TEAM 14: Lear Jiang, Adeed Choudhury, Parker Tikson, Kevin Matheny, Daniel Yan
Energy and Energy Policy
8 December 2014
Solar Industry and Incentives: Implications and the Future of the Solar Investment Tax Credit
Background:
In 2006, the Federal Government implemented the Investment Tax Credit (ITC) for solar
and wind renewable energy projects. The ITC offers a 30 percent tax credit to the project’s
sponsor for taxable income equal to the value of the project’s depreciable expenditures. There is
no maximum limit on the credit. However, sponsors of commercial-scale projects (as opposed to
residential ones) often do not earn enough taxable income from the project to take full advantage
of the credit, and so must pursue one of three options to make the federal incentive efficient.
First, it can utilize the credit on outside income – that is if the sponsor has other taxable
accounts it operates, it can shift the credit to those tax expenses. This is the “best possible
outcome” (Bolinger 2014) for the sponsor, because it uses the tax credit in full within an optimal
amount of time. Second, it can carry the credit forward over time for up to a period of twenty
years after the project becomes profitable – that is, after all the costs of the project have been
overtaken by its revenues. This option is usually inefficient for the sponsor because inflation and
other factors contribute to the depreciation of the value of the credit over time. Last, the sponsor
can bring in a third-party tax equity investor to finance the project. This tax equity investor is
usually a firm that possesses a large amount of taxable income and would benefit from the
sponsor’s unused credits. For investing in the project, the sponsor transfers the majority of risk
and tax credits to the investor. Although there are high costs associated with this option, due to
legal fees, transaction fees and other service fees, this is the option most often pursued by a
sponsor who cannot take full advantage of the tax credit (US PREF 2011).
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To avoid the high costs and inefficiency associated with bringing in tax equity investors,
in 2009 Congress enacted the 1603 cash grant program as a part of the ITC. Under the program,
sponsors may choose to receive cash in lieu of the 30% tax credit. The program spurred the solar
industry to record growth between 2009 and 2011, but due to the high immediate costs of the
cash transfers to the Federal Government, the 1603 program was scrapped as a part of
Sequestration cuts in 2011. The current Investment Tax Credit is set to decrease from 30% to
10% by December 31, 2016. There has been ample research conducted on the potential effects of
the reduction, much of which will be discussed later in this paper. There has also been ample
research on the Federal Government’s return on investment (ROI) of these incentives, which will
also be discussed later. However, there has been little research on the potential effects of a
renewal of the cash grant program, even at the lower rates scheduled to go into effect in 2017.
This paper explores the effects of an Investment Tax Credit cash grant program,
compared to simply the tax credit if rates were to decrease from 30% to 10%. First, we will
present a general overview of the solar industry and the technological advances that have led to
its boom. Second, we will provide a review of the current literature surrounding solar
development incentives, its effects on the industry, and on government revenues. Third, we will
present a summary of the current tax incentive system – which is the main solar incentive
currently available. We will also attempt to show why the heavy reliance on third part tax equity
investors is inefficient. Fourth, we will examine the brief years under the cash grant program
and how solar project development was incentivized differently, and ultimately more efficiently
than a pure tax credit. Last, we will attempt to examine the effects on Power Purchase
Agreement (PPA) prices – essentially the effect on energy consumers – between a pure tax credit
and a cash grant program at levels of 30% and 10% and compare the efficiency of both projects.
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Science of Solar Photovoltaic Systems:
Solar energy is the most abundant and renewable source of energy on Earth. It is the
fundamental energy for life on earth and it allows earth to maintain livable temperatures through
a constant influx and outward radiation of solar and infrared energy fueled by the sun. The sun is
not a finite well from which we can draw energy when we choose, but rather, it is constantly
exuding energy weather we like it or not and it is to our discretion what happens to the energy
that reaches earth to some extent.
Earth’s albedo, which is the fraction of reflected sunlight from the earth relative to
all of the light that reaches earth, is estimated to be around 30%, which leaves the remaining
70% to be absorbed, in some way, by the earth. Some of this energy will be captured by the
atmosphere, some of it by our oceans and bodies of rock, and some of it by organic plant matter.
That which was captured by organic matter was found long ago to be able to transformed into
heat energy by humans whether it was through burning the wood from today’s trees, or burning
the fossil fuels such as coal and oil which have resulted from organic matter that captured solar
energy millions of years ago and have been long since buried by meters to kilometers of
sediment. The product of such a process is as follows:
CH4[g] + 2 O2[g] -> CO2[g] + 2 H2O[g] + energy
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This basically demonstrates that by using energy that has already been captured by
organic matter, we will inevitably produce CO2 as a byproduct.
(Planetforlife.com)
After thousands of years, and an enormous spike since the industrial revolution, the
burning the fossil fuels has produced an unprecedented increase in atmospheric CO2.
Fortunately, the industrial revolution has also led to unprecedented advancement in technology
which has resulted in the ability to directly capture the energy of the sun and either store it or use
it on-hand without the production of atmospheric pollutants such as CO2. There are several
methods that have been, and continue to be, investigated for the most efficient capture of solar
energy.
The first type considered is solar heating. It’s purpose is to concentrate solar energy using
flat or parabolic light receptors made up of panels or cells that absorb sunlight energy and
convert it directly to heat in order to water, air, and other objects for commercial and residential
purposes. This energy can also be stored and transported as electricity by heating small cells of
water to produce steam which then drives a turbine, producing the movement of electrons and
therefore, viable energy.
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Artificial Photosynthesis is a newer technology and is essentially a chemical process that
replicates the natural process of photosynthesis, a process that converts sunlight, water, and
carbon dioxide into carbohydrates and oxygen.
Finally, the type of solar energy capture that has shown the most promise and application
is in solar photovoltaics. These cells observe the photoelectric effect, which causes them to
absorb photons of light and release electrons, which are then captured, resulting in a current that
can be stored, transported, and used as electricity (Nasa, 2002).
(OldDominionInnovations.com)
Solar Architecture is the integration of solar panel technology with modern building
techniques. The use of flexible thin film photovoltaic modules provides fluid integration with
steel roofing profiles that enhances the building's design. However, this was not a very feasible
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application until solar panels were thin and/or malleable enough to adjust to a variety of surfaces.
Orienting a building to the Sun, selecting materials with favorable thermal mass or light
dispersing properties, and designing spaces that naturally circulate air also constitute as solar
architecture. One major improvement to the architecture of solar panels themselves is the ability
to pivot to a wide array of angles in order to follow the sun and receive it’s energy normal to the
surface because the larger the angle relative to normal, more light energy is reflected and
therefore less is absorbed.
As installation costs are relatively high and “roof space” for small-scale users is relatively
small, efficiency is of primary importance. Currently, the commercial solar photovoltaic cells
with the greatest efficiency are capturing around 25% of the energy that reaches the cell (in
absolutely ideal conditions), but in reality, this number is even lower
(http://en.wikipedia.org/wiki/Solar_cell#Efficiency). These numbers are continually creeping
upward in thanks to both university-sponsored research as well as the research and
implementation of new ideas by large corporations such as Panasonic. In terms of technology,
there has been a gradual shift from using thin film to using fine crystalline silicon and with the
mechanical addition of pivoting panels in relation to the relative location of the sun, theoretical
efficiencies have increased over the past decade along with increases in realized efficiencies
through research and implementation every year. The following chart documents the levelized
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cost of energy relative to other leading energy forms.
(Solarcellcentral.com)
It is well know that solar power is not as reliable as other types such as coal or natural gas
that can be accessed with the flick of a switch and used reliably for as long as necessary (on a
short scale). Solar power is reliant on the sun and therefore can only be harnessed during the
daytime with clear skies. Because of this, the power is very intermittent and is helpful as a
supplementary source, but would not be reliable as a primary source of energy without
innovation. With this being such an important bottleneck, innovation is inevitable and there has
recently been a big step taken to solve this using large scale-battery storage running on largescale power grids that can be instantly accessed. This would allow access to solar energy at all
times of the day, including late at night, and could relieve solar energy of it’s dependence on
fast-burning fossil fuels to fill in the gaps. While energy storage is nothing new in technology,
implementing this battery storage system could give solar energy the ability scale up at lowenough prices to be competitive as a primary power source without governmental subsidies.
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(www.businessinsider.com)
However, there are many other factors that influence the efficiency of solar power as a
whole in terms of cost per unit energy. Following trends seen in other technologies such as cell
phones, cameras, and flat screen TVs, yet far exceeding trends of other renewable energies, the
manufacturing costs of solar power are decreasing by 20% every time the production volume
doubles, this is referred to as Swanson’s Law (Sandowski, 2014). So as we continue to
implement solar power, the costs of installation, maintenance, and therefore the power itself will
gradually drop as the technology as well as the process of interconnection, or the creation of
large-scale grids, become more efficient and there are more and more competitors pushing
innovation in the market. In fact, it is reasonable to say that solar power produced through solar
photovoltaic cells is now at the stage to be a standalone competitor and should seek private
investment as opposed to governmental subsidies (Nahi, 2013). As solar photovoltaics have
become more powerful, efficient, and competitive, governmental subsidies and tax cuts, which
used to be fuel for innovation, have become a crutch to increase profit margins for profitable
energy companies and lead to less motivation to innovate than would a competitive market.
Governmental subsidies should be concentrated to fueling the innovation of newer solar
technologies that would otherwise be unable to achieve private investment. Solar photovoltaic
innovation would benefit marginally and predictably from these subsidies, but it is time to push
standalone PV cells out of the nest because they’ve reached the stage that they can and must fend
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for themselves. The government should refocus spending on the innovation and integration of
newer technologies to help realize the potential for revolutionary advancements.
Literature Review:
Most of the literature regarding solar energy focuses on its technology. For example, in “A
Review of Solar Energy” by Govinda R. Timilsina, Lado Kurdgelashvili, and Patrick A. Narbel,
the authors believe that solar energy has received large growth recently due to technological
upgrades and cost-friendly government policies, which support renewable energies. However,
they examine the cost of solar compared to other conventional fossil fuel technologies and find
that solar’s development and use has been limited due to its high relative costs, even when
accounting for environmental impact.
Currently, solar energy has expanded technologically and now includes not only the
small-scale photovoltaic cells that the industry began with, but also newer solar concentrated
systems, solar thermal systems, and large-scale photovoltaic systems. These systems feed into
grids, supplying the grid with electric power. In addition to these technological advances, the
costs of a PV system have dropped substantially. In 1992, the installed cost of a PV system was
$16,000/kW, a figure that dropped to $6,000/kW by 2006 and continues to fall (Timisilina,
Kurdgelashvili, Narbel 2011).
Furthermore, solar has the potential to power the entire global energy demand and expand
to represent 11% of the global energy supply mix by 2050. Solar’s total potential power is
greater than that of all other current renewable technologies (see Figure 5). The installation of
solar energy technologies has also grown at a rapid rate, going from 1.4 GW in 2000 to about 40
GW in 2010, an average annual growth rate of 49% for PV cells. In addition, solar concentrated
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power (CSP) has doubled in that same time period, reaching 1,095 MW in 2010. Solar thermal
technology increased fivefold, from 40 GW to 185 GW in the same 10-year period. For PV cells,
Germany, Spain, Italy, Japan, and the US make up about 78% of the global installations in 2010
(8). The CSP market is concentrated in the Southwestern US and Spain, and solar thermal is
installed primarily in China.
The authors then study the economics of solar energy, first by comparing the cost of
generating electricity from different sources using the “levelized cost” (LCOE) method. The
equation is, as follows:
𝐿𝐶𝑂𝐸 =
𝑂𝐶
∗ 𝐶𝑅𝐹 + 𝑂𝑀𝐶 + 𝐹𝐶
𝐶𝐹 ∗ 8760
where
𝐶𝑅𝐹 =
𝑟 ∗ (1 + 𝑟)𝑇
(1 + 𝑟)𝑇 − 1
In this equation, OC is the overnight construction cost (amount invested, excluding
interest payments), OMC is the series of annualized operation and maintenance costs, FC is the
series of annualized fuel costs, CRF is the capital recovery factor, CF is the capacity factor, r is
the discount rate, and T is the time in years, of the plant’s life.
Figure 5: Estimates of Technical Potential of Renewable Energy Resources
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According to this model, the costs of solar power per megawatt-hour generated is much
higher than that of all other comparable technologies, including conventional ones such as fossil
fuels, coal, and nuclear, and renewable ones such as wind, natural gas, and hydroelectric (see
Figure 6).
The authors are quick to point out that conventional gas and coal have environmental
costs not internalized by the equation, and attempt to model the true cost of such technologies by
assigning the cost of a metric ton of CO2 produced to be between $0 and $100. They find that
even when taking these costs into account, the costs of solar are still larger than the costs of gas
and coal (see Figure 7). They point to these relative costs as a primary factor in why the solar
energy industry, with all its potential, hasn’t taken off yet.
In an outline of technical, economic, and regulatory barriers to the PV and CSP/solar
thermal industries, they also go on to list other problems such as high initial costs, lengthy
payback periods for investors, small revenue streams, lack of general experience in building
plants, increasing material costs, limited space, and grid access restrictions to build such units.
Figure 6: LCOE of Electricity Production by Technology
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Next, the authors highlight the economic policies which support solar energy today, such
as feed-in-tariffs, investment tax credits, direct subsidies, renewable energy portfolios, and
public investment.
A feed-in-tariff the most popular policy, as it has been implemented in over 75
jurisdictions around the world, including some states in the US. It is a premium payment given
to new and renewable energy technologies, not just solar, which are currently not cost
competitive with conventional technologies. The tariff granted is based on the cost of electricity
produced, and gives a reasonable return on investment for the producer of the energy.
Interestingly, tariff policies are not uniform and differ across countries. For example, Germany
incorporates a “corridor mechanism” which decreases the tariff rates if the PV capacity
installation the previous year exceeded a “corridor path” that the government sets, and vice
versa. The authors point to the feed-in-tariffs as the catalyst for the recent growth of grid
connected solar power. However, the downside to feed-in-tariffs is that they raise electricity
costs on the consumer and may be dicey politically and financially if the tariff rates keep
changing for countries which employ the corridor mechanism.
Figure 7: Economic Attractiveness of Solar Technologies when Environmental
Damages of Fossil Fuel Technologies are Accounted
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Direct subsidies include investment grants, capacity payments, or production based
payments. Countries such as Spain and India have incorporated direct subsidy programs into
policy, although India changed their subsidy from capacity based to production based due to
criticism that should incentivize production as opposed to capacity. In the United States, the
California Solar Initiative provides a solar subsidy. They use performance-based rebates, which
take into account the site of the system, the expected system performance, location, and other
factors into account.
Renewable energy portfolios, or RPS, are requirements for electricity suppliers to obtain
a certain percentage of their electricity supply from renewable energy sources. RPS is typically
implemented in developed countries, and is used to set penetration targets for renewable energy
in the total electricity supply mix. In the United States, RPS has been introduced in 31 out of 50
states. The standards go from a low of 10% to a high of 40% for electric energy suppliers (29).
Public financing is a tool used by many developing country governments to spur
investment from the public by selling energy bonds. For example, the United States’ Energy
Policy Act of 2005 created Clean Energy Renewable Bonds (CREBs) to finance renewable
energy projects. $800 million of tax credit bonds were issued in 2007, and the Energy
Improvement and Extension Act of 2008, combined with the American Recovery and
Reinvestment Act of 2009 raised $2.4 billion for new CREBs combined. By October 2009, the
Department of Treasury issued another $2.2 billion in CREBs on top of the previous issues.
Researchers like Patricia Salkin explore more in depth various governmental incentives
surrounding renewable energy, and there is much literature concerning state and local incentives.
In “The key to Unlocking the Power of Small Scale Renewable Energy: Local Land Use
Regulation,” Salkin discusses multiple avenues for providing incentives, and discusses the ways
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in which these incentives are put in place on federal, state and local levels. This provides a good
foundation for understanding renewable incentives; we will work deeper into the nuances of the
Investment Tax Credit after this overview.
The Investment Tax Credit was enacted by Congress in 2005, and provides a tax
credit for homeowners and project developers for up to thirty percent of the cost of constructing
various forms of renewable energy, including solar electric and solar water heating. This
investment tax credit (ITC) is now available to businesses as well, but is set to sunset in 2017 to
10 percent (Salkin, 2012). In 2011 President Obama signed into action the Better Buildings
Initiative, which calls upon Congress to redesign tax deductions and offer more government
backed loans to businesses that retrofit existing buildings. These types of federal actions
incentivize investment in renewable energy sources, including solar energy, but Salkin stops
short of evaluating the optimal levels of such incentives. For example, in Congress, it has been
argued that a market-based approach to solar and other renewable energy investments is more
cost effective than these types of federal incentives and many in the Republican Party have
advocated for the ending of federal incentives altogether.
While we will concentrate mainly on the federal ITC, there are a myriad of different
approaches to incentivizing solar development at the state level as well. For example, in
Colorado, independently owned residential solar electric generation systems that are not used for
income production are exempt from property taxes. Colorado also authorizes counties to offer
property tax or sales tax incentives for residential and commercial property owners who install
renewable energy fixtures, including solar panels. In Illinois, on the other hand, the Renewable
Energy Resource Solar and Wind Energy Rebate Program offers a rebate of up to $30,000 for the
construction and use of solar and wind energy sources for homeowners, businesses, public
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agencies and non-profit entities (Salkin 2012). In a different move, Massachusetts created the
Renewable Energy Trust Fund to make grants, loans, equity investments, rebates, and provide
other types of financial assistance for the development and increased use of renewable energy
resources.
In each case states approached incentivizing renewable development differently.
Colorado offers some of the most comprehensive and diversified incentives, piggybacking on the
Federal ITC with huge incentives for residential solar generation, including exemption from
property taxes. Illinois offers a more straightforward, rebate style approach, and Massachusetts is
one of many states that offer discounted financing for both the construction and use of solar and
other forms of renewable energy. Salkin offers many detailed examples, but she fails to address
the economic effectiveness of these different approaches, never answering why states use
different method, or which method could be most effective. We hope to fill this gap in with our
research regarding federal incentives.
Municipalities also engage in renewable energy legislation. For example, the city of
Honolulu offers financing for the installation of solar water heating systems to homes of income
qualified owners, meaning those in the low and moderate income levels (343). This type of
incentive is similar to the Renewable Energy Trust in Massachusetts, although it targets
individuals who may not have the finances to build these types of energy systems otherwise.
Salkin also addresses the time and cost involved in getting permits for renewable energy
sources. The Department of Energy has created fast-track procedures for granting renewable
energy loans, and recently (as of 2012) announced availability of more than $27 million in new
funding that will reduce non-hardware cost of solar energy projects. Many states have followed
suit and are enacting fast-track type legislation to speed up the permitting process for solar and
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other energy systems. The Network for New Energy Choices reports that many state and local
governments have been fast tracking these projects, and furthermore, the report recommends
adopting flat or zero permit fees for photovoltaic solar energy production. At the state level,
there are already Renewable Portfolio Standards (RPS) being enacted, which aim to diversify
and incentivize renewable energy. For example, Oregon’s Renewable Energy Act of 2007
requires the state’s largest utilities to generate at least five percent of their electricity from
renewable energy sources by 2011, increasing to twenty-five percent by 2025
Finally, Salkin discusses both net-metering and feed-in tariff incentives that are offered at
the state and local levels to further incentivize renewable energy use and production. Net
metering allows electricity consumers to sell back some portion of excess qualified renewable
energy to their utility provider. This type of legislation makes it attractive to both use, but also
conserve, solar and other renewable energies. In New York, recent amendments to the law
expanded the state’s solar net metering program applying it to businesses and increased the size
of eligible solar photovoltaic systems to 25 KW for residential customers and 2 MW for nonresidential customers.
Feed-in tariffs are similar to net metering techniques, but require utilities to purchase
renewable energy at fixed rates and honor longer-term contracts. This type of incentive fosters
more economic and infrastructural stability. Salkin highlights these types of incentives, but
focuses herself more on the direct taxed- based incentives, and we will do the same in this paper
as well. However, while these state and municipal initiatives may attempt different solutions to
the same problem, they are often too small in scope to make an accurate model or base federal
policy off of – the Investment Tax Credit remains the only federal incentive that is applicable to
all solar projects in development.
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Other researchers have attempted to analyze the return on investment for federal
incentives. A United States Partnership for Renewable Energy Finance study entitled “Paid in
Full: An Analysis of the Return to the Federal Taxpayer for Internal Revenue Code Section 48
Solar Energy Investment Tax Credit” examines the ITC in particular. The study delves into the
potential tax return benefits from implementing the Investment Tax Credit. Its primary argument
is that over the life of solar assets (30 years), the initial cost of federal expenditures associated
with the ITC can be more than offset by the tax revenues generated in lease and Power Purchase
Agreement scenarios, both of which create fixed payment structures and provide a positive
financial return on investment to the federal taxpayer. Even taking depreciation into account, a
$10,500 residential solar credit can deliver a $12,469 nominal benefit to the government and a
$300,000 commercial solar credit can create $380,127 nominal benefit to the government.
Beyond revenue benefits, the ITC also includes numerous other benefits such as job creation,
energy independence, preservation of natural resources and cleaner air.
Although the paper presents a strong argument, there are many factors their model does
not incorporate: Most importantly, although the model is looking at a 30-year period, it fails to
incorporate inflation (or a discounted valuation of money). Taken the historical values of
inflation, the tax returns from the solar installations would undoubtedly less – but because most
other factors are held constant, the model presents an ideal scenario to compare the ITC at
different rates, or comparing other forms of incentives, which this paper will analyze in detail
later on.
Despite having a simplified model with unconfirmed assumptions, the study effectively
shows that the Investment Tax Credit is indeed an effective investment for the federal
government. If income taxes from job creation were included in the model, the ITC returns
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would be even larger. Furthermore, although other benefits such as energy independence,
preservation of natural resources and cleaner air cannot be quantified, their benefits are equally
as important and are effectively promoted through the ITC.
Current ITC System:
The current ITC system is heavily dependent on third party tax equity investors for
financing projects. This is due to many sponsors lacking “tax appetite” (Bolinger 2014), the
income necessary to take full advantage of the face-value of the credit. For example, if in a given
year a project sponsor earns $1,000,000 in taxable income and the corporate tax rate is as it
stands at 39.1 percent, then the sponsor is obligated to pay $391,000 in taxes to the Federal
Government. However, with the investment tax credit, 30 percent of the project’s expenditures
can be written off on taxes – and they often exceed the amount the sponsor owes to the
government. On average, residential solar installations cost around $40,000 for just 7 kilowatts.
For utility scale solar projects, industry estimates for total capital expenses (CapEx) range
between costs of $2,000/kW and $3,000/kW for alternating current (Bolinger 2014). Given that
most utility scale projects are sized over 20 megawatts, which brings estimates for even the
smallest sponsor-backed projects to over $40,000,000 in expenditures. Even if these estimates
are not completely precise – it indicates that for most solar projects, the amount of tax credit due
to a sponsor are often higher than the amount the sponsor owes in federal taxes. Indeed this is
exactly the case, as many project sponsors do not have sufficient “tax appetite” and so seek out
third part tax equity investors. The infusion of cash directly into the project’s financing, also
called “monetization” lowers the immediate cost of construction for the project. Thus, even if
there are high costs associated with bringing in a tax equity investor, it still spurs the solar
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industry into development.
During a tax equity transfer, the investor “usually has a substantial, but passive, interest
(e.g., 99.99 percent)” in a newly created limited partnership (LP) or limited liability company
(LLC), while the sponsor of the solar project usually has a “de minimis (e.g., 0.01 percent)
interest. If this structure is followed, it allows the tax equity investor to obtain 99.99 percent of
the tax benefit from the ITC (OCC 2014). There are two main methods for a tax equity
investment. In the Sale-Leaseback Model, the sponsor sells the entire solar project to the
investor, who in turn leases the project back to the sponsor. This allows the investor to retain the
ITC benefits, while allowing the sponsor to maintain the revenue it receives from a Power
Purchase Agreement (PPA). This is the most common form of a tax equity investment in solar.
In a Partnership Flip, the investor and the sponsor join together to share the costs, risks, and
benefits of the project. In this model, the investor does not receive the full benefit of the tax
credit nor does the sponsor receive the full revenue from a PPA. They are both shared. This
model is more common for wind projects than for solar.
The current ITC system is highly inefficient. Third party tax equity monetization is
judged to be “more than twice as expensive as 15-year term debt on an after-tax basis” (Bolinger
2014). However, because projects might otherwise not be built, or because project sponsors do
not have enough financial security to finance projects purely through debt, third party tax equity
monetization remains a crucial cog in the solar industry. The costs for monetization are high
because there are not enough investors willing to take on solar projects. Only firms with very
large amounts of tax liability are willing to take on the risk necessary to finance projects through
either the sale-leaseback or partnership flip methods. This is due to the potential of not realizing
the entirety of the tax benefit before it expires in twenty years time (deadline set for the ITC).
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The firms must also be large enough to willingly hold stake in a solar project for several years,
be able to afford to hire the qualified experts to advise them on such complex tax structures, and
also be willing to engage in opportunities not core to its business (NREL 2012).
Usually, only massive banks and other highly profitable firms engage in this transfer.
Even so, the supply of tax equity investors remains limited. During the recession between 2008
and 2009, the recorded number of tax equity investors for utility scale solar projects “willing to
make new investments decreased from about 20 to five” (NREL 2012). That means only five
firms were willing to essentially finance the entire solar industry during the recession. This skew
of supply and demand shifts heavily in favor of the investors – as they can dictate the price of the
transfer, sale, leaseback, partnership, etc. Even after the recession has ended, industry estimates
still put the number of willing tax equity investors to be around fifteen. Most of these entities are
financial providers such as banks (JP Morgan, Credit Suisse, Wells Fargo, etc.) and in 2010, the
top ten tax equity investors accounted for 97% of the financing for utility scale solar projects.
Industry estimates placed the demand for tax equity investors to be between $7 billion
and $10 billion in 2011 and 2012, but investors supplied only $3.6 billion in 2011. This gap
allows suppliers more control in dictating terms of financing to sponsors. There is currently little
transparency in this market, as sponsors and investors often sign non-disclosure agreements and
much of the pricing is negotiated directly between two parties, often with anecdotal evidence
regarding the costs and risks of each associated project. Moreover, due to the high variability in
the different types, and sizes, and the technology of each project, there is little influence that an
in-need sponsor has over an investor at the negotiating table. This makes the market for investors
very inelastic – price is not a main determinant in the number of suppliers, thus, an increase or a
decrease in the rate of the ITC may have little influence on the financing for future projects. How
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this may shift, and how different rates affect project financing compared to other types of
incentives will be discussed more in depth later on in this paper.
Aside from negotiating costs, solar project sponsors also must account for the high cost
of the transaction. Legal fees for due diligence review and assessment are especially expensive.
The review period for such deals often delay the start of construction, but more importantly have
been estimated to cost sponsors between 15% and 40% of the entire tax credit awarded simply
for seeking out a third party investor. More importantly, because these costs are so high, often
sponsors are only willing to seek out such investors for the largest projects, potentially leaving
many other projects in the pipeline or undeveloped. However, there is currently no better
mechanism in place to secure the funds necessary to finance solar projects, and indeed without
the ITC – even with its highly inefficient use of capital – utility scale solar development may be
even lower.
Effects of 1603 Cash Grant Program:
Due to the risks and complications discussed in the previous section, the market for tax
equity suppliers is extremely volatile and beholden to market trends even if they are not elastic
with respect to price. During the 2008 financial crisis, the number of tax equity investors willing
to make new investments decreased dramatically – from twenty to five (NREL 2012). This
withdrawal of investors led to significant stagnation in new renewable development, especially
in solar. In response, Congress enacted the 1603 Cash Grant Program for 2009 and beyond as a
substitute for the tax credit in the hopes of spurring development. The new program allowed
renewable energy projects to replace their 30 percent ITC credit with a 30 percent cash grant – a
direct payment sent within 60 days of commercial operation date, essentially paying the ITC in
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full. This was a major improvement to sponsors in regards to the time it took to fully realize the
incentive. Instead of seeking out costly tax equity investors or keeping the credit on their books
for years until fully realizing the tax benefits, which due to inflation and other factors decreased
the value of the credit; sponsors would now fully realize the 30 percent credit within two months
of their power plant coming online. Although the Cash Grant program expired on December 31,
2011 due to sequestration cuts, projects that started construction prior to 2012 are still eligible to
receive the grant (Renewable Energy World). To this date, the grants provided continue to
stimulate project development.
The cash grant program provides numerous benefits over the tax credit, despite
theoretically providing the same amount of monetary support (30%). There are three main
advantages to project sponsors. First, award amounts are paid out sooner than the tax credit, and
can be realized sooner. This provides an advantage in terms of the time value of money. As
already discussed, even if a sponsor is able to take full advantage of the tax credit over the course
of a few years, which is rare, inflation devalues the money, making it worth less when compared
to the cash that is provided directly under the grant program. Second, the grant program does not
rely on tax equity investors, which is a costly and inefficient way to finance a project. Since the
cash grant provided often directly helps to finance a project without the added cost of bringing in
lawyers for a long due diligence process, projects move quicker down the pipeline, and sponsors
save more money to spend on other projects. Moreover, instead of most of the government
money being diverted to investment banks and large corporations, the cash grant program
directly funds solar developers – spurring the entire industry. Last, the barrier to entry for firsttime developers is reduced, which supports smaller projects, which might otherwise have been
cut at the margins. Sponsors are able to borrow approximately 95 percent of the grant to finance
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the initial project, something that was impossible with the tax credit. This leads to better and
more accurate project financing models for sponsors, and more cash on hand to fund the project,
without the cost of securing an investor. This increase of development provides more
opportunities for the Federal Government to collect taxes on new projects, as well as spurring the
whole industry.
The most important benefit remains the avoidance of tax equity investors. The up-front
cash provided by the grant program is safe, reliable and allows better planning while minimizing
risk, as well as forgoing the expenditures on legal and professional fees which could total up to
40 percent of the credit to begin with (NREL 2012). While the primary weakness of the 1603
Cash Grant program is that it does not monetize the accelerated depreciation – projects still have
to tap their own or a third party’s tax appetite to make efficient use of these depreciation benefits,
or simply forego the incentive, the 1603 Program has still catalyzed the solar market. Over 80
percent of the solar projects built between 2009-2011 opted for the cash grant incentive, with
growth in the industry during that time topping 104 percent (SolSystems 2011). According to the
National Renewable Energy Laboratory, the $9 billion clean power cash grant created over
20,000 jobs directly, 13 gW of renewable energy and delivered $5 billion in total economic
output through the creation of solar panel projects. A separate study from the Solar Energy
Industries Association predicts that a reincarnation of the 1603 Cash Grant could lead to 58,000
jobs by 2016 (SEIA 2012).
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(US PREF 2011)
The expiration of the 1603 Cash Grant Program has most notably led to market
consolidation, rise in tax equity costs and funding challenges for innovative technologies.
Its expiration has had the largest impact on small sponsors who have difficulties accessing the
tax equity market. Since these developers lack a significant portfolio, financial strength and
experience, it is much more difficult for them to raise the necessary capital. Even before the 1603
Program, the tax equity market heavily favored mature, experienced developers who were
creating large-scale projects. Some tax equity investors have minimum investment thresholds
that smaller scale developers simply cannot meet. To compound this problem, the cost of
securing the tax equity from an investor has risen over the years from 9% of the credit in 2007 to
around 12-13% in 2012 (US PREF 2012). As the smaller developers are being squeezed out of
the market, the solar market has consolidated. Currently, two companies – SolarCity and Vivent,
dominate over half of the residential solar market. This is vastly different from 2011 – right after
the cash program ended, and the trend is shown clearly in the graph below. As with any other
industry, market consolidation could potentially lead to decreased competition, increased pricing
and a bottleneck on innovation.
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(GreenTech Media)
1603 Cash Grant vs. ITC:
Based on a research report by the Climate Policy Initiative, the current 30% investment
tax credit for an average PV project would cost the federal government $31/MWh which is
equivalent to a 15% cash grant (CPI 2013). These differences in costs are primarily due to first,
the timing of the incentives: The cash grant is given to the developer within 60 days of operation
or provided in loan form for project financing, whereas the ITC isn’t fully realized for 5-10 years
or never at all if the sponsor brings in a tax equity investor. And second, any investor can use the
cash incentives, whereas tax benefits require tax liabilities. Tax equity investors take the risk that
they may not have enough tax liabilities to use the tax credits, so they demand a higher return.
This accounts for the difference between the cost to government for the ITC and for the 1603
Cash Grant.
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(CPI 2012)
Cash Grant vs. Tax Credit – Analysis:
Our model hopes to compare what the costs to government would be if the ITC were
replaced with a similar cash grant program at rates of 15 percent and 30 percent by calculating
the total rate of return. It assumes similar conditions to the one conducted by the U.S. Partnership
for Renewable Energy in their paper “Paid in Full: An Analysis of the Return to the Federal
Taxpayer for Internal Revenue Code Section 48 Solar Energy Investment Tax Credit (ITC).”
Other than the exception that we included an analysis of a 15 percent tax grant program in as an
alternative, all other assumptions for the cost analysis to the Federal Government remain the
same. Our model also narrows the scope of the study only to the state of California, which
represents the vast majority of utility scale solar projects in development.
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Monthly Lease/PPA Plan (30% ITC vs. 15% Cash Grant):
ITC
Cash Grant
kW
200.0
200.0
kWh/kW
1,450
1,450
$/W COGS
$4.17
$4.17
$/W Price
$5.00
$5.00
Energy Lease/PPA Price in $/kWh
$0.16
$0.16
Solar Energy Escalator
1.4%
1.4%
Energy Production – Degradation Rate
0.50%
0.50%
Energy Price After Lease/PPA Term in $/kWh
$0.16
$0.16
Energy Escalator After Lease/PPA Term
1.4%
1.4%
Upfront Utility Rebate in $/W
$0.00
$0.75
Federal Tax Rate
35%
35%
Lease/PPA Term in Years
20
20
System Life in Years
30
30
Initial investment rate
30%
15%
Initial investment
$300,000
$150,000
Nominal Gross Revenue
$685,084
$685,084
Nominal Net Benefits
$385,084
$385,084
Return on Investment
128%
357%
The left column contains assumptions taken from the US PREF analysis of the ITC’s return on
investment. The right column contains data we compiled given the assumptions on the left and
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information we took into account regarding the 1603 Cash Grant Program. The data represents
an extrapolation of the results provided by the Climate Policy Initiative in regards to a 30 percent
tax credit providing the same incentive to project sponsors as a 15 percent cash grant. We
focused on the return on investment to the Federal Government, as we are looking to provide a
policy recommendation after the sunset of the 30% ITC. From our analysis, it is clear that a cash
grant program, provided at an even lower incentive rate than the tax credit, would provide the
same amount of incentive for the industry – but more importantly, would provide a much higher
rate of return for the Federal Government. A 15 percent cash grant program would save the
government twice as much in costs put into the project, but would have a similar effect on the
industry.
(CPI 2012)
Conclusion and Implications:
Given the evidence provided for the 1603 Cash Grant Program, we conclude that the
1603 Cash Grant is far superior to the ITC in terms of returns to the developer, the solar industry
as a whole, and to the Federal Government. The 30 percent tax credit for the ITC is scheduled to
sunset at the end of 2016, making solar industry developers wary of the demand for projects and
market ahead. However, a replacement of the 30 percent ITC with a simple 15 percent tax credit
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would provide the same boost to the industry as a continuation of the incentive, and would save
the government money as well. Even if the incentive rate dropped down to 10 percent, as
scheduled, if it were replaced with a cash grant program, the solar industry would not experience
as sharp a potential drop in development as would be expected if it fell to a 10 percent tax credit.
Thus, if we were to put forward a policy recommendation, it would be in favor of a 15 percent
cash program to directly finance solar development.
However, there are a few key factors that make our recommendations unlikely to take full
effect. The least of which is political stagnation in Washington. Cash grants need to be provided
upfront, and are often borrowed by sponsors prior to construction to finance the original
development, thus they are a massive immediate burden on the Federal Government, even if it
provides a better long-term investment. Given the current atmosphere in Washington
surrounding budgetary discourse, it seems unlikely that the newly elected Republican-led
Congress would be willing to spend current dollars to fuel renewables development. Even though
our paper focuses on the solar industry and its monetary costs and benefits in regards to the
industry, and to the Federal Government, there are countless other factors that come into play
when examining the true benefits of renewable energy development. As discussed above in the
science section – the Sun provides an unending supply of power to our planet, and it is up to us
to decide how much of it to harness.
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