The Inflation and Reduction Act, macroeconomic factors and an ESG debate are just some of the variables affecting sector growth, and Jon Miller, Director, Tax Equity Capital Markets for Nelnet, dives deep to address said variables.
CCBJ: To start, please tell us about your background and what led you to your role with Nelnet?
I have a background in clean energy finance spanning over 13 years, where I have gained expertise in tax equity and capital markets, particularly in the context of solar projects. I first crossed paths with Nelnet while speaking at a KPMG tax seminar in Omaha, Nebraska. Over the next year or so, we stayed in touch, and when Nelnet decided to launch its own co-investment syndication platform, they approached me to lead it. I jumped at the opportunity, and we've successfully grown it for the last three years and have had record-breaking years ever since I joined.
Please describe some of the broad-stroke issues that should be top of mind for corporate executives as they relate to the financial or other impacts of shifts towards clean energy and the prevalence of ESG-related dialogue.
For corporations and investors looking to enter the clean energy space, there's a tremendous amount of opportunity. Although solar, wind and clean energy in general have been growing by leaps and bounds for the past 10 years, the clean energy sector only accounts for 22 percent of total US electricity generation. And the Inflation Reduction Act passed in 2022 added more fuel to the fire. That bill alone created new and improved tax credits and incentives at the federal and state levels, and funding through federal government loan programs. In short, the industry is rapidly maturing. For investors looking at the space, there are primarily three options available.
One could start their own development company, where you go out and originate the solar or wind asset itself. You find the land, get the interconnection agreement, find a buyer for the power, and then a financial partner usually comes in to assist you in financing the construction. Development offers the greatest return, but also comes with the greatest risk.
Another option is providing capital to developers or becoming a long-term asset owner. You’re investing and acquiring other companies’ development projects or operational projects. Your return here is less than pure play development, but the risk is likewise reduced.
The third option is investing in “tax equity,” or the tax credits generated by clean energy projects. The tax credits on solar and wind projects, and on all clean energy technologies nowadays, are a very important piece to getting these projects financed. Most developers and long-term project owners lack sufficient tax liability to take advantage of the amount of credits produced by their projects, and so they turn to corporate tax-payers to monetize the credits for them. For a tax equity investor, in exchange for their investment, they receive tax credits, cash, and depreciation benefits from the ownership of the project.
The risk-return profile on tax equity is tremendous, as you can often receive above average returns with comparatively little risk. Tax equity investments are tailored to meet the specific needs of the investor; and because tax equity is the scarcest source of funding in the capital stack, tax equity typically has considerable leverage when negotiating the terms of their investment.
Specifically, what can you tell us about newly passed GAAP guidance allowing clean energy tax equity investments to use proportional amortization?
This one is huge! In March of this year, the FASB issued ASU 2023-02, which expands the universe of tax equity investments that may elect to apply the proportional amortization method of accounting. The ability to apply proportional amortization removes a layer of complexity from the GAAP accounting for tax credit transactions. Previously, renewable energy tax equity investments typically had to show a large loss “above the line” in their EBITDA, and then a large tax benefit “below the line”. This mismatch caused many publicly traded companies to back away from these investments. But now, under proportional amortization, a lot of the “noise” is removed, and everything is shown on a net basis in the income tax expense (benefit) line.
Having the ability to use this new form of accounting will bring quite a few corporations who passed on tax equity investments before due to the accounting complexity back into the fold. Due to specific facts and circumstances of each investor though, consulting with experienced professionals and accountants on the applicability of proportional amortization is prudent.
What are some of the new features that have been introduced by the Inflation Reduction Act which was passed last year?
As for issues that are top of mind for clean energy participants, the hottest topic right now is the Inflation Reduction Act of 2022 (IRA) that was passed last year, which created almost $400 billion in tax incentives for clean energy projects and technologies. Many of the incentives are still waiting on Treasury and IRS guidance to clarify some of the rules. A key feature of the IRA is that it covers multiple clean energy technologies. As long as a project is a net zero emitter of pollution, the technology is eligible for these tax incentives, mainly through tax credits. So what used to be mainly limited to solar, wind, and a handful of other technologies, are now available to a myriad of new technologies, such as standalone battery storage projects to help grid operators manage the supply and demand of energy on their systems.
There is a large volume of different incentives in the bill, too many to cover in this interview. But, I’ll try to hit on some of the more important ones.
First, the main tax credit programs (the Investment Tax Credit and the Production Tax Credit) have been extended for a minimum of 10 years and most likely longer. This is going to provide certainty and scale to the industry.
Second, the amount of tax credits that a clean energy project can generate has gone way up. The base credit, in terms of the investment tax credit, is 30% (assuming the project is below a certain size or meets prevailing wage and apprenticeship standards), but now there are bonus credits available that when aggregated could bring the credit all the way up to 70% of the project’s cost.
Third, instead of having to be an investor in the underlying project to receive the tax credits, there is now the option of just selling the tax credit to a buyer via a purchase and sale agreement. This has the potential to remove a lot of deal structure complexity and streamline the monetization of the tax credits.
For the aforementioned reasons, the IRA is a hot topic—and will remain so as the Treasury and the IRS crank out guidance on an almost biweekly cadence to address the law’s many provisions needing interpretation.
Please share your observations about the macroeconomic conditions effecting the clean energy industry.
Another topic of conversation these days is how macroeconomic conditions are negatively affecting the clean energy space. The banking liquidity crunch is drying up credit that's long been available to renewable energy developers and investors. With the recent Fed rate hikes and bank failures, banks are tightening their belts and increasing their interest rates, which is making projects less profitable for long-term owners, as well as increasing their underwriting standards, which is drying up credit into the space.
While the IRA has created a considerable momentum and excitement in the space, the bank liquidity crisis and rising interest rates have put a damper on the clean energy industry over the last three months or so. I’m a firm believer these challenges are only short term and will sort themselves out. We expect the sector’s compound annual growth rate, which has averaged 10 to 15 percent over the past 10 years, to continue at that pace, if not accelerate a bit more.
How are Nationwide Interconnection queues inhibiting clean energy growth?
We have to remember that the US electric grid was not originally designed to accommodate large-scale renewable energy projects, and as a result, the infrastructure needed for interconnection is often insufficient or outdated. The interconnection queues to get clean energy projects approved and hooked up to utility grids is another key issue for developers and investors right now. By some accounts, there are over 10,000 renewable energy projects at the moment across the U.S. looking to get interconnected and approved. The average wait time for a project to get through the interconnection process is five years, substantially longer than it was in the not-too-distant past, when it was one to three years, or even less in some areas. This is particularly concerning as the federal, state, and local governments have published their intentions to hit clean energy mandates in the near future. If these interconnection queues stay at their current levels, it's going to be extremely difficult to hit those mandates. Also, if a project is delayed and cannot be completed in time to take advantage of favorable financing and incentive programs, or if a developer is required to fund significant grid upgrades as a condition to getting a project interconnected, it may no longer be financially viable to build it.
How is ESG impacting investments from state pension funds and other institutional investors?
The last hot topic I’d like to discuss is the ESG backlash we're seeing of late. Several years back BlackRock CEO Larry Fink, in an annual letter to CEOs of companies BlackRock held in its portfolio, basically said, "You need to immediately start incorporating and factoring ESG analysis into your business strategy and address these issues to prove that you're insulated from ESG risks." While companies were already seeing the positive benefits of ESG, Larry was the first to really make it known that companies were now on alert to disclose ESG factors in their annual filings and describe what they’re doing to mitigate ESG risk and create positive impact for people, communities, and the public.
But what started as a wake-up call resulted in a cultural and political flashpoint, and we're starting to see groups saying it’s not a relevant investment factor that fund managers and underwriters should be analyzing; that there's no direct correlation between ESG issues and financial return and risks.
Recently, the largest state pension fund in Florida removed $2 billion of assets under management from BlackRock over these ESG issues. Texas is doing the same with some of its mandates that fund managers that sell services to some of their public pension institutions take ESG out of the equation. I believe it will be two to five years before the ESG debate sorts itself out. I would note that European countries have already embraced ESG and know the financial benefits and risk-mitigating factors that it can bring to companies and investors.
This article is for informational purposes only, and the writer’s views are his own and do not constitute legal, tax, accounting, investment or other professional advice. You should consult your professional adviser for legal or other professional advice. Nothing herein should be construed as, and may not be used in connection with, an offer to sell, or a solicitation of an offer to buy or hold, an interest in any security or investment product, and nothing herein is to be construed as a recommendation to buy or sell any security or class of securities. Investments in investment products managed by Nelnet Renewable Energy are available only to qualified, “accredited investors,” as such term is defined in federal securities laws.
Published May 30, 2023.
