Financial incentive overview As touched upon as part of this study s technology evaluation, favorable tax and other financial incentives are a significant catalyst to the growth of biogas end-use technologies. Financial incentives for renewable energy projects include various tax credits, accelerated depreciation tax benefits, feasibility and/or implementation grants, project development assistance, special utility tariffs to support renewable energy, and other state and utility driven benefit programs. The ability to identify viable sources of financial assistance can significantly improve project economics and may ultimately determine the success of a renewable energy business plan. For most processors, addressing a by-product issue isn t typically considered the most optimal use of their capital in today s climate. Investing and expanding the scope of non-core operations is an uncomfortable proposition for management these investments don t typically support sufficient returns to warrant them compared to core businesses. This makes a model of nontraditional financing, leveraging as many credits and incentives as possible, an attractive option more often than not. These avenues are often underutilized, but, when able to be accessed and structured properly, can lower a company s financing costs, increase investment returns, and enhance cash flow. Processors are able to expand manufacturing capacity, including by-product management capabilities, more affordably by using tax credits municipalities cannot given their tax-exempt status. Those municipalities can then be relieved from having to pursue bonding to help fund POTW improvements to handle the additional capacity. For processors, the responsibility for by-product management and its accompanying costs is theirs either way. A strategic look at financing options, potentially incorporating credits and incentives, simply puts more bottom-line control in their hands. Page 51
Renewable energy tax credit overview Production tax credit (PTC) Originally established by the 1992 Energy Policy Act, the PTC provides tax credits for each megawatt hour (MWh) of electricity a qualifying project generates. For each MWh produced, the renewable energy project s owner receives a tax credit that can be applied directly to its tax bill. The PTC incentive is production-based the more hours a project produces power and the more MWh it produces, the more credits it generates. The credit applies only to the first ten years of the project s life, but adjusts to keep pace with inflation. Today that credit is roughly $11/MWh for open-loop biomass or waste-to-energy projects, as demonstrated in the table below. Figure 25. Production tax credit by renewable energy resource Resource Type In-Service Deadline Credit Amount (2011) Wind 12/31/2012 2.2 /kwh Closed-Loop Biomass 12/31/2013 2.2 /kwh Open-Loop Biomass 12/31/2013 1.1 /kwh Geothermal Energy 12/31/2013 2.2 /kwh Landfill Gas 12/31/2013 1.1 /kwh Municipal Solid Waste 12/31/2013 1.1 /kwh Qualified Hydroelectric 12/31/2013 1.1 /kwh Marine and Hydrokinetic (150 kw or larger) 12/31/2013 1.1 /kwh For reference, closed-loop biomass systems are characterized by production of biomass feedstock exclusively for the generation of renewable energy, whereas open-loop projects utilize waste by-products from other processes. Page 52
Investment tax credit (ITC) The ITC is equal to a percentage of the project s qualified capital expenditure and is not linked to production. The ITC is generally set at 30% of qualified capital expenditures; however, certain facilities can only earn a 10% credit. In order to utilize the ITC, projects have to be placed in service by specific dates currently identified as follows: Figure 26. ITC percentage of eligible costs by renewable energy project type Energy Property by Resource Type In-Service Deadline Applicable Percentage of Eligible Costs Closed-loop Biomass 12/31/2013 30% Open-loop Biomass 12/31/2013 30% Geothermal under IRC 45 12/31/2013 30% Landfill Gas 12/31/2013 30% Trash 12/31/2013 30% Qualified Hydropower 12/31/2013 30% Marine and Hydrokinetic 12/31/2013 30% Solar 12/31/2016 30% Geothermal under IRC 48 12/31/2016 10% Fuel Cells 12/31/2016 30% Microturbines 12/31/2016 10% Combined Heat and Power 12/31/2016 10% Small Wind 12/31/2016 30% Geothermal Heat Pumps 12/31/2016 10% Large Wind 12/31/2012 30% Tax credit incentives require a project owner to have a tax appetite, or need, to derive value. Historically, many developers could not easily use tax credits because they did not have significant tax liabilities to offset. Third-party tax equity providers emerged to fill this gap by investing in projects primarily for the tax benefits, rather than cash distributions from operations. These tax credit investors realized a return on investment through tax credits, along with additional tax benefits from realizing losses associated with accelerated depreciation practices known as the Modified Accelerated Cost Recovery System (MACRS). Page 53
MACRS allows tangible property to be depreciated on an accelerated basis according to a detailed schedule specified by the Internal Revenue Service. For example, anaerobic digesters can be considered seven-year property and depreciated over the course of eight years (Figure 27). The non-cash impact of increased depreciation expenses in the early years of a project allow the project to generate significant losses from a tax standpoint, while remaining healthy from a cash flow perspective. Such losses, when taken on by an investor with significant profits from other business interests, may derive value by decreasing the company s overall profitability and subsequent tax liability. Figure 27. MACRS depreciation schedule for biogas projects Yr 1 Yr 2 Yr 3 Yr 4 Yr 5 Yr 6 Yr 7 Yr 8 MACRS 14.29% 24.49% 17.49% 12.49% 8.93% 8.92% 8.93% 4.46% MACRS + bonus 57.145% 12.245% 8.745% 6.245% 4.465% 4.460% 4.465% 2.230% In addition to MACRS benefits, the Economic Stimulus Act of 2008 included a 50% first-year bonus depreciation provision for qualified renewable energy systems placed into service in 2008. This was extended for 2009 and 2010, and in December 2010, increased to 100% firstyear bonus depreciation for qualified renewable energy projects placed in service before January 2012. Bonus depreciation is still available in 2012, but reverted from 100% to 50% of the eligible basis. The global financial crisis vastly reduced the demand for tax credit investments, as banks no longer forecasted profits and tax credit need. Because this key driver of renewable energy projects had essentially disappeared, development of new projects slowed dramatically. To address this financing gap, Section 1603 of the American Recovery and Reinvestment Act (ARRA) allowed facilities to opt for a cash grant from the US Department of Treasury in lieu of the 10%/30% ITC. The cash grant was applicable for all projects placed in service in 2009-2011, as well as those that began construction in 2009, 2010, or 2011. Approximately $11.9 billion of 1603 grants had been awarded to various renewable energy projects as of June 8, 2012. 32 Feedstock eligibility for dairy and cheese waste can typically fall into one of two categories under Section 1603: open-loop biomass, as defined in Section 45[c][3]; or municipal trash, as defined in Section 2(27) of the Solid Waste Disposal Act (42 USC 6903). With the above being understood, the key component to securing the 1603 grant (assuming a project met safe harbor) or the ITC is the production of electricity. Figure 28 attempts to demonstrate this important distinction, using a municipal solid waste (MSW) project as a proxy, with a project perspective first without renewable energy generation and then with renewable generation included. Note: feedstock from cheese processing could be interpreted as MSW. As long as the investments were qualified as eligible 1603 grant costs, increasing the project budget by adding renewable generation could reduce the overall capital requirements of the project sponsor. 32 www.treasury.gov/initiatives/recovery/pages/1603.aspx Page 54
Figure 28. Section 1603 grant opportunity example Expansion without 1603 Grant or Investment Tax Credit On-site Off-site Dairy Plant $4 M Taxable Entity - - - - - - - - - - Anaerobic Treatment $5 M Taxable Entity = Cost goes up for dairy plant $9 M Total Project Spend = All assets Non-Eligible Expansion with 1603 Grant or Investment Tax Credit On-site Dairy Plant $4 M Anaerobic Treatment $5 M Engine $1 M - - - - - - - - - - - - - Taxable Entity Now $10M spend has up to $6M eligible for 30% 1603 Grant or Investment Tax Credit = $1.8M grant or tax credit potential Reduces potential project net costs from $10M down to approximately $8M With the expiration of the 1603 program, renewable energy projects must again look for tax credit investments as a primary financing strategy. The US Partnership for Renewable Energy Finance (US PREF), a program of the American Council on Renewable Energy (ACORE), conducted its own study on the historical and projected size of the US tax equity market. 33 The US PREF analysis concluded that tax equity investment demand for project financing will continue to outweigh supply of available tax equity from established investors. 33 US Partnership for Renewable Energy Finance. ITC Cash Grant Market Observations. http://uspref.org/wp-content/uploads/2011/07/us-pref-itc- Grant-Market-Observations-12.1.2011-v2.pdf. Page 55
The US PREF analysis, as follows, suggests that other potential new tax credit investors could emerge based on substantial tax burdens that exist within their respective organizations. Investor owned utilities are a key market segment included in the analysis, based on substantial tax burdens along with perceived industry understanding and alignment. It remains to be seen if new participants will join the ranks of renewable energy tax credit investors, but there is logic to suggest new participants will emerge. The following charts were included in the whitepaper, The Return-and returns-of tax equity for US renewable projects, by Bloomberg New Energy Finance as an illustration of tax credit equity need and potential supply. Figure 29. Bloomberg and US PREF tax equity supply and demand charts 34 8 Historical and projected financing from tax equity and Treasury grant ($bn) 7 6 5 4 $3.9 $1.9 $2.0 Projected incremental 2011 Treasury grant Treasury grant 3 2 1 0 $6.1 $2.0 $1.7 $1.9 $3.2 $3.4 $3.3 $3.6 $1.3 $1.9 $1.9 $0.5 2005 2006 2007 2008 2009 2010 YTD2011 2011E 2012E Projected incremental tax equity Tax equity 60 Cash paid for taxes (trailing 12 months) for 500 largest US public companies by sector ($bn) 50 40 30 20 10 0 $48 $35 $9 $14 Energy Financial Industrial Tech / Telecom $30 Other Cash paid for taxes (trailing 12 months) for 15 major investor-owned utilities in US ($bn) Exelon Corp Public Service Enterprise Group Inc Constellation Energy Group Inc Dominion Resources Inc/VA PacifiCorp PPL Corp Southern Co Edison International Unisource Energy Corp Wisconsin Energy Corp DTE Energy Co DPL Inc Sempra Energy Duke Energy Corp MDU Resources Group Inc 0.0 0.2 0.4 0.6 0.8 1.0 1.2 1.4 34 The Return-and returns-of tax equity for US renewable projects. Bloomberg New Energy Finance. November 21 2011. Page 56
New markets tax credits The New Markets Tax Credit (NMTC) was enacted by the Community Renewal Tax Relief Act of 2000 (P.L. 106-554, 113 Stat. 2763) to provide an incentive to stimulate investment in low-income communities (LIC). Qualified investment groups apply to the US Department of the Treasury s Community Development Financial Institutions Fund (CDFI) for an allocation of the NMTC. The investment group, known as a Community Development Entity (CDE), seeks taxpayers to make qualifying equity investments in the CDE. The CDE then makes equity investments in low-income communities and low-income community businesses, all of which must be qualified. The tax credit value is 39% of the cost of the qualified equity investment and is claimed over a seven-year credit allowance period. In each of the first three years of the investment, the investor receives a credit equal to 5% of the total amount paid for the stock or capital interest at the time of purchase. For the final four years, the value of the credit is 6% annually. Investors must retain their interest in a qualified equity investment throughout the seven-year period. Figure 30. Historical NMTC placements Round Year Awards Amount ($ bil) Ave. award ($ mil) 1 2001-2002 66 $2.5 $38 2 2003-2004 63 $3.5 $56 3 2005 41 $2.0 $48 4 2006 63 $4.1 $65 5 2007 61 $3.9 $64 6 2008 70 $3.5 $50 7 2009 32 $1.5 $47 8 2009 99 $5.0 $50 9 2010 99 $3.5 $35 10 2011 70 $3.5 $50 Total 664 $33.0 $49.7 Page 57
The following figure has been included to demonstrate the financial impact of a NMTC allocation to a project from an upfront cash perspective. Figure 31. Critical NMTC clarification NMTC allocation Tax credits or cash The math NMTC allocation $10,000,000 NMTC rate 39% Tax credits $3,900,000 Investor discounts & costs 49% Net NMTC cash to the project $2,000,000 The Rural Energy for America Program (REAP) The USDA Rural Energy for America Program (REAP) provides assistance to agricultural producers and rural small businesses through loan guarantees and grants for renewable energy projects, including anaerobic digesters. The USDA REAP program is comprised of the following components: 35 USDA REAP program components Renewable energy system and energy efficiency improvement guaranteed loan and grant program The energy audit and renewable energy development assistance grant program The feasibility studies grant program Description Provides financial assistance to agricultural producers and rural small businesses to purchase, install, and construct renewable energy systems; make energy efficiency improvements; use renewable technologies that reduce energy consumption; and participate in energy audits, renewable energy development assistance, and feasibility studies. Assists agriculture producers and small rural businesses by conducting energy audits and providing information on renewable energy development assistance. Assists, financially, applicants that need to complete a feasibility study, which are required in applications for many of USDA s and other government agencies energy programs. 35 http://www.rurdev.usda.gov/ Page 58
State renewable energy incentives Focus on Energy Focus on Energy is Wisconsin s statewide energy efficiency and renewable energy assistance program funded by the State s investor-owned energy utilities and participating municipal and electric cooperative utilities. Focus on Energy has been in existence since 2001. It provides resources and financial incentives for Wisconsin residents to pursue renewable energy and efficiency projects that otherwise would not be completed, or to complete projects sooner than scheduled. The primary organizations that make up the Focus on Energy program include: Public Service Commission of Wisconsin The Public Service Commission (PSC) has oversight of the statewide energy efficiency and renewable energy programs. This includes: review and approval of the Program Administrator selected by the utilities, and of the contracts between the utilities and Program Administrator for the administration of statewide programs; contracting with one or more independent parties for an annual performance evaluation and financial audits of the statewide programs; requiring each energy utility to spend the amount required to fund statewide energy efficiency and renewable resource programs; and managing day-to-day program activities. Statewide Energy Efficiency and Renewable Administration (SEERA) SEERA creates and funds statewide energy efficiency and renewable energy programs. SEERA also contracts, on the basis of competitive bids, with one or more persons to administer the programs. SEERA has no obligations regarding the statewide programs other than creating and funding the programs and contracting for their administration. Program Administrator Shaw Environmental & Infrastructure, Inc., the Program Administrator for Focus on Energy, is responsible for overall contract management and coordination of specific program offerings, utility coordination, umbrella marketing and communication activities, and reporting to SEERA and the PSC. Recently the PSC issued an order establishing updated requirements for the relative inclusion of renewable energy technologies in Focus on Energy s portfolio of programs. The order establishes an annual budget cap of $10 million for renewable energy incentives. In addition, the order dictates that, starting in 2013, 75 percent of renewable energy funding must be allocated to biogas, biomass, and geothermal technologies and 25 percent to solar thermal, photovoltaic, and wind technologies. 36 The updated policies bode well for the development of biogas renewable energy technology applications in Wisconsin. 36 http://www.focusonenergy.com/renewable/ Page 59
Wisconsin Economic Development Corporation Clean Energy Manufacturing Revolving Loan Program Wisconsin Economic Development Corporation s Clean Energy Manufacturing Revolving Loan Program is currently in the design phase, but is anticipated to provide low interest loans at 2% for up to a total maximum of 25% of costs for selected renewable energy projects. Anticipated guidelines will require at least a one-to-one match of loan funds from sponsor capital contributions. The program will target low-interest loans to businesses that promote: > > Major renewable energy production projects > > The manufacture of clean energy products > > Advanced manufacturing of clean energy components > > Retooling to provide component parts and other critical needs for a successful, totally integrated supply chain > > Improving industrial users competitiveness through energy efficiency and renewable energy deployment Property and sales and use tax impacts A discussion regarding property and sales and use tax for Wisconsin anaerobic digester projects is presented in Appendix 2. Advanced renewable energy tariffs and net metering Net metering is a utility mechanism whereby generators of distributed generation can offset electrical load (essentially wind back a consumption meter) by generating on-site energy. Because the same meter is used to track both the consumption and production to determine a singular net metered amount, all generation that offsets load usage is saving the customer on their currently billed electricity rate. Although net metering billing policies vary by each utility, in general terms, if the customer generates more electricity than they use, they will be compensated for surplus energy at their current tariff rate, the utility s avoided cost of wholesale power, or a specified special net metering tariff rate. The PSC requires that Wisconsin s electric utilities allow net metering for customers that generate electricity with systems up to 20 kw in capacity and some utilities allow net metering for larger systems. There is no limit on total enrollment of distributed generation projects, but the larger projects often entail specific stipulations related to net energy consumption/production and the corresponding rates paid or realized by the customer. Advanced renewable tariffs (also known as feed-in tariffs or green pricing tariffs) are used by Wisconsin s electric utilities to specifically incentivize distributed generation of renewable energy. Advanced renewable tariff rates are typically higher than the utility s net metering buy-rate for non-renewable energy, in order to reflect higher production costs, and incentivize the development of renewable energy resources at a credibly fair rate. Advanced renewable Page 60
tariffs are typically offered by utilities in capped subscription blocks, limiting additional investment in renewable distributed generation once a tariff is fully subscribed. Wisconsin net metering and advanced renewable tariffs are included as Appendix 3. State incentive program comparison New York 37 The State of New York is recognized as a leader in the support and promotion of biogas electricity projects. Primary biogas economic development support in New York is provided through the New York State Energy Research and Development Authority (NYSERDA). NYSERDA provides many energy efficiency and renewable energy programs, but is a leader in energy innovation and business development for biogas, through its agriculture and industrial waste management programs. NYSERDA s support aims to reduce compliance costs and realize additional value to support agri-business viability in the State. To this end, programs have been designed to focus on facilities with significant manure and food waste challenges, to include anaerobic digestion, on-site biogas electricity generation, and composting of bio-solids. NYSERDA has linked its waste management objectives to the State of New York s RPS targets. New York s RPS is set to achieve a 30% renewable energy target by 2015. Not only does New York have an aggressive RPS target, but policy makers have also carved out a provision for distributed / on-site renewable energy production, known as the customer sited tier (CST). New York s CST provision within the RPS is set to require roughly 6% of all incremental renewable energy additions to come from CST. As a point of interest, although not required to comply with this standard as a municipal utility in New York, the Long Island Power Authority has voluntarily adopted similar renewable energy targets. Renewable generation from biogas is eligible for both tiers of New York s RPS, but the CST provision is a specific action to support projects at agricultural and waste generating processing facilities. The CST programs have been specifically designed to support only behind the meter solar and biogas-related installations, with incentive amounts equaling up to 50% of installed project costs, or $3 million per applicant. Specifically, NYSERDA has published a Program Opportunity Notice to provide approximately $57 million to support the installation and operation of biogas electricity systems in New York State through 2015. NYSERDA s actions have clearly demonstrated New York s commitment to advancing biogas technology projects. 37 http://www.nyserda.ny.gov/ Page 61
Overview of project structures to optimize tax benefits Because strict restrictions exist pertaining to project eligibility for each tax credit, grant, and other incentive, it is also important to review the impact of project and transaction structures against incentive eligibility. The ability to effectively identify financial incentives and strategically structure renewable energy projects to optimize such incentives is a critical determinant of project success. At the entity level, these factors will drive stakeholder value for specific projects; in the aggregate, setting appropriate incentive levels and supporting effective financial project development practices can support Wisconsin s continued leadership of biogas utilization. A number of project structures have been and can be used to gain the most out of renewable energy tax credits and other incentives. The transaction structure often utilizes multiple parties, as discussed previously in the discussion on tax credit benefits, project developers do not often have the size or tax liability to take advantage of all the project benefits. The Internal Revenue Service also has distinct requirements related to ownership and benefit sharing mechanisms allowable for a project to qualify for tax credit benefits. These factors make it important to properly structure a project with tax professionals with specific expertise in this area. The following section will highlight effective tax equity transaction structures that are popular in the industry. Partnership flip One common renewable energy project structure is known as a partnership flip. A special tax credit equity investor will typically own 99% of the project for an agreed upon time or until an agreed upon hurdle rate is met. Often the partnership flip is structured so the tax credit investor can realize the full tax benefits of advanced depreciation, along with the project tax credits in the form of PTC or ITC. In the case of the PTC, since the PTC entails a ten-year horizon, the flip would typically take place after year ten. If an ITC is elected with an up-front tax credit, IRS rules require the tax credit investor to maintain primary ownership for at least five years to avoid recapture provisions. Once the flip time period or hurdle rate of return has been met for a project, the primary ownership reverts back to the developer who receives most of the project cash flows, typically 95% to meet IRS safe harbor provisions related to partnership flips. Sale leaseback Another tax credit equity structure to monetize renewable energy tax credits is known as the sale leaseback. In order for this structure to work, the project developer has to sell the project to the tax credit equity investor and pay a lease to the investor for the project. In this structure, the lease payments will represent cash flows from operations and the tax credit investor can realize all the renewable energy tax credits as the owner. This structure typically includes a buy-out / turnover provision, where the developer will become the primary owner (not completely dissimilar from the flip structure). Lease pass through The lease pass through is conceptually inverse to the sale leaseback structure. In this structure, the tax credit equity investor pays lease payments to the developer, who maintains ownership of the project. In this relationship, the developer of the project is able to pass-through the tax Page 62
credit benefits to the tax credit investor. This structure can be more complicated, but does afford flexibility in profit/loss sharing. Other renewable energy transaction types exist and may make more sense based on your unique project considerations. Any project structuring decisions should be made in consultation with your tax advisory professionals. Additional considerations of tax credit investment opportunities As discussed in this section, with the expiration of Section 1603 financing capability, renewable energy projects likely must again look for tax credit investments as a primary financing strategy. In many cases, projects will need to be creative in approaching tax equity markets. We ve discussed the Bloomberg New Energy Finance study that considers new potential entrants into renewable energy tax credit investing. However, the project size and unique operating characteristics will also play a key role in successfully procuring an investment. In other words, potential investors (whether established players or new market entrants) may not be able to afford or tolerate the transaction costs and/or friction involved with reviewing multiple smaller biogas projects. From a funding capability perspective, Wisconsin projects may find value in exploring project aggregation opportunities, potentially creating an investment fund for a group of projects. This approach may provide the critical mass necessary to incent a tax credit investor to perform the necessary due diligence and incur the relevant transaction costs to participate in a project. The answer is not included in this report and will require more review in each specific situation, but the idea is that all project value streams should be considered for optimization, including those related to project structuring and financial negotiations. Project value Tax benefits = Financial institutions or strategic tax burdened corporation > > ITC > > Advanced depreciation Operational cash flow = Owners / investors, customers, bondholders Investment timeline Page 63
About the Wisconsin State Energy Office The State Energy Office (SEO) is committed to supporting Wisconsin s goal of: generating electric power and transportation fuels from renewable resources; capturing more of the emerging bioindustry and renewable energy market; and leading the nation in groundbreaking research that will make clean energy more affordable and will create good paying Wisconsin jobs. The focus of the SEO > > Ensure and facilitate implementation of energy independence initiatives > > Serve as the single point of contact and ombudsperson for businesses, local units of government and NGOs pursuing bio development, energy efficiency, and energy independence > > Develop energy independence policy options > > Identify federal funding opportunities and facilitate state / local government and private sector application for funding > > Serve as the State Energy Office and perform duties necessary to maintain federal designation and federal funding About Baker Tilly is the full-service accounting and advisory firm whose renewable energy and manufacturing/distribution specialized professionals connect with you through refreshing candor and clear industry insight. We speak your language and identify with your goals to consistently deliver solutions that are just right for you. With more than 1,400 employees, Baker Tilly provides a wide range of accounting, tax, and advisory services. Ranked as one of the largest firms in the country, Baker Tilly serves clients from offices in Chicago, Detroit, Minneapolis, New York, Washington DC, and throughout Wisconsin. Baker Tilly is an independent member of Baker Tilly International, a worldwide network of independent accounting and business advisory firms in 125 countries, with more than 24,000 professionals. The combined worldwide revenue of independent member firms exceeds $3 billion. Pursuant to the rules of professional conduct set forth in Circular 230, as promulgated by the United States Department of Treasury, nothing contained in this communication was intended or written to be used by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer by the Internal Revenue Service, and it cannot be used by any taxpayer for such purpose. No one, without our express prior written permission, may use or refer to any tax advice in this communication in promoting, marketing, or recommending a partnership or other entity, investment plan or arrangement to any other party. Baker Tilly refers to, an independently owned and managed member of Baker Tilly International. The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. 2012 Wisconsin State Energy Office