Canary Media thanks KORE Power for its support of our special coverage of the Inflation Reduction Act’s first year.
The Inflation Reduction Act has unleashed what could be a trillion-dollar flood of tax credits for U.S. clean energy and decarbonization investments over the next decade.
To capture as much of the value of these tax credits as possible — and, in turn, build as much new clean energy as possible — project developers need to partner with companies and financial institutions in what’s called a tax-equity market. Thanks to three decades of tax-credit-focused clean energy policy, this is a well-established ecosystem; it’s become the financial engine that makes solar, wind and battery subsidies work in the U.S.
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But here’s the problem: The volume of tax credits introduced by the climate law is unlike anything these tax-equity marketplaces have ever dealt with — and without serious changes, these new credits would almost certainly overwhelm this key market.
A provision of the climate law known as “transferability” aims to solve this. The rules for how it works are as complicated as major new federal tax-credit policies tend to be, but the concept is relatively simple. For decades, financiers have had to become co-owners of the clean energy projects they invest in in order to claim the associated tax credits. In contrast, the new deal structure introduced in the Inflation Reduction Act allows investors to buy those credits on an open market, drastically lowering barriers to entry and potentially unleashing a torrent of new project funding worth billions.
“This will truly transform the way clean energy projects are financed,” said Andy Moon, CEO and co-founder of Reunion Infrastructure, one of a number of startups that have launched to facilitate and support the emerging market for tax-credit transfers. “It’s hard to overstate. This will be a huge deal.”
Many clean energy projects aren’t financially feasible without the help of tax credits, but the amount of money a project developer can receive from those credits is limited by the size of its tax bill — and most developers don’t pay nearly enough in taxes to make use of those credits. Today’s tax-equity markets help solve this: Clean-energy project developers partner with big banks and financial institutions with massive tax bills that are looking to reduce how much they owe to the federal government. In turn, these deep-pocketed partners return some of that value to the project developers in the form of cash payments.
That allows project developers to maximize the value of the credits and build far more clean energy projects much faster than would be possible if developers relied on their own tax liability alone.
At its peak prior to the new law, the U.S. tax-credit investment market processed about $20 billion in clean-energy projects per year. Under the Inflation Reduction Act, that annual figure is expected to be at least two to three times larger, according to multiple analyses. And with the supply of clean energy tax credits uncapped by the federal government and restricted only by the volume of creditworthy projects, the eventual demand could grow even further.
To incentivize project developers to build out clean energy as quickly as the climate crisis demands, the tax-equity market also needs to rapidly expand its capacity. That’s where transferability will play a vital role — and big banks, new startups, renewable energy developers and armies of lawyers and consultants are all rushing to put it into practice.
One of these advisory firms, Reunion Infrastructure, is benefiting mightily from the flood of interest in tax-credit transfers. In July, the startup announced it had amassed more than $1 billion in credits from “high-quality solar, wind, battery storage, and biogas projects” that are ready to be snapped up by corporate buyers. By mid-August, the total had doubled to $2 billion, according to CEO Andy Moon.
The pace of deals is likely to pick up even further in the wake of the U.S. Treasury Department issuing guidance in June on transferability and another option for streamlining tax-credit transactions, known as direct pay.
“There have been deals literally waiting on the sidelines to be implemented once the structure was in place,” said Allison Nyholm, vice president of government affairs at the American Council on Renewable Energy, a trade group representing clean energy companies and customers. An ACORE survey of clean-energy developers and investors in June indicated that more than 80 percent of them intended to use transferability or direct pay in their investments over the next three years.
This week, Bank of America unveiled details of the first tax-credit transfer deal to be made public, an agreement to buy $580 million in wind energy tax credits from a $1.5 billion wind farm being built by clean power developer Invenergy. “We’re creating a market where you can have more players around the table all participating in the clean-energy transition,” Karen Fang, Bank of America’s global head of sustainable finance, told The Wall Street Journal.
But Patrick Worrall, vice president of the asset marketplace at clean energy marketplace provider LevelTen Energy, warned that “the only way that the IRA can fulfill its promise is if there are many more parties who jump into the tax investment game.” That’s because the relatively small pool of large financial institutions that now do tax-equity deals don’t have the investment appetite or capacity to finance nearly as many projects as the Inflation Reduction Act’s expanded tax credits can support.
Transferability makes such expansion possible — but it doesn’t guarantee it. “There’s nothing there if these parties don’t start coming to the market and making these investments,” Worrall said. “This was all set up by the federal government to enable these corporations to enable this transition.”
From tax equity to transferability: A sea change in how clean energy is financed
Why can’t today’s tax-equity markets handle the coming wave of clean energy tax credits initiated by the Inflation Reduction Act? Simply put, the traditional way of doing things is just too complicated and expensive to meet the scale and scope of investments coming, Moon said.
Moon and his co-founder at Reunion Infrastructure, Billy Lee, both come from the tax-equity investment world, starting together at solar development pioneer SunEdison and then working separately at large banks and private equity firms. “We’ve pitched tax equity [deals] to corporates for 15 years — and they very rarely do it,” Moon said. “It’s very complex.”
At the core of that complexity is the long-standing rule that allowed only the project owner to claim tax credits associated with the project. The government structured the rules that way to ensure that the benefits of the tax credits would go to an entity with a vested interest in ensuring the project was actually built and operated properly.
But it also complicated the process of using tax credits to build clean energy projects. Project developers and deep-pocketed tax-equity investors used complex transaction structures, such as partnership flips and sale-leasebacks, to make the investor the owner of the project for as long as it would take for them to be eligible to claim the tax credit. After that, they would “flip” ownership back to the developer for the remainder of the project’s lifespan.
These labyrinthine partnerships can take millions of dollars in legal and administrative costs to put together, and because of their inherent complexity, there is little opportunity to streamline or standardize based on past efforts and make future deals simpler or cheaper, Moon said. They also force investors into the position of owning a clean energy project for years at a time, exposing them to risks that very few companies are willing to take on.
That’s why the pool of tax-equity investors is as small as it is, LevelTen’s Worrall said. “Over 50 percent of it is JPMorgan and Bank of America,” with about 40 other institutions rounding out the market, he said. And because these deals are so complex and risky, these investors have little appetite or capacity to expand how much new business they can take on — “they’re investing regularly, and they’re full.”
These conditions have led to a “huge supply-demand imbalance for tax equity,” Moon said. “Projects that could previously get tax equity are in the last six months struggling — there just isn’t enough. And if you don’t get tax equity, you can’t build a project.”
Another problem with the status quo is that tax-equity investors tend to only target deals of $100 million and up. That has forced developers of smaller-scale projects like community solar to sell to project aggregators that bundle numerous smaller projects together into high-dollar portfolios valuable enough to attract the interest of banks.
