Norton Rose Fulbright’s Keith Martin answers our questions on tax equity and the wind market after PTC sunsets
As the wind industry prepares for the PTC phaseout, questions remain on how the tax equity market will fare post 2020, if and how the debt-to-equity ratio will change in future wind projects, how will bonus deprecation rules be affected, and more. We asked wind expert Keith Martin, Co-head of Projects, US from NORTON ROSE FULBRIGHT, to give us his take on how the financial structure of wind financing will change or be affected by the upcoming PTC phaseout.
After production tax credits for wind end, what kind of financial structure or wind financing do you foresee in the future?
Keith Martin: Wind projects will fall back on a combination of debt and equity. Tax equity can be seen as a form of debt where the financing party is willing to be repaid partly in cash and partly in tax benefits. Five-year depreciation is probably not enough by itself to make tax equity viable.
How will the debt-to-equity for wind projects change after PTC is phased-out?
KM: Debt service coverage ratios for wind projects are currently 1.4x at P50 numbers. This determines how much debt can be raised against a project. The rest will be equity or some combination of equity and mezzanine debt that is a form of preferred equity. It costs less than true equity because it is paid first.
We’ve been hearing a lot on bonus depreciation rules lately. Can you expand on bonus deprecations rules? How does that impact modeling?
KM: The US allows the full cost of a wind farm to be deducted in the year the project is put in service. This is called a 100% depreciation bonus. Most wind farms are financed currently in the tax equity market using a partnership flip structure where the wind developer and a tax equity investor own the project as partners. Each partner in any partnership has a “capital account” and an “outside basis.” These are two ways of tracking what each put into the partnership and is allowed to take out. When either metric hits zero, certain things happen. A partner’s capital account is basically the equity the partner has in the project.
In the typical wind project, the tax equity investor pays something like 55% of the capital cost of the project for an interest in it. This is his opening capital account. Capital accounts are a fluid concept. They go up as the investor puts more money into the deal or has to report a share of taxable income from electricity sales. They go down as the investor pulls out benefits: cash distributions and tax losses like depreciation.
A capital account that is 55% of the capital cost of the project does not leave enough room to give the investor a deduction for 100% — or even 99% — of the capital cost. Once the investor’s capital account hits zero, the remaining depreciation shifts largely to the developer.
How has the 2017 tax reform affected the willingness of tax equity investors within the wind industry to finance 80% or 60% projects?
KM: Tax reform reduced the value of the tax benefits on wind farms. Therefore, less tax equity can be raised against these tax benefits. There are two tax benefits. They are tax credits and depreciation. The reduction in the corporate income tax rate from 35% to 21% reduced the value of the depreciation, but did not affect tax credits. The tax benefits used to be worth something like 56 cents per dollar of capital cost in the typical wind farm. They are worth something like 44 cents after tax reform. How much tax equity can be raised is a function not only of the value of the tax benefits, but also of other factors like what share of cash the partnership gives the tax equity investor.
What will the tax equity market look like after 2020?
KM: There will still be an active tax equity market. There will be new wind farms going into service that still qualify for tax credits, albeit at reduced rates, through 2024 and possibly longer. Solar projects will qualify for investment tax credits of 22% to 30% through 2023 and of 10% after 2023. The 10% investment tax credit for solar is permanent. In addition, Congress could extend the deadlines for offshore wind farms to qualify for credits and provide a tax credit for energy storage facilities.
Don’t miss your chance to hear the latest federal and state developments and tax issues affecting the wind industry from Keith Martin at Wind F&I 2019 in sunny San Diego, CA.
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