Tax Reform and Renewable Energy: The Implications for Project Developers and Renewable Energy Costs

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Eric Selmon Hugh Wynne

Office: +1-646-843-7200 Office: +1-917-999-8556

Email: eselmon@ssrllc.com Email: hwynne@ssrllc.com

SEE LAST PAGE OF THIS REPORT FOR IMPORTANT DISCLOSURES

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December 19, 2017

Tax Reform and Renewable Energy:

The Implications for Project Developers and Renewable Energy Costs

From the perspective of the renewable energy industry, the key elements of the final Conference Committee tax bill now moving through Congress are (i) the maintenance of the current tax code’s provisions regarding the level and the phase-out over time of renewable energy tax credits, (ii) a cut in the corporate tax rate from 35% to 21%, and (ii) an increase in bonus depreciation from 50% to 100% and its extension through 2022, after which it will be phased out over the following five years (see Exhibit 2). The impact could have been much worse; several provisions that would have reduced renewable energy tax credits, or materially curtailed their value to tax equity investors, were removed in the final version of the bill (see Exhibit 3).

As a result, we calculate that the power prices required under 20-year power purchase agreements to justify investment in new wind and solar projects will be significantly higher under the Conference Committee tax bill than under the current tax code: we expect 2018 solar PPA prices to be up 3% to 13%, and wind PPA prices to be up 5% to 20%, depending on the tax status of the developer (Exhibits 4 & 5). Thereafter, expected declines in the installed cost of utility scale wind and solar projects, and anticipated improvements in the capacity factor of wind turbines, are expected to drive PPA prices down. We estimate that 2020 solar PPA prices will be up 3% to down 7% relative to those expected in 2018 under the current tax code, while 2020 wind PPA prices should be up 5% to down 8% — implying little net change from current levels (Exhibits 6 & 7). However, the drop in the investment tax credit for solar to 10% in 2022, combined with the phase-out of bonus depreciation commencing in 2023, will cause the decline in solar PPA prices to stall. For wind, the long-term outlook is far worse: the expiry of the production tax credit in 2020, combined with the phase-out of bonus depreciation, will cause wind PPA prices to spike: by 2024, we estimate that wind PPA prices will be 42% to 85% higher than the levels anticipated for 2018 under the current tax code.

The phase-out of the production tax credit for wind from $24/MWh in 2017 – equivalent to ~50% of the unsubsidized cost of wind — to zero in 2020 will have a much greater impact on the levelized cost of wind energy than the reduction in the investment tax credit from 30% today to 10% in 2022 will have on the levelized cost of solar. The implication is that the relative cost of the two energy sources will shift markedly: under the Conference Committee bill, we estimate the 2018 PPA price of wind (~$24/MWh) to be only 48% of that for solar (~$50/MWh); by 2024, we expect the PPA price of wind to have increased to ~$37/MWh, or 81% of the price of solar ($46/MWh) (Exhibit 8). More importantly, we expect the levelized cost of energy from wind – which, at $20/MWh under the current tax code, is now competitive with round-the-clock power prices in the windiest regions of the country — to have risen by 2024 to a level some 75% above the round-the-clock price of power in these regions. Rather than penetrating power markets on the basis of its lower price, wind energy will once again require the support of PPAs with utilities operating under state renewable energy mandates or corporations voluntarily seeking to increase their use of renewable energy, if it is to grow. Developers competing for these contracts in regions with strong solar resources, moreover, will find the relative cost of wind vs. solar will be far less attractive.

For developers reliant on tax equity and tax equity investors, the Base Erosion Anti-Abuse Tax (BEAT) provision is also important, as it will create uncertainty among tax equity investors as they figure out the impacts. For companies with payments to related foreign entities that exceed 3% of deductible expenses, the BEAT provision could limit use of ITCs and PTCs to only 80% of their value through 2025 and 0% thereafter. This could impact many tax equity investors and some large corporate investors in renewables, such as Google. We analyzed three potential scenarios for how the tax equity markets might react and discuss them in greater detail in the Portfolio Manager Summary below. The least impactful would be an increase in the required IRR for tax equity investments – we estimate that a 100bps increase would increase the required price for solar PPAs by less than 1% and for wind PPAs by ~3%. The worst case scenario would be the inability of some developers to obtain tax equity, increasing their required PPA by 50% for solar projects and more than 100% for wind projects, making them uneconomic.

Portfolio Manager’s Summary

Solar:

  • While the 2018 PPA prices required to justify investment in new solar projects will be higher under the Conference Committee tax bill, we expect the installed cost of solar will continue to decline over the coming decade, pushing solar PPA prices in 2020 and 2024 down to levels broadly similar those prevailing today under the current tax code.
    • We expect ongoing declines in the installed cost of solar power plants, which we see falling at a 6.2% CAGR through 2024 from 2016, to offset the 20 percentage point drop in the ITC and the phase out of bonus depreciation.
    • As a result, the solar PPA prices required under the Conference Committee bill would be broadly similar (in constant dollars) in 2020 (up 3% to down 7%, depending on the tax status of the developer) and 2024 (up 4% to down 8%) to those prevailing today under the current tax code. (See Exhibits 4 and 5.)
      • More aggressive forecasts see solar declining at a CAGR of >8% through 2024, potentially hitting $0.80/W in 2020 and <$0.70/W by 2024, which would reduce our estimates of required PPA prices by ~15%. However, this assumes a limited and temporary impact from Section 201 tariffs on solar imports.
  • Importantly, we expect the PPA price of solar to remain substantially above the average 2018 on-peak forward price of power at key hubs in the sunniest regions of the country (see Exhibit 5), implying the need for continued support from above-market PPAs — even if installation costs fall as fast as the most optimistic forecasts suggest.
  • We therefore expect no fundamental change in the drivers of and outlook for solar development: solar development will likely continue to depend on state renewable portfolio standards and above market contracts with firms, such as Google, seeking to increase their use of renewable energy.

Wind:

  • By contrast, we expect wind development to be materially adversely affected by the phase-out of the production tax credit in 2020. (See Exhibits 6 and 7).
    • Relative to the PPA price required to justify development of a new wind project in 2018 under the current tax code, the PPA prices required under the Conference Committee bill (measured in constant 2017 dollars) could be some 42% to 86% higher in 2024.
    • At these levels, PPA prices for new wind projects, which today we estimate are often competitive with round-the-clock power prices in the windiest regions of the country, will likely rise 75% above market prices by 2024. (See Exhibit 7.)
    • Wind development will therefore require the support of above market PPAs. PPA prices for new wind projects, which we estimate today to be half the PPA price for solar under the current tax code, may rise to levels just 15%-20% below solar PPA prices by 2024. (See Exhibit 8).
  • We therefore expect wind power to lose its current status as a renewable resource that is increasingly cost-competitive with wholesale power prices, and once again to become dependent, like solar, on state renewable portfolio standards and above market contracts with firms such as Google – materially limiting its prospective growth post-2020.
  • Relative to solar, moreover, the cost advantage of wind will be materially eroded, rendering it less attractive in regions where both resources are abundant, even in the context of requests for proposals put out by utilities facing state renewable mandates.

Impact on the Market for Tax Equity

  • While the reduction in tax rates would potentially reduce the tax appetite of existing tax equity investors, we do not expect this to have a material impact on the availability of tax equity. Currently, corporations’ appetite for tax equity appears to exceed the available supply, and new tax equity investors are entering the market.
  • More importantly, the Conference Committee bill introduces a Base Erosion Anti-Abuse Tax (BEAT) that could adversely affect the market for tax equity.
    • The aim of the base erosion tax is to prevent multinational companies from reducing their US taxes by “stripping” their U.S. earnings by making payments to foreign affiliates. Companies trigger the base erosion tax if more than 3% of their U.S. tax deductions are due to payments to related foreign parties.
    • Such companies would be subject to the claw back of 20% of the renewable tax credits claimed during the period 2018 through 2025. Credits claimed after 2025 could be fully clawed back.
    • BEAT thus limits the value of solar ITCs and in particular the 10-year wind PTC, which otherwise would be available to new projects well beyond 2025, to companies that may be subject to the tax.
  • It is difficult to estimate precisely the economic impact of BEAT on the PPA price of wind and solar as we do know yet how the tax equity market will react to its provisions. We can, however, frame the potential implications:
    • In a worst-case scenario, where a developer that is unable to absorb the tax benefits of renewable energy projects cannot access the tax equity market due to BEAT – and therefore cannot monetize the renewable energy credits — we estimate that the 2018 PPA price required to recover the cost of a new solar project could be $78/MWh, over 50% above that under the current tax code. For a wind project, the impact could be much worse, with its PPA price more than doubling from current levels to ~$50/MWh. Such projects, therefore, would likely not be built.
    • On the other hand, if the reaction in the equity market were limited to a 100 basis point increase in the cost of tax equity (say from 7.0% to 8.0% p.a.), we would expect the impact to be de minimis, increasing the PPA price of solar by less than 1% going forward and by ~3% for wind projects.
    • An intermediate outcome is that BEAT would cause investors to offer tax equity only for 80% of the value of wind production tax credits through 2025.[1] This would increase the PPA price of wind by 48% to ~$35/MWh in 2018 and by 35% to ~$32/MWh in 2020, dramatically reducing the attractiveness of such projects.
  • Most vulnerable to the impact of BEAT would be independent developers unable to absorb the tax benefits of renewable energy credits and therefore heavily reliant on the tax equity market to monetize these benefits. Regulated utilities and corporations that can take advantage of renewable energy credits internally, and that do not rely on tax equity, would not be at risk.
    • We note, however, that many of the most active corporate investors, such as Google and Apple, would be subject to BEAT and would thus see an increase in the risk of investing in renewable projects due to their potential inability to use the tax credits.

Company Impacts

  • Absent a significant change in approach by tax equity investors due to BEAT, we do not see a major impact on current expectations for renewable development through 2024.
  • Within our universe, NextEra, Avangrid and Southern have planned the largest development of unregulated renewable generation capacity over the next few years (estimated at 3% to 5% of market cap annually), followed by AEP, ConEd, and Duke (1% to 2% of market cap).
    • A number of companies in our universe are also planning significant construction of regulated renewable generation capacity at their utilities, such as AEP, CMS and XEL. We do not see the tax changes having a significant impact on their projects.
  • Among publicly traded renewable companies, the module manufacturers, particularly those with development arms, such as Canadian Solar, First Solar and SunPower, have the greatest exposure to utility-scale solar development. TPI Composites and Vestas are among the most exposed to utility-scale wind development.

Exhibit 1: Heat Map: Preferences Among Utilities, IPP and Clean Technology

Source: FERC Form 1, company reports, SNL, SSR analysis

Exhibits

Exhibit 2: Key Elements of the Conference Committee Tax Bill

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Source: Conference Committee Report on the proposed amendment to H.R. 1; Keith Martin, Norton Rose Fulbright, Final US tax bill: effect on project finance market, Dec. 13, 2017.

Exhibit 3: Key Provisions of the House and Senate Tax Bills Eliminated from the Conference Committed Bill

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Source: Conference Committee Report on the proposed amendment to H.R. 1; Keith Martin, Norton Rose Fulbright, Final US tax bill: effect on project finance market, Dec. 13, 2017.

Exhibit 4: Percentage Increase in Estimated Solar PPA Price Under the Final Tax Bill, as Compared to the Estimated 2018 PPA Price Under the Current Tax Code

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Source: Conference Committee Report on the proposed amendment to H.R. 1; Lawrence Berkeley National Laboratory, Utility Scale Solar 2016National Renewable Energy Laboratory, U.S. Solar Photovoltaic System Cost Benchmark: Q1 2017, SSR estimates and analysis

Exhibit 5: Estimated Solar PPA Price Under Current Tax Code and Final Tax Bill (Expressed in Constant 2017 Dollars) Compared to Average 2018 On Peak Forward Power Prices in WECC

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Source: Conference Committee Report on the proposed amendment to H.R. 1; Lawrence Berkeley National Laboratory, Utility Scale Solar 2016; National Renewable Energy Laboratory, U.S. Solar Photovoltaic System Cost Benchmark: Q1 2017; SSR estimates and analysis

Exhibit 6: Percentage Increase in Estimated Wind PPA Price Under the Final Tax Bill, as Compared to the Estimated 2018 PPA Price Under the Current Tax Code

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Source: Conference Committee Report on the proposed amendment to H.R. 1; Lawrence Berkeley National Laboratory, Wind Technologies Market Report, 2011-2016; SNL; SSR estimates and analysis

Exhibit 7: Estimated Wind PPA Price Under Current Tax Code and Final Tax Bill (Expressed in Constant 2017 Dollars) Compared to Average 2018 ATC Forward Power Prices in ERCOT and SPP

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Source: Conference Committee Report on the proposed amendment to H.R. 1; Lawrence Berkeley National Laboratory, Wind Technologies Market Report, 2011-2016; SNL; SSR estimates and analysis

Exhibit 8: Estimated Average Wind and Solar PPA Prices Under the Current Tax Code and Final Tax Bill (Expressed in Constant 2017 Dollars), and the Ratio Between Them

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Source: Conference Committee Report on the proposed amendment to H.R. 1; Lawrence Berkeley National Laboratory, Utility Scale Solar 2016; National Renewable Energy Laboratory, U.S. Solar Photovoltaic System Cost Benchmark Q1 2017 Report; Lawrence Berkeley National Laboratory, Wind Technologies Market Report, 2011-2016; SSR estimates and analysis

Exhibit 9: Solar Investment Tax Credit (1) Exhibit 10: Bonus Depreciation
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1. The current IRS definition of start of construction allows a project to qualify for the level of tax credits in a particular year if the project incurs 5% of total project costs in that year and complete construction within four years.

Source: Internal Revenue Service; Consolidated Appropriations Act, 2016

Exhibit 11: The Production Tax Credit for Wind ($/MWh)

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Source: Internal Revenue Service; Consolidated Appropriations Act, 2016

Exhibit 12: Estimated Historical and Assumed Future Installed Cost of Utility Scale Solar PV Projects ($/Watt DC)

______________________________________________________________________________Source: National Renewable Energy Laboratory, U.S. Solar Photovoltaic System Cost Benchmark Q1 2017 Report; SSR estimates and analysis

Exhibit 13: Estimated Historical and Assumed Future Installed Cost of Wind Projects ($/Watt AC) and Capacity Factors (%)

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Source: Lawrence Berkeley National Laboratory, Wind Technologies Market Report, 2011-2016; SSR estimates and analysis

©2017, SSR LLC, 225 High Ridge Road, Stamford, CT 06905. All rights reserved. The information contained in this report has been obtained from sources believed to be reliable, and its accuracy and completeness is not guaranteed. No representation or warranty, express or implied, is made as to the fairness, accuracy, completeness or correctness of the information and opinions contained herein.  The views and other information provided are subject to change without notice.  This report is issued without regard to the specific investment objectives, financial situation or particular needs of any specific recipient and is not construed as a solicitation or an offer to buy or sell any securities or related financial instruments. Past performance is not necessarily a guide to future results.

©2017, SSR LLC, 225 High Ridge Road, Stamford, CT 06905. All rights reserved. The information contained in this report has been obtained from sources believed to be reliable, and its accuracy and completeness is not guaranteed. No representation or warranty, express or implied, is made as to the fairness, accuracy, completeness or correctness of the information and opinions contained herein.  The views and other information provided are subject to change without notice.  This report is issued without regard to the specific investment objectives, financial situation or particular needs of any specific recipient and is not construed as a solicitation or an offer to buy or sell any securities or related financial instruments. Past performance is not necessarily a guide to future results.

  1. We do not expect such an impact on solar ITCs as they are received and thus easier for tax equity investors to plan for and accommodate. 
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