Investors debate linkage between potential higher corporate tax rates and overall tax equity availability

Despite significant challenges in the tax equity market throughout the latter half of 2020, including lingering availability issues that continue to persist, 2020 remained a strong year for a renewables industry bolstered by the explosion of the corporate PPA market and a strong lending environment. In fact, the overall market is going through such a period of growth that CohnReznick Capital Senior Managing Director Connor McKenna referred to the start of a new era for renewable energy finance during a UT Law conference last week.

“We’re going into another phase here, which is the continued maturation of this market as we look at greater scale and greater opportunity,” McKenna said.

But with that increased scale comes new challenges in a tax equity market that is already seeing widespread shortages, particularly for mid-sized and smaller developers.

“As renewable projects get larger, the need for tax equity increases,” Stonepeak Infrastructure Partners Managing Director William Demans explained. “Typically, tax equity providers are not comfortable committing tax equity for more than 12 months in advance, but these construction timelines are ballooning to 18 to 24 months. This makes securing tax equity even harder. It’s a major challenge.”

“The good news is, offsetting the complications of the tax equity market is a really strong debt market,” McKenna added. “We’re seeing a significant amount of capital looking to be deployed on the debt side in the U.S. This is creating significant market competition leading to creative and constructive approaches to financing some of these projects. Those seeing it from a cash perspective are seeing the value and providing the necessary capital.”

Additionally, even as the tax equity market currently struggles to keep up with record demand, industry vets like Demans and McKenna are finding encouraging signs on the horizon that contradict previous predictions that the tax equity industry was on its way out of relevance. Demans says the two-year solar ITC extension passed in the omnibus spending bill at the end of 2020 is particularly “critical” for getting tax equity back on track.

“As an equity investor, we often feel quite beholden to the uncertainty around tax equity,” Demans said. “So to have an extension that gives us runway to make complete investment decisions is a boon for the industry that should help to continue to build out solar and wind.”

“Having another two years of knowing exactly what your capital stack looks like is really important for investors,” McKenna agreed. “You can’t overstate how important this is for the strength of the market going into this year.”

Beyond the solar ITC extension, however, there is a potentially even more important policy position from the Biden Administration that could lead to an even greater focus on tax equity in the years ahead: higher corporate taxes which should cause corporation tax capacity to balloon and drive an increase in tax equity availability in the market.

“Higher corporate tax rates ironically have a positive benefit toward renewable energy specifically in terms of the availability of tax equity,” Demans said.

In order to take advantage of the potential for a higher volume tax equity market, industry lobbyists have been focused on pushing for the establishment of a standalone storage ITC to help bolster a technology that is increasingly being designated as vital for the grid as more renewables are added each year. However, even without its own tax credit, Demans says that utilities in places like California and Massachusetts are already driving investor interest in the space through monthly capacity contracts.

“Energy storage is really starting to grow in the current market,” Demans said. “Historically, the revenue was monetized through merchant market opportunities, but, increasingly utilities, especially in California, are starting to understand the value of storage and are offering monthly capacity contracts to projects that work almost like a lease. That is a highly financeable contractual structure that lenders are just eating up.”

Market driven trends like these capacity contracts and the booming corporate PPA market in states like Texas are expected to continue to drive the industry forward with or without significant policy assistance on the federal level. In fact, even as McKenna supports federal policy moves like the solar ITC extension and the establishment of a storage ITC, he cautions that these policies take time to implement and that, for the time being, the industry will continue to be dictated by natural market trends.

“There has been a tremendous focus on policy for renewable industry, but the changing of the administration is not a watershed moment,” McKenna said. “At the end of the day, we have to recognize that while policy is important, the implementation and actual follow through takes time.”