Partly Cloudy?

- Christine Tezak, Senior Energy & Environment Policy Analyst, Robert W. Baird & Co.

October 2011
As we evaluate the federal tax and investment incentive horizon this fall, the situation looks mixed. On one hand, the tendency for Congress to do less than more holds some good news. We do not expect there to be much risk that the solar investment tax credit (ITC) will be terminated before its scheduled expiration at the end of 2016. On the other hand, budget constraints have made an extension of the Sec. 1603 cash grant program unlikely, in spite of the potential downdraft in economic activity that looms ahead. Solyndra’s bankruptcy filing is ill-timed, casting an additional pall over the Department of Energy’s Innovative Technology Loan Guarantee Program. Congress’ tendency for inertia leads us to the following conclusions.

First, the Good News: ITCs Look Good till 2016 
The Joint Select Committee on Deficit Reduction (Deficit Supercommittee), has not taken any particular solution “off the table,” including broad tax reform. In such a context, the solar investment tax credit qualifies as a “tax expenditure.” This means that the Joint Tax Committee assumes that the U.S. Treasury foregoes revenue by allowing enterprises to claim this incentive. While there will always be argument that this type of accounting is incorrect – that there’d be much less economic activity if the incentive was not in place – that is how the tax writing committees and the Congressional Budget Office evaluate them. Solar market participants and their investors need to keep an eye on this conversation for the following reason. If the intention of broad corporate tax reform is to “broaden the base and lower the rates” the mechanism to achieve it is to eliminate tax expenditures – such as ITCs, the R&D tax credits, interest deductions, accelerated depreciation, etc. – in favor of a lower rate that all enterprises would pay.

The good news for solar, in our view, is that broad tax reform is a very low probability event. The Deficit Supercommittee is very constrained on time (a plan needs to be submitted to the Congressional Budget Office in mid-to-late October to be vetted in time for a vote on November 23). Crafting major tax reform in a matter of weeks when Congress spent seven months in its efforts to lift the debt ceiling looks very ambitious. Further, certain tax expenditures are important to the business models of many diverse industries, and recent Congressional testimony suggests to us that the business tax rate may need to be lower than the 25% target that Senate Finance Committee Chairman Max Baucus (D-Mont.) thinks may be achievable in order to get major segments of U.S. industry to support it. Therefore, we see early elimination of the solar ITC as a casualty of broad tax reform as unlikely.

The Deficit Supercommittee needs to find other reductions if broad tax reform won’t solve the problem, and as such, the early termination of the solar ITC could fit this need. We however view this as unlikely as well for two completely different reasons. The Democrats wholeheartedly support this renewable energy program, and they still have a majority in the Senate and their president sits in the White House. Perhaps more importantly, however, is that early elimination of a tax incentive runs afoul of the “no tax increase” pledge that many Republicans have taken. The Americans for Tax Reform (ATR), a prominent conservative organization, considers the early termination of an incentive as a tax increase – and for this reason opposed the early termination of the volumetric ethanol excise tax credit this spring, in spite of a 73-27 vote in the Senate to terminate it early1. Failure to extend a program concluding naturally, however, does not run afoul of the ATR pledge. In a strange twist of fate, we do not view the solar ITC (or the renewable energy production tax credit (PTC)) as significantly vulnerable in the Deficit Supercommittee deliberations. It is an extremely unusual situation, but it bodes positively for continuation of the incentive.

On Other Hand, Sec. 1603 Cash Grant Extensions Look Difficult
The conversion of the PTC to an ITC and the conversion of ITCs into a cash grant has been a big boon for both wind and solar projects. Since the finalization of the Internal Revenue Service rules required by the 2009 American Reinvestment & Recovery Act (2009 ARRA or Stimulus) in mid-2009, solar electric and solar thermal projects have claimed $1.3 billion of the $8.5 billion (15%) of the grants awarded between September 2009 and mid-August 2011. However, the overall program’s cost to the U.S. Treasury significantly exceeded the initial projections. When the program was first created in the 2009 ARRA, it was projected to be a wash with the assumptions made to extend the PTC and ITC programs through their current expiration dates. The single-year extension of the Sec. 1603 cash grant program in last year’s tax extenders bill, however, was deemed to represent an additional tax expenditure by the Treasury of $2.9 billion.

Renewable energy advocates have been working Capitol Hill aggressively this summer to make the case that legislators interested in fostering job growth should support another extension of the Sec. 1603 program. We understand that both Republicans and Democrats have been sympathetic to the case, but the ugly reality remains: if the Joint Tax Committee and the Congressional Budget Office will consider an extension of this program as an additional burden to the U.S. Treasury, we consider the prospects of another 12-month extension as unlikely. The fact the underlying tax incentives remain – particularly for solar – for several more years plays into Congressional inertia, and a justification for inaction. Why expend the political capital to extend an incrementally expensive program when its conclusion leaves an attractive tax preference in place?

Converting the Loan Guarantee Program to a Clean Energy Bank
Since the 2009 ARRA modifications to the 2005 Energy Policy Act’s Title XVII Innovative Technology Loan Guarantee Program (LGP), many in the renewable energy community have been pushing to convert the program to a Clean Energy Bank, which would be funded once and be able to sustain new loans over time by re-lending the repaid funds. Infrastructure banks do make sense, and the concept has a strong champion in Senate Energy Chairman Jeff Bingaman (D-N.M.). The price tag, however, remains a problem. At $9-10 billion in start-up funding this initiative received no serious consideration beyond the Senate Energy Committee in 2010 and the crowded calendar between now and the end of 2011 provides no hope, in our view, even if the Senate Energy Committee moved it again. It is an idea that resonates with many, but financing it in the current budget environment looks impossible.

In terms of the LGP’s most prominent black eye – Solyndra’s Chapter 11 bankruptcy filing – we’d make a couple of observations. This manufacturing facility was one of the earliest projects ever submitted under Title XVII, and predated the 2009 ARRA funding expansion. The LGP has always assumed some projects would fail – this underpins the higher credit subsidy costs that many applicants complained about – and Solyndra may merely prove that no program bats 1.000%. Setting Solyndra aside, the LGP has many other solar projects in the queue that are not manufacturing but project loans. Will First Solar, Suntech and BrightSource prove to be the successes that validate that the program works?

Will these LGP projects lead to the subsequent rounds of growth and financing through the public markets? We certainly think they can, but the projects are just now moving forward. The successes may only be measurable a few years from now. That timeline doesn’t help justify moving forward with an expensive program now.

Looking Ahead – Are There Other Options?
The Deficit Supercommittee may well recommend that Congress undertake broad tax reform. We’re not expecting that serious work could be consummated prior to the 2012 elections and look ahead for this issue to come back up in 2013. What might that mean for this space?

If the LGP goes into maintenance mode (no new additional funding given budget constraints) and a Clean Energy Bank never materializes (for the same reason), and extending the Sec. 1603 program looks untenable, what might Congress consider instead?

There are a few ideas out there. One is to extend master limited partnership (MLP) treatment to renewable energy projects. This idea was included in the Bipartisan Policy Commission’s spring review of options to foster alternative energy projects. The Congressional Research Service published a June report that specifically explored MLPs as an option as the Sec. 1603 winds down.

In some respects, this would make a great deal of sense, and could be seen as consistent with Congress’ recent moves to extend MLP treatment to pipelines that transport biofuels or carbon dioxide captured from utility and industrial power generators. But one must keep in mind that when it comes to broad tax reform, Democrats seem inclined to put partnerships under corporate tax obligations. Republicans seem less so, but that may also constrain how far Republicans could push a corporate tax rate down.

Another idea was floated by Republicans in the House this year. In “Roadmap for America’s Energy Future” (H.R. 909), Rep. David Nunes (R-Calif.) proposes to take the federal share of oil and natural gas royalties from drilling in new areas of the Outer Continental Shelf (OCS) and the Arctic National Wildlife Refuge (ANWR) and use them to fund a reverse auction for renewable power contracts. In this case, royalty revenues – yet to be received – would be dedicated to a new use. The approach uses the conventional energy sector as a funding source for clean energy development.

While we don’t expect this bill to move this year, this idea may be revived in the future – particularly as PTC/ITC programs get closer to their sunset dates. Democrats generally don’t like the idea of opening up the ANWR or more OCS, but the reverse auction concept intrigued political heavyweight Henry Waxman (D-Calif.) and was not fully rejected. Waxman is the ranking member of the House Energy & Commerce Committee, and his comments on the Nunes approach encourage some to believe there may be other ways to continue support for renewable energy going forward.


1The underlying bill on which this measure was attached failed to move in the House, and the provision has not been enacted.

This is not a complete analysis of every material fact regarding any company, industry or security. The opinions expressed here reflect our judgment at this date and are subject to change. The information has been obtained from sources we consider to be reliable, but we cannot guarantee accuracy.