, biomass power, and small-scale wind. With the financial markets that developers had previously relied on to exchange future tax credits for current cash in disarray last year, the 1603 grants were a crucial stop-gap. However, with electricity demand still lagging and renewables facing strong competition from cheap natural gas, the US wind industry has gone into a slump that might deepen further, once developers' new projects are no longer eligible for up-front cash grants, forcing them to wait for tax credits that accrue as power is generated.
Several proposals to extend the 1603 grants are floating around the Congress, including one from Senator Cantwell (D-WA), but the mid-term elections are looming and the mood in the country is turning away from direct economic stimulus, so an extension is far from a sure thing. Nor does the argument that the grants are deficit-neutral, because they merely accelerate payments, entirely wash. Once the incentive for wind power reverts to the Production Tax Credit (PTC) or substitute Investment Tax Credit (ITC) on 1/1/11, companies would again need substantial taxable earnings to claim it, and not all would qualify. That's one of the main reasons that cash up front was such a powerful incentive for developers. It's also never been clear how the tax equity market was expected to revive fully as long as firms could get cash from the Treasury instead, without any transaction fees beyond filling out the paperwork. Whatever we do about the expiring stimulus grants, we need to get this market on a trajectory back to normal.
The best solution for bridging this transition might involve a measure that doesn't seem to have been aimed at the renewable energy sector at all. Last week President Obama proposed allowing businesses to expense 100% of capital investments in 2011. This would kick in just as eligibility for the 1603 grants ends, and at the 35% tax rate that most corporations are subject to, it could actually be worth more than the 30% renewable energy ITC upon which the grants were based. That would help compensate for the difference between receiving these funds up front and waiting to file a tax return. The new benefit would also be calculated on the amount invested, like the grants, rather than the quantity of power produced, as under the PTC.
There's an additional advantage to this approach, which would put the decision for capital investment and allocation entirely back in the hands of corporate managers and boards--who are accountable for their results--rather than government bureaucrats with little experience at running a business or gauging which projects make sense and which don't. And if it means that companies that can't wait until they file taxes to collect the benefit must convince a banker or other investor of the merits of the project, that's an extra layer of market discipline that might winnow out some projects now, but would help ensure that those that survive are more viable.
In the long run, renewable energy must stand on its own feet, without incentives that are orders of magnitude larger, per unit of energy produced, than those for conventional energy. Most renewable electricity technologies aren't ready to make that leap, but forcing them to rely on the same 100% investment expensing that other businesses would be given next year (if enacted into law) looks like a good first step, instead of extending a stimulus program that must end sooner or later.
As of the Treasury Department's most recent update, renewable energy projects have received a total of $5.2 billion under the "1603" grant program, with more than 85% going to large-scale wind farms. Solar electric and thermal projects received $330 million, or about 6%, trailed by geothermal, biomass power, and small-scale wind. With the financial markets that developers had previously relied on to exchange future tax credits for current cash in disarray last year, the 1603 grants were a crucial stop-gap. However, with electricity demand still lagging and renewables facing strong competition from cheap natural gas, the US wind industry has gone into a slump that might deepen further, once developers' new projects are no longer eligible for up-front cash grants, forcing them to wait for tax credits that accrue as power is generated.
Several proposals to extend the 1603 grants are floating around the Congress, including one from Senator Cantwell (D-WA), but the mid-term elections are looming and the mood in the country is turning away from direct economic stimulus, so an extension is far from a sure thing. Nor does the argument that the grants are deficit-neutral, because they merely accelerate payments, entirely wash. Once the incentive for wind power reverts to the Production Tax Credit (PTC) or substitute Investment Tax Credit (ITC) on 1/1/11, companies would again need substantial taxable earnings to claim it, and not all would qualify. That's one of the main reasons that cash up front was such a powerful incentive for developers. It's also never been clear how the tax equity market was expected to revive fully as long as firms could get cash from the Treasury instead, without any transaction fees beyond filling out the paperwork. Whatever we do about the expiring stimulus grants, we need to get this market on a trajectory back to normal.
The best solution for bridging this transition might involve a measure that doesn't seem to have been aimed at the renewable energy sector at all. Last week President Obama proposed allowing businesses to expense 100% of capital investments in 2011. This would kick in just as eligibility for the 1603 grants ends, and at the 35% tax rate that most corporations are subject to, it could actually be worth more than the 30% renewable energy ITC upon which the grants were based. That would help compensate for the difference between receiving these funds up front and waiting to file a tax return. The new benefit would also be calculated on the amount invested, like the grants, rather than the quantity of power produced, as under the PTC.
There's an additional advantage to this approach, which would put the decision for capital investment and allocation entirely back in the hands of corporate managers and boards--who are accountable for their results--rather than government bureaucrats with little experience at running a business or gauging which projects make sense and which don't. And if it means that companies that can't wait until they file taxes to collect the benefit must convince a banker or other investor of the merits of the project, that's an extra layer of market discipline that might winnow out some projects now, but would help ensure that those that survive are more viable.
In the long run, renewable energy must stand on its own feet, without incentives that are orders of magnitude larger, per unit of energy produced, than those for conventional energy. Most renewable electricity technologies aren't ready to make that leap, but forcing them to rely on the same 100% investment expensing that other businesses would be given next year (if enacted into law) looks like a good first step, instead of extending a stimulus program that must end sooner or later.
Monday, March 08, 2010
Renewable Energy and Domestic Content
The current scuffle between the US Congress and the wind industry began last fall with reports of a large wind farm in Texas involving both Chinese investors and Chinese wind turbines. It ratcheted up last week, with four key Senators proposing to close the "loophole" that enables renewable energy projects built with imported hardware to receive stimulus funds. The American Wind Energy Association (AWEA) promptly retorted that the problem wasn't the wind projects and their suppliers, but a lack of consistent renewable energy policies coming out of the Congress. The more I've thought about this situation, the more I am convinced that both parties to this tiff are missing the bigger picture.
Let's start with the response by AWEA, which used the occasion to reiterate their consistent support for a national renewable electricity standard they contend would provide a clear policy signal for anyone contemplating investing in the facilities and workforce needed to manufacture wind turbines, solar arrays and other renewable energy gear here in the US. That sounds good, but it's equally clear from the record rate of wind installations last year that demand wasn't the problem, nor was it lack of government incentives to stimulate that demand. The Production Tax Credit for wind power has already been extended through 2012 and seems unlikely to be allowed to expire again, and the Investment Tax Credit for solar was extended through 2016. For that matter, 29 states plus the District of Columbia already have Renewable Portfolio Standards of the type AWEA is advocating for the country as a whole, and many of the states without one lack good wind resources in any case. The main aspect that has been in contention is whether the option to convert these tax credits to up-front cash grants--the benefit at the heart of the controversy over foreign-sourced wind turbines--should be extended beyond the end of this year. On the whole, then, the uncertainties faced by wind manufacturers don't look any worse than those confronting other manufacturers, and they might not even be as bad.
Next consider the complaint of the four Senators that such renewable energy grants ought to be reserved for projects that create green jobs here in the US, rather than overseas. This concern was prompted by a study suggesting that the lion's share of such grants to date has gone to non-US firms. While that negates most of the Keynesian stimulus benefits of the policy, it's also a nearly-inevitable result of the way that global manufacturing is now structured. Expecting all wind turbines funded by stimulus grants to be stamped "Made in USA" is no more realistic than expecting every car, computer, and paperclip paid for by stimulus money to have been made by American workers in an American factory. For good or ill, we don't live in that world anymore, and that's one reason that the entire federal stimulus has been less effective than hoped in promoting domestic employment: a large fraction of what we consume is either made elsewhere or includes many non-US components. Although wind turbine manufacturing started as a small, localized undertaking in the US and a few European countries, it has grown with extraordinary speed during precisely the same period that the supply chains of numerous industries became thoroughly globalized.
While these trends of manufacturing globalization and blanket support for renewable energy set the stage for it, the current collision over domestic content in the wind industry is the direct consequence of the pervasive green jobs theme that both politicians and advocacy groups like AWEA adopted for similar reasons of expediency last year: how else do you justify spending billions in tax dollars on this sort of thing during a recession, if it doesn't stimulate the US economy and create lots of jobs?
The solution to this conundrum is tricky. Since it's unlikely that either side can now admit that green jobs have been oversold as a justification for renewable energy policies, both sides ought to focus their efforts on manufacturing, and by that I don't mean just throwing up a few final-assembly plants where imported turbine parts can be bolted together, but rather addressing the factors that have affected US competitiveness across a wide range of industries. That includes high corporate tax rates, weak tax incentives for manufacturing investment, and the stifling overlap in federal, state and local regulations. More urgently, it should be clear that the solution does not involve erecting trade barriers in the form of domestic-content rules that would provoke retaliatory measures that would harm successful US export sectors. Nor does it include obscuring the magnitude of renewable energy subsidies by moving them out of the federal budget--where they are at least visible--and into the cost base of utilities by converting them into renewable energy mandates. While it might be appropriate to shift the burden from taxpayers to ratepayers, the industry needs smart incentives, not a perpetual subsidy along the lines of corn ethanol (three decades and counting.)
I used to think that all of these arcane and inefficient incentives could be swept aside by putting a price on greenhouse gas emissions, via either cap & trade or a carbon tax. I'm now skeptical about that, because of the way that Congress has insisted on combining cap & trade with a renewable electricity standard plus direct, technology-specific subsidies in the Waxman-Markey bill and its siblings. The spectacle of the US Treasury writing checks for hundreds of millions of dollars to Spanish and Chinese wind turbine companies is the inevitable result of this kind of convoluted thinking.
Let's start with the response by AWEA, which used the occasion to reiterate their consistent support for a national renewable electricity standard they contend would provide a clear policy signal for anyone contemplating investing in the facilities and workforce needed to manufacture wind turbines, solar arrays and other renewable energy gear here in the US. That sounds good, but it's equally clear from the record rate of wind installations last year that demand wasn't the problem, nor was it lack of government incentives to stimulate that demand. The Production Tax Credit for wind power has already been extended through 2012 and seems unlikely to be allowed to expire again, and the Investment Tax Credit for solar was extended through 2016. For that matter, 29 states plus the District of Columbia already have Renewable Portfolio Standards of the type AWEA is advocating for the country as a whole, and many of the states without one lack good wind resources in any case. The main aspect that has been in contention is whether the option to convert these tax credits to up-front cash grants--the benefit at the heart of the controversy over foreign-sourced wind turbines--should be extended beyond the end of this year. On the whole, then, the uncertainties faced by wind manufacturers don't look any worse than those confronting other manufacturers, and they might not even be as bad.
Next consider the complaint of the four Senators that such renewable energy grants ought to be reserved for projects that create green jobs here in the US, rather than overseas. This concern was prompted by a study suggesting that the lion's share of such grants to date has gone to non-US firms. While that negates most of the Keynesian stimulus benefits of the policy, it's also a nearly-inevitable result of the way that global manufacturing is now structured. Expecting all wind turbines funded by stimulus grants to be stamped "Made in USA" is no more realistic than expecting every car, computer, and paperclip paid for by stimulus money to have been made by American workers in an American factory. For good or ill, we don't live in that world anymore, and that's one reason that the entire federal stimulus has been less effective than hoped in promoting domestic employment: a large fraction of what we consume is either made elsewhere or includes many non-US components. Although wind turbine manufacturing started as a small, localized undertaking in the US and a few European countries, it has grown with extraordinary speed during precisely the same period that the supply chains of numerous industries became thoroughly globalized.
While these trends of manufacturing globalization and blanket support for renewable energy set the stage for it, the current collision over domestic content in the wind industry is the direct consequence of the pervasive green jobs theme that both politicians and advocacy groups like AWEA adopted for similar reasons of expediency last year: how else do you justify spending billions in tax dollars on this sort of thing during a recession, if it doesn't stimulate the US economy and create lots of jobs?
The solution to this conundrum is tricky. Since it's unlikely that either side can now admit that green jobs have been oversold as a justification for renewable energy policies, both sides ought to focus their efforts on manufacturing, and by that I don't mean just throwing up a few final-assembly plants where imported turbine parts can be bolted together, but rather addressing the factors that have affected US competitiveness across a wide range of industries. That includes high corporate tax rates, weak tax incentives for manufacturing investment, and the stifling overlap in federal, state and local regulations. More urgently, it should be clear that the solution does not involve erecting trade barriers in the form of domestic-content rules that would provoke retaliatory measures that would harm successful US export sectors. Nor does it include obscuring the magnitude of renewable energy subsidies by moving them out of the federal budget--where they are at least visible--and into the cost base of utilities by converting them into renewable energy mandates. While it might be appropriate to shift the burden from taxpayers to ratepayers, the industry needs smart incentives, not a perpetual subsidy along the lines of corn ethanol (three decades and counting.)
I used to think that all of these arcane and inefficient incentives could be swept aside by putting a price on greenhouse gas emissions, via either cap & trade or a carbon tax. I'm now skeptical about that, because of the way that Congress has insisted on combining cap & trade with a renewable electricity standard plus direct, technology-specific subsidies in the Waxman-Markey bill and its siblings. The spectacle of the US Treasury writing checks for hundreds of millions of dollars to Spanish and Chinese wind turbine companies is the inevitable result of this kind of convoluted thinking.
Friday, February 06, 2009
Wind Power Stimulus
As reported by the American Wind Energy Association, the US added 8,358 MW of new wind power capacity last year, beating the previous year's record additions by 60%. Some of that surge in capacity likely resulted from developers racing to get their projects on-line before December 31, 2008, when the Production Tax Credit (PTC) for wind was due to expire, before it was extended in October for another year. Either way, it's a remarkable effort, and it would be tough to beat, even if the problems in the financial markets weren't undermining the ability of developers to obtain loans and attract investors looking for a stake in the tax credits that wind and other renewable energy projects generate. AWEA and the industry it represents are looking to the pending federal stimulus bill for help. However, because of the way the tax credits for renewable energy are structured, assistance for the wind industry is a microcosm of the issues surrounding the entire stimulus and its speed of delivery.
The US wind power sector faces two key challenges during this recession. First, the PTC for wind power, which after adjustment for inflation is worth 2.1 cents for each kilowatt-hour of electricity generated, is again due to expire at year end. And if that weren't bad enough, it has become much harder to capture the full value of that 2.1 cents, because it is not a cash payment, but rather a non-refundable tax credit against income taxes. If a wind generation company isn't making a big enough profit, some or all of the tax credit could be left on the table. Wind developers have historically gotten around this limitation by transferring their future tax credits to investment banks and other profitable companies with big tax liabilities, in exchange for cash or a stake in the project known as "tax equity." Lehman was a big player in this market, prior to its demise, and the financial crisis and recession have dried up many other sources. That's why the industry has been asking for Congress to make the PTC "refundable"--payable even to firms without any tax liability.
The problem with this is that the PTC lasts for 10 years, once a project that qualifies for it starts up. The current stimulus package, both the House bill that passed last week and the Senate's version, as best I can tell, would confer the PTC on wind projects put into service through the end of 2012--and even longer in the case of other renewable power technologies, such as geothermal, biomass power, and tidal and incremental hydropower. While extending the PTC would certainly increase the amount of new wind capacity added in the next several years, only a small fraction of the federal funds involved would be parceled out this year and next. However, it will reduce federal tax revenue each year until 2022. Even if wind capacity only increased at its 2007 rate of 5,000 MW per year for the next four years, and the PTC was allowed to expire in 2013, this would add around $1 billion to the annual federal budget deficit for up to a decade after the recession ends. As numbing as the long strings of zeroes in the current stimulus figures might be, we will eventually be back in a world in which every billion counts. The justification for taking on such a lasting burden for wind power looks especially shaky, in light of a recent study indicating that up to two-thirds of the "green jobs" associated with new US wind projects would be created offshore.
Instead of making the PTC refundable, the current version of the stimulus bill would allow developers to make an "irrevocable election" to receive a 30% "Section 48" energy investment tax credit (ITC) in lieu of the "Section 45" PTC, for the life of the project. Although the Section 48 credits aren't refundable, either, allowing wind and other technologies to opt for the ITC front loads their tax benefits, compensating for the shrinkage of the tax equity market. They also appear to qualify for the bill's generous "carry-back" provisions. In the process, this front loads the crucial stimulus spending without affecting future federal budgets, other than by the interest payments on the larger debt. I would be even more comfortable with this solution, if the only extension offered for wind power were for projects electing the ITC conversion, with no hangover of lost tax revenue beyond the recession. After all, the purpose of assisting wind power within the stimulus is to create "green jobs" now, and to keep the industry going through a rough patch, not to contribute to the enormous post-recovery budget deficits we must expect. If the Congress wishes to extend the regular PTC, it should do so outside the stimulus and under the "pay-go" rules that would require the cost to be offset elsewhere.
The US wind power sector faces two key challenges during this recession. First, the PTC for wind power, which after adjustment for inflation is worth 2.1 cents for each kilowatt-hour of electricity generated, is again due to expire at year end. And if that weren't bad enough, it has become much harder to capture the full value of that 2.1 cents, because it is not a cash payment, but rather a non-refundable tax credit against income taxes. If a wind generation company isn't making a big enough profit, some or all of the tax credit could be left on the table. Wind developers have historically gotten around this limitation by transferring their future tax credits to investment banks and other profitable companies with big tax liabilities, in exchange for cash or a stake in the project known as "tax equity." Lehman was a big player in this market, prior to its demise, and the financial crisis and recession have dried up many other sources. That's why the industry has been asking for Congress to make the PTC "refundable"--payable even to firms without any tax liability.
The problem with this is that the PTC lasts for 10 years, once a project that qualifies for it starts up. The current stimulus package, both the House bill that passed last week and the Senate's version, as best I can tell, would confer the PTC on wind projects put into service through the end of 2012--and even longer in the case of other renewable power technologies, such as geothermal, biomass power, and tidal and incremental hydropower. While extending the PTC would certainly increase the amount of new wind capacity added in the next several years, only a small fraction of the federal funds involved would be parceled out this year and next. However, it will reduce federal tax revenue each year until 2022. Even if wind capacity only increased at its 2007 rate of 5,000 MW per year for the next four years, and the PTC was allowed to expire in 2013, this would add around $1 billion to the annual federal budget deficit for up to a decade after the recession ends. As numbing as the long strings of zeroes in the current stimulus figures might be, we will eventually be back in a world in which every billion counts. The justification for taking on such a lasting burden for wind power looks especially shaky, in light of a recent study indicating that up to two-thirds of the "green jobs" associated with new US wind projects would be created offshore.
Instead of making the PTC refundable, the current version of the stimulus bill would allow developers to make an "irrevocable election" to receive a 30% "Section 48" energy investment tax credit (ITC) in lieu of the "Section 45" PTC, for the life of the project. Although the Section 48 credits aren't refundable, either, allowing wind and other technologies to opt for the ITC front loads their tax benefits, compensating for the shrinkage of the tax equity market. They also appear to qualify for the bill's generous "carry-back" provisions. In the process, this front loads the crucial stimulus spending without affecting future federal budgets, other than by the interest payments on the larger debt. I would be even more comfortable with this solution, if the only extension offered for wind power were for projects electing the ITC conversion, with no hangover of lost tax revenue beyond the recession. After all, the purpose of assisting wind power within the stimulus is to create "green jobs" now, and to keep the industry going through a rough patch, not to contribute to the enormous post-recovery budget deficits we must expect. If the Congress wishes to extend the regular PTC, it should do so outside the stimulus and under the "pay-go" rules that would require the cost to be offset elsewhere.
Monday, August 25, 2008
Pay-Go for Renewable Energy Credits
While Congress and the Presidential candidates are busily debating far-reaching energy proposals, the existing tax credits for wind and solar power and other renewable energy are still slated to expire at the end of the year. The uncertainty about their continuation is apparently beginning to slow down new installations and may be putting some of those vaunted "green collar" jobs at risk, at least temporarily. Although a broad consensus supports their renewal, the hang-up is over funding. I'd like to offer an alternative that at least makes policy sense, if not political sense. Its appeal will be limited by the reticence of both sides of this debate to be seen explicitly raising the price Americans pay for energy.
I've lost count of the number of times the Senate has missed extending the Renewable Electricity Production Tax Credit (PTC) and the Solar Investment Tax Credit (ITC) this year. Six? Seven? One of the latest such efforts was S.3335, the "Jobs, Energy, Families, and Disaster Relief Act of 2008". Voting against something with that title must have felt like voting against motherhood and apple pie, although the bill should more accurately have been designated the "Renewable Energy and Comprehensive Pork Act of 2008," including as it did such diverse provisions as a "Seven Year Cost Recovery Period for Motorsports Racing Track Facility," "Provisions Related to Film and Television Productions," and my favorite, the "Modification of Rate of Excise Tax on Certain Wooden Arrows Designed for Use by Children." I wish I were making this up. Having previously failed to satisfy the requirement for revenue neutrality, also known as "Pay-Go", by singling out the oil & gas industry for loss of a manufacturing tax credit--an idea resurrected in the proposed "Gang of 10 Compromise"--the revenue provisions of this bill focused on tax changes on deferred income and securities transactions.
All of this seems unnecessarily convoluted. If the Congress wishes to adhere to the principal of revenue neutrality with regard to incentives for renewable energy, the most sensible place to seek funding is one that also encourages energy demand reduction, to complement the PTC's and ITC's supply and efficiency contributions: a tax on the forms of energy these renewables are intended to displace. Contrary to a widely-held misunderstanding, oil accounts for less than 2% of the US electricity supply, so wind , solar, and other forms of renewable electricity displace virtually no petroleum. But even as Americans are driving less and consuming less gasoline, thanks to high fuel prices, electricity demand continues to grow steadily. From April 2007 through March 2008, US electricity demand was running 2% ahead of the previous 12 month period, on a par with its five-year average growth rate of 1.6%. Considering that last year 72% of our power was generated from the combustion of fossil fuels, taxing electricity consumption to pay for the extension of the PTC and ITC would reduce both demand and emissions, while hastening our widely-desired conversion to renewable energy sources.
I've seen a wide range of estimates of the cost of renewing the PTC and ITC. At last year's installation rate for wind power alone, extending the PTC indefinitely would add roughly $300 million each year to the federal deficit, compounded. That aggregates to about $17 billion in lost federal tax revenue over 10 years. A tax of 0.1 ¢/kWh on sales of fossil-fuel-generated electricity would raise more than $25 billion over that period, while increasing the average consumer's monthly bill by only about $1 per month. If we're looking for "Pay-Go" that aligns policy with purpose, that seems like a much better candidate than taxing other forms of energy production and potentially leaving us even less energy-secure than we were.
I've lost count of the number of times the Senate has missed extending the Renewable Electricity Production Tax Credit (PTC) and the Solar Investment Tax Credit (ITC) this year. Six? Seven? One of the latest such efforts was S.3335, the "Jobs, Energy, Families, and Disaster Relief Act of 2008". Voting against something with that title must have felt like voting against motherhood and apple pie, although the bill should more accurately have been designated the "Renewable Energy and Comprehensive Pork Act of 2008," including as it did such diverse provisions as a "Seven Year Cost Recovery Period for Motorsports Racing Track Facility," "Provisions Related to Film and Television Productions," and my favorite, the "Modification of Rate of Excise Tax on Certain Wooden Arrows Designed for Use by Children." I wish I were making this up. Having previously failed to satisfy the requirement for revenue neutrality, also known as "Pay-Go", by singling out the oil & gas industry for loss of a manufacturing tax credit--an idea resurrected in the proposed "Gang of 10 Compromise"--the revenue provisions of this bill focused on tax changes on deferred income and securities transactions.
All of this seems unnecessarily convoluted. If the Congress wishes to adhere to the principal of revenue neutrality with regard to incentives for renewable energy, the most sensible place to seek funding is one that also encourages energy demand reduction, to complement the PTC's and ITC's supply and efficiency contributions: a tax on the forms of energy these renewables are intended to displace. Contrary to a widely-held misunderstanding, oil accounts for less than 2% of the US electricity supply, so wind , solar, and other forms of renewable electricity displace virtually no petroleum. But even as Americans are driving less and consuming less gasoline, thanks to high fuel prices, electricity demand continues to grow steadily. From April 2007 through March 2008, US electricity demand was running 2% ahead of the previous 12 month period, on a par with its five-year average growth rate of 1.6%. Considering that last year 72% of our power was generated from the combustion of fossil fuels, taxing electricity consumption to pay for the extension of the PTC and ITC would reduce both demand and emissions, while hastening our widely-desired conversion to renewable energy sources.
I've seen a wide range of estimates of the cost of renewing the PTC and ITC. At last year's installation rate for wind power alone, extending the PTC indefinitely would add roughly $300 million each year to the federal deficit, compounded. That aggregates to about $17 billion in lost federal tax revenue over 10 years. A tax of 0.1 ¢/kWh on sales of fossil-fuel-generated electricity would raise more than $25 billion over that period, while increasing the average consumer's monthly bill by only about $1 per month. If we're looking for "Pay-Go" that aligns policy with purpose, that seems like a much better candidate than taxing other forms of energy production and potentially leaving us even less energy-secure than we were.
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