franke.uchicago.edufranke.uchicago.edu/.../Team14-EnergyPaper.docx · Web viewTo avoid the high costs and inefficiency associated with bringing in tax equity investors, in 2009 Congress

TEAM 14: Lear Jiang, Adeed Choudhury, Parker Tikson, Kevin Matheny, Daniel YanEnergy and Energy Policy 8 December 2014

Solar Industry and Incentives: Implications and the Future of the Solar Investment Tax Credit

Background:

In 2006, the Federal Government implemented the Investment Tax Credit (ITC) for solar

and wind renewable energy projects. The ITC offers a 30 percent tax credit to the project’s

sponsor for taxable income equal to the value of the project’s depreciable expenditures. There is

no maximum limit on the credit. However, sponsors of commercial-scale projects (as opposed to

residential ones) often do not earn enough taxable income from the project to take full advantage

of the credit, and so must pursue one of three options to make the federal incentive efficient.

First, it can utilize the credit on outside income – that is if the sponsor has other taxable

accounts it operates, it can shift the credit to those tax expenses. This is the “best possible

outcome” (Bolinger 2014) for the sponsor, because it uses the tax credit in full within an optimal

amount of time. Second, it can carry the credit forward over time for up to a period of twenty

years after the project becomes profitable – that is, after all the costs of the project have been

overtaken by its revenues. This option is usually inefficient for the sponsor because inflation and

other factors contribute to the depreciation of the value of the credit over time. Last, the sponsor

can bring in a third-party tax equity investor to finance the project. This tax equity investor is

usually a firm that possesses a large amount of taxable income and would benefit from the

sponsor’s unused credits. For investing in the project, the sponsor transfers the majority of risk

and tax credits to the investor. Although there are high costs associated with this option, due to

legal fees, transaction fees and other service fees, this is the option most often pursued by a

sponsor who cannot take full advantage of the tax credit (US PREF 2011).

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To avoid the high costs and inefficiency associated with bringing in tax equity investors,

in 2009 Congress enacted the 1603 cash grant program as a part of the ITC. Under the program,

sponsors may choose to receive cash in lieu of the 30% tax credit. The program spurred the solar

industry to record growth between 2009 and 2011, but due to the high immediate costs of the

cash transfers to the Federal Government, the 1603 program was scrapped as a part of

Sequestration cuts in 2011. The current Investment Tax Credit is set to decrease from 30% to

10% by December 31, 2016. There has been ample research conducted on the potential effects of

the reduction, much of which will be discussed later in this paper. There has also been ample

research on the Federal Government’s return on investment (ROI) of these incentives, which will

also be discussed later. However, there has been little research on the potential effects of a

renewal of the cash grant program, even at the lower rates scheduled to go into effect in 2017.

This paper explores the effects of an Investment Tax Credit cash grant program,

compared to simply the tax credit if rates were to decrease from 30% to 10%. First, we will

present a general overview of the solar industry and the technological advances that have led to

its boom. Second, we will provide a review of the current literature surrounding solar

development incentives, its effects on the industry, and on government revenues. Third, we will

present a summary of the current tax incentive system – which is the main solar incentive

currently available. We will also attempt to show why the heavy reliance on third part tax equity

investors is inefficient. Fourth, we will examine the brief years under the cash grant program

and how solar project development was incentivized differently, and ultimately more efficiently

than a pure tax credit. Last, we will attempt to examine the effects on Power Purchase

Agreement (PPA) prices – essentially the effect on energy consumers – between a pure tax credit

and a cash grant program at levels of 30% and 10% and compare the efficiency of both projects.

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Science of Solar Photovoltaic Systems:

Solar energy is the most abundant and renewable source of energy on Earth. It is the

fundamental energy for life on earth and it allows earth to maintain livable temperatures through

a constant influx and outward radiation of solar and infrared energy fueled by the sun. The sun is

not a finite well from which we can draw energy when we choose, but rather, it is constantly

exuding energy weather we like it or not and it is to our discretion what happens to the energy

that reaches earth to some extent.

Earth’s albedo, which is the fraction of reflected sunlight from the earth relative to

all of the light that reaches earth, is estimated to be around 30%, which leaves the remaining

70% to be absorbed, in some way, by the earth. Some of this energy will be captured by the

atmosphere, some of it by our oceans and bodies of rock, and some of it by organic plant matter.

That which was captured by organic matter was found long ago to be able to transformed into

heat energy by humans whether it was through burning the wood from today’s trees, or burning

the fossil fuels such as coal and oil which have resulted from organic matter that captured solar

energy millions of years ago and have been long since buried by meters to kilometers of

sediment. The product of such a process is as follows:

CH4[g] + 2 O2[g] -> CO2[g] + 2 H2O[g] + energy

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This basically demonstrates that by using energy that has already been captured by

organic matter, we will inevitably produce CO2 as a byproduct.

(Planetforlife.com)

After thousands of years, and an enormous spike since the industrial revolution, the

burning the fossil fuels has produced an unprecedented increase in atmospheric CO2.

Fortunately, the industrial revolution has also led to unprecedented advancement in technology

which has resulted in the ability to directly capture the energy of the sun and either store it or use

it on-hand without the production of atmospheric pollutants such as CO2. There are several

methods that have been, and continue to be, investigated for the most efficient capture of solar

energy.

The first type considered is solar heating. It’s purpose is to concentrate solar energy using

flat or parabolic light receptors made up of panels or cells that absorb sunlight energy and

convert it directly to heat in order to water, air, and other objects for commercial and residential

purposes. This energy can also be stored and transported as electricity by heating small cells of

water to produce steam which then drives a turbine, producing the movement of electrons and

therefore, viable energy.

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Artificial Photosynthesis is a newer technology and is essentially a chemical process that

replicates the natural process of photosynthesis, a process that converts sunlight, water, and

carbon dioxide into carbohydrates and oxygen.

Finally, the type of solar energy capture that has shown the most promise and application

is in solar photovoltaics. These cells observe the photoelectric effect, which causes them to

absorb photons of light and release electrons, which are then captured, resulting in a current that

can be stored, transported, and used as electricity (Nasa, 2002).

(OldDominionInnovations.com)

Solar Architecture is the integration of solar panel technology with modern building

techniques. The use of flexible thin film photovoltaic modules provides fluid integration with

steel roofing profiles that enhances the building's design. However, this was not a very feasible

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application until solar panels were thin and/or malleable enough to adjust to a variety of surfaces.

Orienting a building to the Sun, selecting materials with favorable thermal mass or light

dispersing properties, and designing spaces that naturally circulate air also constitute as solar

architecture. One major improvement to the architecture of solar panels themselves is the ability

to pivot to a wide array of angles in order to follow the sun and receive it’s energy normal to the

surface because the larger the angle relative to normal, more light energy is reflected and

therefore less is absorbed.

As installation costs are relatively high and “roof space” for small-scale users is relatively

small, efficiency is of primary importance. Currently, the commercial solar photovoltaic cells

with the greatest efficiency are capturing around 25% of the energy that reaches the cell (in

absolutely ideal conditions), but in reality, this number is even lower

(http://en.wikipedia.org/wiki/Solar_cell#Efficiency). These numbers are continually creeping

upward in thanks to both university-sponsored research as well as the research and

implementation of new ideas by large corporations such as Panasonic. In terms of technology,

there has been a gradual shift from using thin film to using fine crystalline silicon and with the

mechanical addition of pivoting panels in relation to the relative location of the sun, theoretical

efficiencies have increased over the past decade along with increases in realized efficiencies

through research and implementation every year. The following chart documents the levelized

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cost of energy relative to other leading energy forms.

(Solarcellcentral.com)

It is well know that solar power is not as reliable as other types such as coal or natural gas

that can be accessed with the flick of a switch and used reliably for as long as necessary (on a

short scale). Solar power is reliant on the sun and therefore can only be harnessed during the

daytime with clear skies. Because of this, the power is very intermittent and is helpful as a

supplementary source, but would not be reliable as a primary source of energy without

innovation. With this being such an important bottleneck, innovation is inevitable and there has

recently been a big step taken to solve this using large scale-battery storage running on large-

scale power grids that can be instantly accessed. This would allow access to solar energy at all

times of the day, including late at night, and could relieve solar energy of it’s dependence on

fast-burning fossil fuels to fill in the gaps. While energy storage is nothing new in technology,

implementing this battery storage system could give solar energy the ability scale up at low-

enough prices to be competitive as a primary power source without governmental subsidies.

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(www.businessinsider.com)

However, there are many other factors that influence the efficiency of solar power as a

whole in terms of cost per unit energy. Following trends seen in other technologies such as cell

phones, cameras, and flat screen TVs, yet far exceeding trends of other renewable energies, the

manufacturing costs of solar power are decreasing by 20% every time the production volume

doubles, this is referred to as Swanson’s Law (Sandowski, 2014). So as we continue to

implement solar power, the costs of installation, maintenance, and therefore the power itself will

gradually drop as the technology as well as the process of interconnection, or the creation of

large-scale grids, become more efficient and there are more and more competitors pushing

innovation in the market. In fact, it is reasonable to say that solar power produced through solar

photovoltaic cells is now at the stage to be a standalone competitor and should seek private

investment as opposed to governmental subsidies (Nahi, 2013). As solar photovoltaics have

become more powerful, efficient, and competitive, governmental subsidies and tax cuts, which

used to be fuel for innovation, have become a crutch to increase profit margins for profitable

energy companies and lead to less motivation to innovate than would a competitive market.

Governmental subsidies should be concentrated to fueling the innovation of newer solar

technologies that would otherwise be unable to achieve private investment. Solar photovoltaic

innovation would benefit marginally and predictably from these subsidies, but it is time to push

standalone PV cells out of the nest because they’ve reached the stage that they can and must fend

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for themselves. The government should refocus spending on the innovation and integration of

newer technologies to help realize the potential for revolutionary advancements.

Literature Review:

Most of the literature regarding solar energy focuses on its technology. For example, in “A

Review of Solar Energy” by Govinda R. Timilsina, Lado Kurdgelashvili, and Patrick A. Narbel,

the authors believe that solar energy has received large growth recently due to technological

upgrades and cost-friendly government policies, which support renewable energies. However,

they examine the cost of solar compared to other conventional fossil fuel technologies and find

that solar’s development and use has been limited due to its high relative costs, even when

accounting for environmental impact.

Currently, solar energy has expanded technologically and now includes not only the

small-scale photovoltaic cells that the industry began with, but also newer solar concentrated

systems, solar thermal systems, and large-scale photovoltaic systems. These systems feed into

grids, supplying the grid with electric power. In addition to these technological advances, the

costs of a PV system have dropped substantially. In 1992, the installed cost of a PV system was

$16,000/kW, a figure that dropped to $6,000/kW by 2006 and continues to fall (Timisilina,

Kurdgelashvili, Narbel 2011).

Furthermore, solar has the potential to power the entire global energy demand and expand

to represent 11% of the global energy supply mix by 2050. Solar’s total potential power is

greater than that of all other current renewable technologies (see Figure 5). The installation of

solar energy technologies has also grown at a rapid rate, going from 1.4 GW in 2000 to about 40

GW in 2010, an average annual growth rate of 49% for PV cells. In addition, solar concentrated

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power (CSP) has doubled in that same time period, reaching 1,095 MW in 2010. Solar thermal

technology increased fivefold, from 40 GW to 185 GW in the same 10-year period. For PV cells,

Germany, Spain, Italy, Japan, and the US make up about 78% of the global installations in 2010

(8). The CSP market is concentrated in the Southwestern US and Spain, and solar thermal is

installed primarily in China.

The authors then study the economics of solar energy, first by comparing the cost of

generating electricity from different sources using the “levelized cost” (LCOE) method. The

equation is, as follows:

LCOE= OCCF∗8760

∗CRF+OMC+FC

where

CRF= r∗(1+r )T

(1+r)T−1

In this equation, OC is the overnight construction cost (amount invested, excluding

interest payments), OMC is the series of annualized operation and maintenance costs, FC is the

series of annualized fuel costs, CRF is the capital recovery factor, CF is the capacity factor, r is

the discount rate, and T is the time in years, of the plant’s life.

Figure 5: Estimates of Technical Potential of Renewable Energy Resources

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According to this model, the costs of solar power per megawatt-hour generated is much

higher than that of all other comparable technologies, including conventional ones such as fossil

fuels, coal, and nuclear, and renewable ones such as wind, natural gas, and hydroelectric (see

Figure 6).

The authors are quick to point out that conventional gas and coal have environmental

costs not internalized by the equation, and attempt to model the true cost of such technologies by

assigning the cost of a metric ton of CO2 produced to be between $0 and $100. They find that

even when taking these costs into account, the costs of solar are still larger than the costs of gas

and coal (see Figure 7). They point to these relative costs as a primary factor in why the solar

energy industry, with all its potential, hasn’t taken off yet.

In an outline of technical, economic, and regulatory barriers to the PV and CSP/solar

thermal industries, they also go on to list other problems such as high initial costs, lengthy

payback periods for investors, small revenue streams, lack of general experience in building

plants, increasing material costs, limited space, and grid access restrictions to build such units.

Figure 6: LCOE of Electricity Production by Technology

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Next, the authors highlight the economic policies which support solar energy today, such

as feed-in-tariffs, investment tax credits, direct subsidies, renewable energy portfolios, and

public investment.

A feed-in-tariff the most popular policy, as it has been implemented in over 75

jurisdictions around the world, including some states in the US. It is a premium payment given

to new and renewable energy technologies, not just solar, which are currently not cost

competitive with conventional technologies. The tariff granted is based on the cost of electricity

produced, and gives a reasonable return on investment for the producer of the energy.

Interestingly, tariff policies are not uniform and differ across countries. For example, Germany

incorporates a “corridor mechanism” which decreases the tariff rates if the PV capacity

installation the previous year exceeded a “corridor path” that the government sets, and vice

versa. The authors point to the feed-in-tariffs as the catalyst for the recent growth of grid

connected solar power. However, the downside to feed-in-tariffs is that they raise electricity

costs on the consumer and may be dicey politically and financially if the tariff rates keep

changing for countries which employ the corridor mechanism.

Figure 7: Economic Attractiveness of Solar Technologies when Environmental

Damages of Fossil Fuel Technologies are Accounted

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Direct subsidies include investment grants, capacity payments, or production based

payments. Countries such as Spain and India have incorporated direct subsidy programs into

policy, although India changed their subsidy from capacity based to production based due to

criticism that should incentivize production as opposed to capacity. In the United States, the

California Solar Initiative provides a solar subsidy. They use performance-based rebates, which

take into account the site of the system, the expected system performance, location, and other

factors into account.

Renewable energy portfolios, or RPS, are requirements for electricity suppliers to obtain

a certain percentage of their electricity supply from renewable energy sources. RPS is typically

implemented in developed countries, and is used to set penetration targets for renewable energy

in the total electricity supply mix. In the United States, RPS has been introduced in 31 out of 50

states. The standards go from a low of 10% to a high of 40% for electric energy suppliers (29).

Public financing is a tool used by many developing country governments to spur

investment from the public by selling energy bonds. For example, the United States’ Energy

Policy Act of 2005 created Clean Energy Renewable Bonds (CREBs) to finance renewable

energy projects. $800 million of tax credit bonds were issued in 2007, and the Energy

Improvement and Extension Act of 2008, combined with the American Recovery and

Reinvestment Act of 2009 raised $2.4 billion for new CREBs combined. By October 2009, the

Department of Treasury issued another $2.2 billion in CREBs on top of the previous issues.

Researchers like Patricia Salkin explore more in depth various governmental incentives

surrounding renewable energy, and there is much literature concerning state and local incentives.

In “The key to Unlocking the Power of Small Scale Renewable Energy: Local Land Use

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Regulation,” Salkin discusses multiple avenues for providing incentives, and discusses the ways

in which these incentives are put in place on federal, state and local levels. This provides a good

foundation for understanding renewable incentives; we will work deeper into the nuances of the

Investment Tax Credit after this overview.

The Investment Tax Credit was enacted by Congress in 2005, and provides a tax

credit for homeowners and project developers for up to thirty percent of the cost of constructing

various forms of renewable energy, including solar electric and solar water heating. This

investment tax credit (ITC) is now available to businesses as well, but is set to sunset in 2017 to

10 percent (Salkin, 2012). In 2011 President Obama signed into action the Better Buildings

Initiative, which calls upon Congress to redesign tax deductions and offer more government

backed loans to businesses that retrofit existing buildings. These types of federal actions

incentivize investment in renewable energy sources, including solar energy, but Salkin stops

short of evaluating the optimal levels of such incentives. For example, in Congress, it has been

argued that a market-based approach to solar and other renewable energy investments is more

cost effective than these types of federal incentives and many in the Republican Party have

advocated for the ending of federal incentives altogether.

While we will concentrate mainly on the federal ITC, there are a myriad of different

approaches to incentivizing solar development at the state level as well. For example, in

Colorado, independently owned residential solar electric generation systems that are not used for

income production are exempt from property taxes. Colorado also authorizes counties to offer

property tax or sales tax incentives for residential and commercial property owners who install

renewable energy fixtures, including solar panels. In Illinois, on the other hand, the Renewable

Energy Resource Solar and Wind Energy Rebate Program offers a rebate of up to $30,000 for the

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construction and use of solar and wind energy sources for homeowners, businesses, public

agencies and non-profit entities (Salkin 2012). In a different move, Massachusetts created the

Renewable Energy Trust Fund to make grants, loans, equity investments, rebates, and provide

other types of financial assistance for the development and increased use of renewable energy

resources.

In each case states approached incentivizing renewable development differently.

Colorado offers some of the most comprehensive and diversified incentives, piggybacking on the

Federal ITC with huge incentives for residential solar generation, including exemption from

property taxes. Illinois offers a more straightforward, rebate style approach, and Massachusetts is

one of many states that offer discounted financing for both the construction and use of solar and

other forms of renewable energy. Salkin offers many detailed examples, but she fails to address

the economic effectiveness of these different approaches, never answering why states use

different method, or which method could be most effective. We hope to fill this gap in with our

research regarding federal incentives.

Municipalities also engage in renewable energy legislation. For example, the city of

Honolulu offers financing for the installation of solar water heating systems to homes of income

qualified owners, meaning those in the low and moderate income levels (343). This type of

incentive is similar to the Renewable Energy Trust in Massachusetts, although it targets

individuals who may not have the finances to build these types of energy systems otherwise.

Salkin also addresses the time and cost involved in getting permits for renewable energy

sources. The Department of Energy has created fast-track procedures for granting renewable

energy loans, and recently (as of 2012) announced availability of more than $27 million in new

funding that will reduce non-hardware cost of solar energy projects. Many states have followed

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suit and are enacting fast-track type legislation to speed up the permitting process for solar and

other energy systems. The Network for New Energy Choices reports that many state and local

governments have been fast tracking these projects, and furthermore, the report recommends

adopting flat or zero permit fees for photovoltaic solar energy production. At the state level,

there are already Renewable Portfolio Standards (RPS) being enacted, which aim to diversify

and incentivize renewable energy. For example, Oregon’s Renewable Energy Act of 2007

requires the state’s largest utilities to generate at least five percent of their electricity from

renewable energy sources by 2011, increasing to twenty-five percent by 2025

Finally, Salkin discusses both net-metering and feed-in tariff incentives that are offered at

the state and local levels to further incentivize renewable energy use and production. Net

metering allows electricity consumers to sell back some portion of excess qualified renewable

energy to their utility provider. This type of legislation makes it attractive to both use, but also

conserve, solar and other renewable energies. In New York, recent amendments to the law

expanded the state’s solar net metering program applying it to businesses and increased the size

of eligible solar photovoltaic systems to 25 KW for residential customers and 2 MW for non-

residential customers.

Feed-in tariffs are similar to net metering techniques, but require utilities to purchase

renewable energy at fixed rates and honor longer-term contracts. This type of incentive fosters

more economic and infrastructural stability. Salkin highlights these types of incentives, but

focuses herself more on the direct taxed- based incentives, and we will do the same in this paper

as well. However, while these state and municipal initiatives may attempt different solutions to

the same problem, they are often too small in scope to make an accurate model or base federal

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policy off of – the Investment Tax Credit remains the only federal incentive that is applicable to

all solar projects in development.

Other researchers have attempted to analyze the return on investment for federal

incentives. A United States Partnership for Renewable Energy Finance study entitled “Paid in

Full: An Analysis of the Return to the Federal Taxpayer for Internal Revenue Code Section 48

Solar Energy Investment Tax Credit” examines the ITC in particular. The study delves into the

potential tax return benefits from implementing the Investment Tax Credit. Its primary argument

is that over the life of solar assets (30 years), the initial cost of federal expenditures associated

with the ITC can be more than offset by the tax revenues generated in lease and Power Purchase

Agreement scenarios, both of which create fixed payment structures and provide a positive

financial return on investment to the federal taxpayer. Even taking depreciation into account, a

$10,500 residential solar credit can deliver a $12,469 nominal benefit to the government and a

$300,000 commercial solar credit can create $380,127 nominal benefit to the government.

Beyond revenue benefits, the ITC also includes numerous other benefits such as job creation,

energy independence, preservation of natural resources and cleaner air.

Although the paper presents a strong argument, there are many factors their model does

not incorporate: Most importantly, although the model is looking at a 30-year period, it fails to

incorporate inflation (or a discounted valuation of money). Taken the historical values of

inflation, the tax returns from the solar installations would undoubtedly less – but because most

other factors are held constant, the model presents an ideal scenario to compare the ITC at

different rates, or comparing other forms of incentives, which this paper will analyze in detail

later on.

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Despite having a simplified model with unconfirmed assumptions, the study effectively

shows that the Investment Tax Credit is indeed an effective investment for the federal

government. If income taxes from job creation were included in the model, the ITC returns

would be even larger. Furthermore, although other benefits such as energy independence,

preservation of natural resources and cleaner air cannot be quantified, their benefits are equally

as important and are effectively promoted through the ITC.

Current ITC System:

The current ITC system is heavily dependent on third party tax equity investors for

financing projects. This is due to many sponsors lacking “tax appetite” (Bolinger 2014), the

income necessary to take full advantage of the face-value of the credit. For example, if in a given

year a project sponsor earns $1,000,000 in taxable income and the corporate tax rate is as it

stands at 39.1 percent, then the sponsor is obligated to pay $391,000 in taxes to the Federal

Government. However, with the investment tax credit, 30 percent of the project’s expenditures

can be written off on taxes – and they often exceed the amount the sponsor owes to the

government. On average, residential solar installations cost around $40,000 for just 7 kilowatts.

For utility scale solar projects, industry estimates for total capital expenses (CapEx) range

between costs of $2,000/kW and $3,000/kW for alternating current (Bolinger 2014). Given that

most utility scale projects are sized over 20 megawatts, which brings estimates for even the

smallest sponsor-backed projects to over $40,000,000 in expenditures. Even if these estimates

are not completely precise – it indicates that for most solar projects, the amount of tax credit due

to a sponsor are often higher than the amount the sponsor owes in federal taxes. Indeed this is

exactly the case, as many project sponsors do not have sufficient “tax appetite” and so seek out

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third part tax equity investors. The infusion of cash directly into the project’s financing, also

called “monetization” lowers the immediate cost of construction for the project. Thus, even if

there are high costs associated with bringing in a tax equity investor, it still spurs the solar

industry into development.

During a tax equity transfer, the investor “usually has a substantial, but passive,

interest (e.g., 99.99 percent)” in a newly created limited partnership (LP) or limited liability

company (LLC), while the sponsor of the solar project usually has a “de minimis (e.g., 0.01

percent) interest. If this structure is followed, it allows the tax equity investor to obtain 99.99

percent of the tax benefit from the ITC (OCC 2014). There are two main methods for a tax

equity investment. In the Sale-Leaseback Model, the sponsor sells the entire solar project to the

investor, who in turn leases the project back to the sponsor. This allows the investor to retain the

ITC benefits, while allowing the sponsor to maintain the revenue it receives from a Power

Purchase Agreement (PPA). This is the most common form of a tax equity investment in solar.

In a Partnership Flip, the investor and the sponsor join together to share the costs, risks, and

benefits of the project. In this model, the investor does not receive the full benefit of the tax

credit nor does the sponsor receive the full revenue from a PPA. They are both shared. This

model is more common for wind projects than for solar.

The current ITC system is highly inefficient. Third party tax equity monetization is

judged to be “more than twice as expensive as 15-year term debt on an after-tax basis” (Bolinger

2014). However, because projects might otherwise not be built, or because project sponsors do

not have enough financial security to finance projects purely through debt, third party tax equity

monetization remains a crucial cog in the solar industry. The costs for monetization are high

because there are not enough investors willing to take on solar projects. Only firms with very

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large amounts of tax liability are willing to take on the risk necessary to finance projects through

either the sale-leaseback or partnership flip methods. This is due to the potential of not realizing

the entirety of the tax benefit before it expires in twenty years time (deadline set for the ITC).

The firms must also be large enough to willingly hold stake in a solar project for several years,

be able to afford to hire the qualified experts to advise them on such complex tax structures, and

also be willing to engage in opportunities not core to its business (NREL 2012).

Usually, only massive banks and other highly profitable firms engage in this transfer.

Even so, the supply of tax equity investors remains limited. During the recession between 2008

and 2009, the recorded number of tax equity investors for utility scale solar projects “willing to

make new investments decreased from about 20 to five” (NREL 2012). That means only five

firms were willing to essentially finance the entire solar industry during the recession. This skew

of supply and demand shifts heavily in favor of the investors – as they can dictate the price of the

transfer, sale, leaseback, partnership, etc. Even after the recession has ended, industry estimates

still put the number of willing tax equity investors to be around fifteen. Most of these entities are

financial providers such as banks (JP Morgan, Credit Suisse, Wells Fargo, etc.) and in 2010, the

top ten tax equity investors accounted for 97% of the financing for utility scale solar projects.

Industry estimates placed the demand for tax equity investors to be between $7 billion

and $10 billion in 2011 and 2012, but investors supplied only $3.6 billion in 2011. This gap

allows suppliers more control in dictating terms of financing to sponsors. There is currently little

transparency in this market, as sponsors and investors often sign non-disclosure agreements and

much of the pricing is negotiated directly between two parties, often with anecdotal evidence

regarding the costs and risks of each associated project. Moreover, due to the high variability in

the different types, and sizes, and the technology of each project, there is little influence that an

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in-need sponsor has over an investor at the negotiating table. This makes the market for investors

very inelastic – price is not a main determinant in the number of suppliers, thus, an increase or a

decrease in the rate of the ITC may have little influence on the financing for future projects. How

this may shift, and how different rates affect project financing compared to other types of

incentives will be discussed more in depth later on in this paper.

Aside from negotiating costs, solar project sponsors also must account for the high cost

of the transaction. Legal fees for due diligence review and assessment are especially expensive.

The review period for such deals often delay the start of construction, but more importantly have

been estimated to cost sponsors between 15% and 40% of the entire tax credit awarded simply

for seeking out a third party investor. More importantly, because these costs are so high, often

sponsors are only willing to seek out such investors for the largest projects, potentially leaving

many other projects in the pipeline or undeveloped. However, there is currently no better

mechanism in place to secure the funds necessary to finance solar projects, and indeed without

the ITC – even with its highly inefficient use of capital – utility scale solar development may be

even lower.

Effects of 1603 Cash Grant Program:

Due to the risks and complications discussed in the previous section, the market for tax

equity suppliers is extremely volatile and beholden to market trends even if they are not elastic

with respect to price. During the 2008 financial crisis, the number of tax equity investors willing

to make new investments decreased dramatically – from twenty to five (NREL 2012). This

withdrawal of investors led to significant stagnation in new renewable development, especially

in solar. In response, Congress enacted the 1603 Cash Grant Program for 2009 and beyond as a

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substitute for the tax credit in the hopes of spurring development. The new program allowed

renewable energy projects to replace their 30 percent ITC credit with a 30 percent cash grant – a

direct payment sent within 60 days of commercial operation date, essentially paying the ITC in

full. This was a major improvement to sponsors in regards to the time it took to fully realize the

incentive. Instead of seeking out costly tax equity investors or keeping the credit on their books

for years until fully realizing the tax benefits, which due to inflation and other factors decreased

the value of the credit; sponsors would now fully realize the 30 percent credit within two months

of their power plant coming online. Although the Cash Grant program expired on December 31,

2011 due to sequestration cuts, projects that started construction prior to 2012 are still eligible to

receive the grant (Renewable Energy World). To this date, the grants provided continue to

stimulate project development.

The cash grant program provides numerous benefits over the tax credit, despite

theoretically providing the same amount of monetary support (30%). There are three main

advantages to project sponsors. First, award amounts are paid out sooner than the tax credit, and

can be realized sooner. This provides an advantage in terms of the time value of money. As

already discussed, even if a sponsor is able to take full advantage of the tax credit over the course

of a few years, which is rare, inflation devalues the money, making it worth less when compared

to the cash that is provided directly under the grant program. Second, the grant program does not

rely on tax equity investors, which is a costly and inefficient way to finance a project. Since the

cash grant provided often directly helps to finance a project without the added cost of bringing in

lawyers for a long due diligence process, projects move quicker down the pipeline, and sponsors

save more money to spend on other projects. Moreover, instead of most of the government

money being diverted to investment banks and large corporations, the cash grant program

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directly funds solar developers – spurring the entire industry. Last, the barrier to entry for first-

time developers is reduced, which supports smaller projects, which might otherwise have been

cut at the margins. Sponsors are able to borrow approximately 95 percent of the grant to finance

the initial project, something that was impossible with the tax credit. This leads to better and

more accurate project financing models for sponsors, and more cash on hand to fund the project,

without the cost of securing an investor. This increase of development provides more

opportunities for the Federal Government to collect taxes on new projects, as well as spurring the

whole industry.

The most important benefit remains the avoidance of tax equity investors. The up-front

cash provided by the grant program is safe, reliable and allows better planning while minimizing

risk, as well as forgoing the expenditures on legal and professional fees which could total up to

40 percent of the credit to begin with (NREL 2012). While the primary weakness of the 1603

Cash Grant program is that it does not monetize the accelerated depreciation – projects still have

to tap their own or a third party’s tax appetite to make efficient use of these depreciation benefits,

or simply forego the incentive, the 1603 Program has still catalyzed the solar market. Over 80

percent of the solar projects built between 2009-2011 opted for the cash grant incentive, with

growth in the industry during that time topping 104 percent (SolSystems 2011). According to the

National Renewable Energy Laboratory, the $9 billion clean power cash grant created over

20,000 jobs directly, 13 gW of renewable energy and delivered $5 billion in total economic

output through the creation of solar panel projects. A separate study from the Solar Energy

Industries Association predicts that a reincarnation of the 1603 Cash Grant could lead to 58,000

jobs by 2016 (SEIA 2012).

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The expiration of the 1603 Cash Grant Program has most notably led to market

consolidation, rise in tax equity costs and funding challenges for innovative technologies.

Its expiration has had the largest impact on small sponsors who have difficulties accessing the

tax equity market. Since these developers lack a significant portfolio, financial strength and

experience, it is much more difficult for them to raise the necessary capital. Even before the 1603

Program, the tax equity market heavily favored mature, experienced developers who were

creating large-scale projects. Some tax equity investors have minimum investment thresholds

that smaller scale developers simply cannot meet. To compound this problem, the cost of

securing the tax equity from an investor has risen over the years from 9% of the credit in 2007 to

(US PREF 2011)

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around 12-13% in 2012 (US PREF 2012). As the smaller developers are being squeezed out of

the market, the solar market has consolidated. Currently, two companies – SolarCity and Vivent,

dominate over half of the residential solar market. This is vastly different from 2011 – right after

the cash program ended, and the trend is shown clearly in the graph below. As with any other

industry, market consolidation could potentially lead to decreased competition, increased pricing

and a bottleneck on innovation.

(GreenTech Media)

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1603 Cash Grant vs. ITC:

Based on a research report by the Climate Policy Initiative, the current 30% investment

tax credit for an average PV project would cost the federal government $31/MWh which is

equivalent to a 15% cash grant (CPI 2013). These differences in costs are primarily due to first,

the timing of the incentives: The cash grant is given to the developer within 60 days of operation

or provided in loan form for project financing, whereas the ITC isn’t fully realized for 5-10 years

or never at all if the sponsor brings in a tax equity investor. And second, any investor can use the

cash incentives, whereas tax benefits require tax liabilities. Tax equity investors take the risk that

they may not have enough tax liabilities to use the tax credits, so they demand a higher return.

This accounts for the difference between the cost to government for the ITC and for the 1603

Cash Grant.

Cash Grant vs. Tax Credit – Analysis:

(CPI 2012)

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Our model hopes to compare what the costs to government would be if the ITC were

replaced with a similar cash grant program at rates of 15 percent and 30 percent by calculating

the total rate of return. It assumes similar conditions to the one conducted by the U.S. Partnership

for Renewable Energy in their paper “Paid in Full: An Analysis of the Return to the Federal

Taxpayer for Internal Revenue Code Section 48 Solar Energy Investment Tax Credit (ITC).”

Other than the exception that we included an analysis of a 15 percent tax grant program in as an

alternative, all other assumptions for the cost analysis to the Federal Government remain the

same. Our model also narrows the scope of the study only to the state of California, which

represents the vast majority of utility scale solar projects in development.

Monthly Lease/PPA Plan (30% ITC vs. 15% Cash Grant):

ITC Cash Grant

kW 200.0 200.0

kWh/kW 1,450 1,450

$/W COGS $4.17 $4.17

$/W Price $5.00 $5.00

Energy Lease/PPA Price in $/kWh $0.16 $0.16

Solar Energy Escalator 1.4% 1.4%

Energy Production – Degradation Rate 0.50% 0.50%

Energy Price After Lease/PPA Term in $/kWh $0.16 $0.16

Energy Escalator After Lease/PPA Term 1.4% 1.4%

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Upfront Utility Rebate in $/W $0.00 $0.75

Federal Tax Rate 35% 35%

Lease/PPA Term in Years 20 20

System Life in Years 30 30

Initial investment rate 30% 15%

Initial investment $300,000 $150,000

Nominal Gross Revenue $685,084 $685,084

Nominal Net Benefits $385,084 $385,084

Return on Investment 128% 357%

The left column contains assumptions taken from the US PREF analysis of the ITC’s return on

investment. The right column contains data we compiled given the assumptions on the left and

information we took into account regarding the 1603 Cash Grant Program. The data represents

an extrapolation of the results provided by the Climate Policy Initiative in regards to a 30 percent

tax credit providing the same incentive to project sponsors as a 15 percent cash grant. We

focused on the return on investment to the Federal Government, as we are looking to provide a

policy recommendation after the sunset of the 30% ITC. From our analysis, it is clear that a cash

grant program, provided at an even lower incentive rate than the tax credit, would provide the

same amount of incentive for the industry – but more importantly, would provide a much higher

rate of return for the Federal Government. A 15 percent cash grant program would save the

government twice as much in costs put into the project, but would have a similar effect on the

industry.

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Conclusion and Implications:

Given the evidence provided for the 1603 Cash Grant Program, we conclude that the

1603 Cash Grant is far superior to the ITC in terms of returns to the developer, the solar industry

as a whole, and to the Federal Government. The 30 percent tax credit for the ITC is scheduled to

sunset at the end of 2016, making solar industry developers wary of the demand for projects and

market ahead. However, a replacement of the 30 percent ITC with a simple 15 percent tax credit

would provide the same boost to the industry as a continuation of the incentive, and would save

the government money as well. Even if the incentive rate dropped down to 10 percent, as

scheduled, if it were replaced with a cash grant program, the solar industry would not experience

as sharp a potential drop in development as would be expected if it fell to a 10 percent tax credit.

Thus, if we were to put forward a policy recommendation, it would be in favor of a 15 percent

cash program to directly finance solar development.

However, there are a few key factors that make our recommendations unlikely to take full

effect. The least of which is political stagnation in Washington. Cash grants need to be provided

upfront, and are often borrowed by sponsors prior to construction to finance the original

development, thus they are a massive immediate burden on the Federal Government, even if it

(CPI 2012)

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provides a better long-term investment. Given the current atmosphere in Washington

surrounding budgetary discourse, it seems unlikely that the newly elected Republican-led

Congress would be willing to spend current dollars to fuel renewables development. Even though

our paper focuses on the solar industry and its monetary costs and benefits in regards to the

industry, and to the Federal Government, there are countless other factors that come into play

when examining the true benefits of renewable energy development. As discussed above in the

science section – the Sun provides an unending supply of power to our planet, and it is up to us

to decide how much of it to harness.

References:

1. Bolinger, Mark. "An Analysis of the Costs, Benefits, and Implications of Different Approaches to Capturing the Value of Renewable Energy Tax Incentives." (2014). ERNEST ORLANDO LAWRENCE BERKELEY NATIONAL LABORATORY. Web. <http://emp.lbl.gov/sites/all/files/lbnl-6610e.pdf>.

2. Go Solar California. "Go Solar California." Go Solar California. 1 Jan. 2014. Web. 9 Dec. 2014. <http://www.gosolarcalifornia.ca.gov/consumers/taxcredits.php>.

3. Mendelsohn, M., & Harper, J. (2012, June 1). “Treasury Grant Expiration: Industry Insight on Financing and Market Implications.” Retrieved December 9, 2014, from <http://www.nrel.gov/docs/fy12osti/53720.pdf>

4. Munsell, M. (2014, July 3). “Top 10 Installers Eclipse 50% of US Residential PV Market in Q1 2014.” Retrieved December 9, 2014, from <http://www.greentechmedia.com/articles/read/top-10-installers-eclipse-50-of-us-residential-pv-market-in-q1-2014>

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5. NREL. “Renewable Electricity Faces Financing Challenges with End of Federal 1603 Grant Program.” (2012, June 29). National Renewable Energy Laboratory. Retrieved December 9, 2014, from <https://financere.nrel.gov/finance/content/renewable-electricity-faces-financing-challenges-end-federal-1603-grant-program>

6. OCC "Public Welfare Investments in Solar Energy Facilities Using Renewable Energy Investment Tax Credit." Office of the Comptroller of the Currency, 1 Jan. 2014. Web. 9 Dec. 2014. <http://www.occ.gov/topics/community-affairs/publications/fact-sheets/fact-sheet-solar-energy-invest-tax-credits-grants.pdf>.

7. Salkin, P. (2012). “The Key to Unlocking the Power of Small Scale Renewable Energy: Local Land Use Regulation.” Digital Commons @ Touro Law Center, 339-367. Retrieved December 9, 2014, from <http://digitalcommons.tourolaw.edu/cgi/viewcontent.cgi?article=1564&context=scholarlyworks>

8. SEIA. "Solar Investment Tax Credit (ITC)." Solar Energy Industries Association. 1 Jan. 2014. Web. 9 Dec. 2014. <http://www.seia.org/policy/finance-tax/solar-investment-tax-credit>.

9. Taub, S., & Fulton, M. (2011, June 1). “Impact on Jobs through the Extension of the ARRA 1603 Cash Grant.” Retrieved December 9, 2014, from <http://reffwallstreet.com/us-pref/wp-content/uploads/2011/06/A_US-PREF-Jobs-Analysis-1603-v2.2.pdf>

10. Timilsina, G., Kurdgelashvil, L., & Narbel, P. (2011). “A Review of Solar Energy Markets, Economics and Policies.” 1-39. Retrieved December 9, 2014, from <http://elibrary.worldbank.org/doi/pdf/10.1596/1813-9450-5845>

11. US PREF. "Paid in Full An Analysis of the Return to the Federal Taxpayer for Internal Revenue Code Section 48 Solar Energy Investment Tax Credit (ITC)." US Partnership for Renewable Energy Finance, 1 Jan. 2012. Web. 9 Dec. 2014. <https://www.novoco.com/energy/resource_files/reports/us-pref_paid_in_full_itc_report_0712.pdf>.

12. US PREF. "Tax Credits, Tax Equity and Alternatives To Spur Clean Energy Financing." US Partnership for Renewable Energy Finance, 1 Jan. 2011. Web. 9 Dec. 2014.

13. Varadarajan, U., Pierpont, B., Hobbs, A., & Rowley, K. (2012). “Supporting Renewables while Saving Taxpayers Money.” CPI Report, 1-36. Retrieved from <http://climatepolicyinitiative.org/wp-content/uploads/2012/09/Supporting-Renewables-while-Saving-Taxpayers-Money.pdf>

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