Tax Reform and Renewable Energy: The Impact on Project Developers

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_____________________________________________________________________________________

Eric Selmon Hugh Wynne

Office: +1-646-843-7200 Office: +1-917-999-8556

Email: eselmon@ssrllc.com Email: hwynne@ssrllc.com

SEE LAST PAGE OF THIS REPORT FOR IMPORTANT DISCLOSURES

_____________________________________________________________________________________

January 4, 2017

Tax Reform and Renewable Energy:

The Impact on Project Developers

Through 2020, the construction of new wind and utility-scale solar projects is forecasted to exceed 60GW, accounting for a majority of new capacity built in the U.S. In this note we assess the risks to that outlook from prospective changes to the tax code. We examine how the Trump and House GOP tax plans would affect the all-in cost of solar and wind power relative to a base case assuming the current tax code remains in effect. We also examine the future cost trajectory of wind and solar energy under the Trump and House tax plans relative to the wholesale price of power, and assess the implications for the future growth of these renewable resources.

Key Conclusions

We calculate that the power prices required under 20-year power purchase agreements (PPAs) to justify investment in new wind and solar projects will be higher under both the Trump and House GOP tax plans than under the current tax code, although the increase will be less than 10% after 2020. Regardless of the tax regime, however, we expect the cost of solar energy to continue to decline, gradually narrowing the gap with on peak power prices in the sunniest regions of the country. By contrast, the cost of wind power will rise significantly once the production tax credits (“PTCs”) expire in 2020, reaching levels that exceed round the clock wholesale power prices even in the windiest areas. The cost advantage of wind over solar will thus be materially eroded, and both resources will likely require PPAs priced above wholesale power prices for development to continue. While we therefore see no fundamental change in the drivers of and outlook for solar development, we believe the growth prospects for wind could be curtailed.

Over the remainder of the decade, one of the key risks for renewable development is likely to be more limited availability of tax equity and therefore a higher cost of capital for developers. Given the lower corporate tax rates introduced by the Trump and House tax plans, we expect the capacity of major tax equity providers to fall significantly, by an estimated 40% under the House plan and by 55% under the Trump plan. By contrast, demand for tax equity among project developers will not decline commensurately until the investment and production tax credits are fully phased out by 2020 and 2022, respectively. Absent a significant increase in taxable income at existing tax equity investors or the entry of new tax equity investors, the supply of tax equity may fall relative to demand and its cost rise. Moreover, developers that are unable to secure tax equity, and are unable to monetize available tax credits internally, will face much higher cash costs, potentially rendering their projects uncompetitive. Developers unable to access tax equity would be forced to increase their required PPA price for solar by 35-40% and for wind by 70-80%. Thus the limited availability of tax equity could create a significant advantage for large developers with the strongest relationships with tax equity providers, and developers able to absorb the tax benefits of renewable projects internally.

A risk to our outlook for solar, and a potential further headwind for wind, is the proposal in the House tax plan to disallow the depreciation of imported capital goods. If implemented, this proposal would materially increase the cost of both wind and solar power until domestic production capacity is expanded.

Please see the next pages for a more detailed summary of this note and a list of stocks affected.

Portfolio Manager’s Summary

Solar:

  • While the PPA prices required to justify investment in new wind and solar projects will be higher under both the Trump and House GOP tax plans, we expect the price of solar energy will continue to decline in real terms over the coming decade even if these tax reforms are enacted.
    • We expect ongoing declines in the installed cost of solar power plants, which we see falling at a 7.6% CAGR through 2024 from 2015, to offset the loss of the ITC and bonus depreciation.
  • Relative to the PPA price required to justify development of a new utility scale solar PV project in 2016 under the current tax code, we estimate that the solar PPA prices required under the Trump and House GOP tax plans would be ~19% lower, measured in constant 2016 dollars, in 2020 and ~25%% lower in 2024. (See Exhibit 4.)
  • Yet even at these lower levels, the PPA price of solar will remain substantially above the average 2016 on peak price of power in southern California, Arizona and Texas. (See Exhibit 4.)
  • We therefore expect no fundamental change in the drivers of and outlook for solar development.
    • Solar development will likely continue to depend on state renewable portfolio standards and above market contracts with firms such as Google.
    • We expect declining PPA prices for solar to encourage additional states to increase their renewable portfolio standards, as five states, including New York and Illinois, did in 2016.
  • However, the more limited availability of tax equity could so raise the cost of some solar projects as to prevent them from being built, possibly slowing the growth rate of solar.
    • Developers who cannot immediately monetize the ITC internally, and are unable to raise tax equity, will be forced to raise additional capital to fund new projects. We calculate they will need to raise the solar PPA prices they offer buyers by 35-40% as a result.

Wind:

  • By contrast, we expect wind development to be materially adversely affected by changes in the tax code, and particularly by the phase-out of the production tax credit. (See Exhibits 6 and 7).
    • Relative to the PPA price required to justify development of a new wind project in 2016 under the current tax code, the PPA prices required under the Trump and House GOP tax plans measured in constant 2016 dollars could be some 27% to 30% higher in 2020 and approximately ~43% higher in 2024. (See Exhibit 9.)
    • At these levels, PPA prices for new wind projects, which today we estimate are often competitive with round-the-clock power prices in the Great Plains states, will likely rise above market prices in 2020 and 2024. (See Exhibit 9.)
    • PPA prices for new wind projects, which we estimate today to be half the PPA price for solar under the current tax code, may rise to levels just 15%-20% below solar PPA prices by 2024.
  • Wind will also be more vulnerable than solar to the loss of tax equity before the expiration of the PTCs, with developers that are forced to absorb these tax benefits internally on a deferred basis required to increase PPA prices by 70-80%, when PTCs are at their full value of $23/MWh.
  • We therefore expect wind power to lose its current status as a renewable resource that is increasingly cost-competitive with wholesale power prices, and once again to become dependent, like solar, on state renewable portfolio standards and above market contracts with firms such as Google – materially limiting its prospective growth post-2020.
  • Relative to solar, moreover, the cost advantage of wind will be materially eroded, rendering it less attractive in regions where both resources are abundant, even in the context of requests for proposals put out by utilities facing state renewable mandates.

Border Adjustment:

  • The border adjustment provision of the House GOP plan would exempt export revenues from the corporate income tax but would subject imports to the tax by prohibiting firms from deducting the cost of imports from taxable income.
  • We have not included the border adjustment provision in our analysis of the House GOP plan, both because its inclusion in the final tax reform is far more uncertain than other proposed provisions, and because there is greater opportunity than with other provisions for developers to mitigate its impact by increasing their purchases U.S. manufactured components.
  • If we assume that imports account for 50% of wind and solar project costs, border adjustment would increase the required PPA price by ~12% for both resources, relative to our base case estimate of PPA prices under the House GOP plan, and ~20% versus the current tax regime.
  • This large an increase in PPA prices would likely slow the growth of solar and add a further headwind to the already unfavorable prospects for wind, putting company growth plans at risk.

Financing:

  • Because the maximum corporate tax rate would be cut from 35% currently to 20% under the House plan and 15% under the Trump plan, the tax capacity of major tax equity providers should fall commensurately, by ~40% under the House plan and ~55% under the Trump plan.
  • By contrast, demand for tax equity among renewable developers should remain robust until the production and investment tax credits are fully phased out by 2020 and 2022, respectively. In the interim, absent a significant increase in taxable income at existing tax equity investors or of new tax equity investors, tax equity investors should enjoy increased pricing power.
    • As noted above, the inability of certain developers to access tax equity would increase their required PPA price for solar by 35-40% and for wind by 70-80%.
    • The renewable developers able finance new projects most competitively, therefore, will be those with the best access to tax equity investors (either due to their size and pipeline of new projects, such as NextEra, or their strong relationships with investment banks, such as NextEra, Southern and Duke), and those with the ability to use the tax benefits internally on a current basis (such as AEP and Southern).
  • As renewable tax credits are phased out, and the value of deductions such as accelerated depreciation is reduced by lower tax rates, we expect an increase in demand for debt financing among renewable developers, to fill the gap left by the reduction in value of tax incentives.
  • These trends may favor regulated utilities seeking to invest in renewable generation. We calculate that the levelized cost of energy (LCOE) from wind and solar projects developed by regulated utilities is lower than for competitive generators, under the current, Trump and House tax plans. This reflects regulated utilities’ longer capital recovery period (30 years vs. 20 under a PPA) and lower weighted average cost of capital over the project’s life. The difference in LCOE is equivalent to ~$0.10-0.15/W difference in cost for both wind and solar, comparable to what is achievable by the lower cost competitive developers.

Company Impacts

  • Within our universe, NRG and NextEra have planned the largest development of unregulated renewable generation capacity over the next few years. Through 2018, we estimate that the average annual cost of these companies’ planned wind and solar capacity additions is equivalent to 9.7% of current market capitalization for NRG and 5.4% for NextEra. (See Exhibit 12)
    • Through the end of the decade, planned annual investments in renewables by Avangrid and Southern average 3.8% and 3.1% of market cap, respectively. AEP, ConEd, and Duke plan to invest ~1.0-2.0% of their market capitalization in new renewable projects annually.
  • Among publicly traded renewable companies, the module manufacturers, particularly those with development arms, such as Canadian Solar, First Solar and SunPower, have the greatest exposure to utility-scale solar development. TPI Composites and Vestas are among the most exposed to utility-scale wind development.

Exhibit 1: Heat Map: Preferences Among Utilities, IPP and Clean Technology

Source: FERC Form 1, company reports, SNL, SSR analysis

Details

The development of new renewable generation capacity has become a large part of many companies’ growth plans and is expected to account for a majority of the new generation built in the U.S. through the end of the decade. In this note, we examine how the Trump and House GOP tax plans would affect the all-in cost of solar and wind power relative to a base case assuming the current tax code remains in effect. We also examine the future cost trajectory of wind and solar energy under the Trump and House tax plans relative to the wholesale price of power, and assess the implications for the future growth of these renewable resources. Finally, we examine the potential for the Trump and House tax plans to materially reduce the availability of tax equity, and calculate how the loss of tax equity could affect the cost of future solar and wind projects.

Exhibit 2: Key Elements of the Trump and House GOP Tax Plans

Source: www.donaldjtrump.com, Speaker of the House Paul Ryan, A Better Way: Our Vision for a Confident America

To assess the impact of the Trump and House GOP tax plans on the cost of solar and wind power, we have modeled how the PPA prices required to support new investment in wind and solar projects would be affected by the following elements of these two plans:

    • Elimination of tax credits: Both the Trump and House GOP tax plans would eliminate business tax credits other than that for research and development. This element of the two plans is consistent with the current tax code, which would phase out the production tax credit for wind by 2020 and the special investment tax credit for solar by 2022. [1] We assume this phase out schedule is maintained under the Trump and House GOP plans. We further assume that the standard 10% ITC for business investment is eliminated by 2022.
    • Bonus depreciation: The House tax plan would introduce 100% bonus depreciation and eliminate the deductibility of interest on future loans. Under the Trump plan, power developers could choose to expense capex and give up the deductibility of interest; we assume, however, that they choose not to and rather retain the interest deduction as the economics are more attractive.[2] We further assume that the Trump plan retains the current provisions of the tax code reducing bonus depreciation from 50% currently to zero in 2020.
    • Lower tax rates: The House tax plan would cut the maximum tax rate for corporations from 35% currently to 20%, while the Trump plan would cut it to 15%.

The proposed changes to the tax code would have a significant impact on the PPA prices required to justify the development and construction of new renewable energy projects. We have compared the PPA prices that would be required by new wind and solar projects under the existing tax code to the PPA prices that would be required under the Trump and House GOP tax plans. In the former case, we have modeled the impact of the following provisions for the current tax code:

    • Tax credits: The investment tax credit for solar is maintained at 30% through 2019, then cut to 26% in 2020 and 22% in 2021, and finally fixed at 10% in 2022 and following years. The production tax credit ($23/MWh in 2016) continues to be adjusted for inflation but is cut by 20% in 2017, 40% in 2018, 60% in 2019 and eliminated in 2020.
    • Bonus depreciation: Bonus depreciation is maintained at 50% in 2017, cut to 40% in 2018 and 30% in 2019, then eliminated in 2020.
    • Tax rate: The maximum corporate tax rate remains 35%.

The key tax changes that would adversely affect renewable energy projects are listed below. Note that the first two, the elimination of renewable energy tax credits and the phase out of bonus depreciation, are features of the current tax code that are assumed to be replicated in the Trump and House GOP tax plans. The third, the elimination of the deductibility of interest on future loans, appears solely in the House GOP plan.

    • The elimination of tax credits. We assume that the Trump and House GOP tax plans phase out the credits for renewable energy on the same schedule as the current tax code.[3] With respect to tax credits, therefore, the only difference between the three scenarios is the elimination in 2022 of the standard 10% ITC for business investment under the Trump and House GOP plans; under the current tax code, the 10% ITC for business investment persists indefinitely.
    • The phase-out of bonus depreciation. We assume that the phase out of bonus depreciation under the Trump plan occurs on the same schedule as under current law. Only the House GOP tax plan would preserve bonus depreciation, increasing it from 50% currently to 100%.
    • The elimination of the deductibility of interest. While the current tax code allows interest expense to be deducted from income, the House GOP plan would eliminate the deductibility of interest on future loans. Under the Trump plan, power developers could choose to expense capex and give up the deductibility of interest; we assume, however, that they choose not to and rather retain the interest deduction as the economics are more attractive.

Impact of Proposed Tax Reforms on the Cost of and Outlook for Solar Energy

Given the above assumptions, we calculate that the power prices required under 20-year power purchase agreements to justify investment in new solar projects will be higher under the Trump and House GOP tax plans, as compared to the prices required under the current tax regime, by ~6.5% to 6.9% in 2018;

~4.5% to 4.9% in 2020; and ~9.0% to 9.5% in 2024 (see Exhibit 3). In 2018, this increase in cost primarily reflects the cut in corporate tax rates under the Trump and House GOP plans and the consequent reduction in value of the tax deductions available to solar project developers due to accelerated depreciation (MACRS) and bonus depreciation. In 2020, bonus depreciation falls away, which explains in part the lesser difference in cost in that year. In 2024, the difference in cost is attributable to the decrease in value of the deduction for accelerated depreciation as well as the absence of the standard business investment tax credit of 10%, which is ongoing under the current tax code but eliminated under the Trump and House tax plans. In each year, the House tax plan adds an additional burden by eliminating the deduction of interest on future loans; measured over 20 years, the immediate expensing of capex allowed under the House plan is offset by the inability over the subsequent 15 years to deduct interest on the project’s debt.

Exhibit 3: Percentage Increase in Estimated Solar PPA Price Under the Trump and House GOP Tax Plans, as Compared to the Estimated PPA Price Under the Current Tax Code

Source: www.donaldjtrump.com; Speaker of the House Paul Ryan, A Better Way: Our Vision for a Confident America; Lawrence Berkeley National Laboratory, Utility Scale Solar 2015; SSR estimates and analysis

Critically, however, we expect the PPA prices required to support new solar projects will continue to decline over the coming decade even under the Trump and House GOP tax plans. As illustrated in Exhibit 4, we estimate the PPA price necessary to support the construction of a new utility scale, fixed mount solar PV project in 2016 to have been ~$57/MWh. By 2020, we expect the PPA prices necessary to support the construction of a similar project will have fallen (in constant 2016 dollars) to ~$44/MWh under the current tax code and ~$46/MWh under the Trump and House tax plans. By 2024, we expect PPA prices to fallen further still, to ~$39/MWh under the current tax code and ~$43/MWh under the Trump and House tax plans. Relative to our estimate of 2016 solar PPA prices, therefore, we calculate that the PPA prices required under the Trump and House GOP tax plans will be 19% cheaper, measured in constant 2016 dollars, in 2020 and ~25% cheaper in 2024 (see Exhibit 4.)

Exhibit 4: Estimated Solar PPA Price Under Current Tax Code, Trump and House GOP Tax Plans, (Expressed in Constant 2016 $) Compared to Average 2016 On Peak Power Prices

Source: Lawrence Berkeley National Laboratory, Utility Scale Solar 2015; SSR estimates and analysis

Underlying this forecast of declining PPA prices for solar is our expectation that the installed cost of solar PV projects will continue to fall. The National Renewable Energy Laboratory (NREL) estimates that the installed cost per Watt of utility scale, fixed mount solar PV projects declined by 11.3% p.a. over the five years from 2011 through 2016, and by 8.3% p.a. over the three years from 2013 through 2016. We assume that these cost declines continue through 2024, albeit at slower rate of 6.2% p.a., driving the installed cost of utility scale solar PV down by 40% from ~$1.42/Watt DC in 2016 to $0.85/Watt DC by 2024 (see Exhibit 5). We calculate that this 40% decline in the installed cost of utility scale solar PV – equivalent to over 50% in real, inflation-adjusted terms — will be more than sufficient to offset the scheduled cut in the solar ITC from 30% currently to 10% in 2021, as well as phase-out of bonus depreciation, which is scheduled to fall from 50% currently to zero in 2020 (see Exhibits 6 and 7).

Exhibit 5: Estimated Historical and Assumed Future Installed Cost of Utility Scale, Fixed Mount Solar PV Projects ($/Watt DC) Source: National Renewable Energy Laboratory, U.S. Solar Photovoltaic System Cost Benchmark Q1 2016 Report; SSR estimates and analysis

Exhibit 6: Investment Tax Credit for Commercial Solar PV Projects Exhibit 7: Bonus Depreciation
Source: Internal Revenue Service; Consolidated Appropriations Act, 2016 Source: Internal Revenue Service; Consolidated Appropriations Act, 2016

Critically, however, even at these lower levels, the PPA price of solar will remain substantially above the average 2016 on peak price of power in southern California, Arizona and Texas. (See Exhibit 4). This is true even in 2024, by which time we expect the installed cost of utility scale solar PV projects to have declined by half in real terms, and the PPA price required to support a new solar project, under the Trump and House GOP tax plans, to have fallen to only $43/MWh in 2016 dollars. By comparison, the average wholesale power price during peak hours in the desert southwest, where the bulk of U.S. solar capacity has been built to date, ranged in 2016 from an average of ~$25/MWh at the Palo Verde hub to ~$30/MWh at the SP15 hub – still some 30% to 40% below our estimated 2024 PPA price of solar. Although illiquid and not a reliable indicator of future pricing, the forward price for on-peak power in 2024 is currently only $31/MWh at Palo Verde and $36/MWh at SP15 in constant 2016 dollars, still well below our forecasted solar prices.

We therefore expect no fundamental change in the drivers of and outlook for solar development. As we expect solar PPA prices to remain substantially higher than on-peak power prices, solar development will likely continue to depend on state renewable portfolio standards for the PPAs required to support its construction. Declining prices, however, should encourage additional states to increase their renewable portfolio standards, as five states including New York and Illinois did in 2016, increasing this policy-driven demand. A second source of demand for solar is likely to be from firms such as Google, that have adopted renewable targets for non-economic reasons, or utilities such as Austin Energy, which offer their customers the choice of renewable electricity. [4]

However, the more limited availability of tax equity could so raise the cost of some solar projects as to prevent them from being built, possibly slowing the growth rate of solar. Developers who, before the expiration of the ITC, are unable to raise tax equity, and thus must use the tax benefits internally on a deferred basis, could be forced to raise the solar PPA prices they offer buyers by 35-40%.

Impact of Proposed Tax Reforms on the Cost of and Outlook for Wind Power

In sharp contrast to the outlook for solar, we expect wind development to be materially adversely affected by changes in the tax code, and particularly the phase-out of the production tax credit. The Consolidated Appropriations Act, 2016, which became law in December 2015, provided for the phase-out over time of the production tax credit (PTC) for wind, just as it phased out the investment tax credit for solar. (See Exhibit 8: the production tax credit will be reduced by 20% in 2017, 40% in 2018, and 60% in 2019, and will be eliminated in 2020. Compare Exhibit 6, which sets out the schedule for the phase-out of the solar investment tax credit.) As explained above, we have assumed that the schedules established by the Consolidated Appropriations Act for phasing out these two renewable energy credits are maintained under the Trump and House GOP tax plans.

Equivalent to 30% of the cost of eligible property, the value of the investment tax credit to solar developers has declined over time in direct proportion to the cost of their investments in eligible solar projects. By contrast, the value of the production tax credit (PTC) for wind has only increased in economic importance as the wind power industry has matured. Originally set at $15/MWh by the Energy Policy Act of 1992, the value of the PTC was indexed to inflation, so that by 2016 the credit had increased to $23/MWh. The wind projects that were the beneficiaries of the subsidy, by contrast, declined significantly in cost over this period. In 1992, when the credit was introduced, the levelized cost of energy from a new wind power project was ~$160/MWh[5], so that the credit was worth less than 10% of the cost of wind power; by 2015, the levelized cost of energy from wind had fallen to ~$50, so that the PTC is now equivalent to approximately half the cost wind power. The loss of the production tax credit for wind will have thus have a larger impact on PPA prices for wind than the loss of the 30% investment tax credit will have on PPA prices for solar.

A second important difference between wind and solar is that the installed cost of wind projects has been declining in recent years at a much slower pace than the installed cost of solar. Whereas between 2010 and 2015 the installed cost of utility scale solar PV projects declined at ~15% p.a., the installed cost of wind projects over this period has fallen by less than 5% p.a. While we assume, therefore, that the installed cost of wind will continue to fall rapidly (at 9.6% p.a., in our forecast, from 2015 through 2024), we assume that the installed cost of wind projects will fall only modestly (at 1.0% p.a. from 2015 through 2024). (See Exhibit 9).

Exhibit 8: The Production Tax Credit for Wind

Source: Internal Revenue Service; Consolidated Appropriations Act, 2016

Exhibit 9: Estimated Historical and Assumed Future Installed Cost of Wind Projects ($/Watt AC)

Source: Lawrence Berkeley National Laboratory, Wind Technologies Market Report, 2011-2015; SSR estimates and analysis

Thus, whereas it is our view that ~10% annual declines in the installed cost of solar over the coming decade will more than offset the loss of the 30% investment tax credit and the 50% bonus depreciation deduction, the much flatter cost curve for wind implies that future cost reductions will not offset the loss of bonus depreciation and the PTC.

 

Rather, relative to the PPA price required to justify investment in a new wind project in 2016, we estimate that the PPA prices required under the Trump and House GOP tax plans would be some 27% to 30% higher in 2020, measured in constant 2016 dollars, and approximately 43% higher in 2024. (See Exhibit 10.)

Exhibit 10: Estimated Wind PPA Price Under Current Tax Code, Trump and House GOP Tax Plans, (Expressed in Constant 2016 $), Compared to Wholesale Power Prices in 2016

Source: Lawrence Berkeley National Laboratory, Wind Technologies Market Report, 2011-2015; SNL; SSR estimates and analysis

While the lowest cost developers may be able to offset some of the impact, the implication of this increase in future PPA prices for the wind industry as a whole, we believe, will be significantly reduced growth post-2020 after the expiration of PTCs. Whereas today we estimate that PPA prices for wind, under the current tax code, are competitive with round the clock power prices in SPP, MISO and CAISO, this will change with the loss of the production tax credit by 2020; by then, even if the current tax code is maintained, we calculate that PPA prices for wind will exceed round the clock power prices in CAISO and MISO and will be only marginally economic in SPP. Under the Trump and House GOP tax plans, we calculate that the PPA price of wind would be even higher, reflecting the reduced value of the deduction for accelerated depreciation at the lower corporate tax rates introduced by these plans. As a result, PPA prices for wind would rise above round the clock prices for power in those regions of the country with the most abundant on-shore wind resources, including the panhandle of Texas, the Great Plains states, and California.

Wind will also be more vulnerable than solar to the loss of tax equity before the expiration of the PTCs, with internal consumption of tax benefits on a deferred basis by developers increasing required PPA prices by 70-80%, when PTCs are at their full value of $23/MWh.

The implication is that the future expansion of wind power, like that of solar energy, will depend on above market PPAs offered by utilities seeking to comply with state renewable portfolio standards. Such PPAs may also be available from firms like Google, that have adopted renewable targets for non-economic reasons, or utilities such as Austin Energy, which offer their customers the choice of renewable electricity.

Even in the market for PPAs, wind could lose ground to solar in regions where both resources are abundant, such as Texas and California. PPA prices for new wind projects, which we estimate to be approximately half those for solar under the current tax code today, will rise to levels only 15%-20% below the PPA prices for solar by 2024. (See Exhibit 11.)

A strategy that may be pursued by wind developers to help offset these cost increases is to repower old wind projects whose PTCs have expired with new turbines. Such repowerings can have substantially lower construction costs than new wind projects, and thus would be at a competitive advantage in securing new PPAs and tax equity. Among publicly traded companies, NextEra Energy is best positioned with over 4,000 MW of wind generation that came online in 2007 and earlier. Avangrid has over 1,000MW of wind of similar vintage, but no other companies have more than a few hundred MWs of such wind.

Exhibit 11: Estimated Average Wind and Solar PPA Prices Under the Trump and House GOP Tax Plans (Expressed in Constant 2016 $), and the Ratio Between Them

Source: Lawrence Berkeley National Laboratory, Wind Technologies Market Report, 2011-2015; National Renewable Energy Laboratory, U.S. Solar Photovoltaic System Cost Benchmark Q1 2016 Report; SSR estimates and analysis

The Border Adjustment Provision of the House GOP Plan

One of the most controversial components of the House GOP plan is the “border adjustment” of the corporate tax. This provision would exempt export revenues from the corporate income tax, but would subject imports to the tax by prohibiting firms from deducting the cost of imports from taxable income. This would have a major impact on renewable development in the U.S. as, currently, the majority of solar panels, power electronics and wind turbines are imported. We have not included the border adjustment provision in our analysis of the House GOP plan because, as the subject of the greatest controversy, its inclusion the final tax reform is far less certain than other proposed provisions, and because there is greater opportunity than with other provisions for developers to mitigate its impact by increasing their purchases of U.S. manufactured components.

However, should the border adjustment provision become law, the impact would be significant on both solar and wind. If we assume that imports account for 50% of wind and solar project costs, border adjustment would increase required PPA prices by ~11-12% for both resources, relative to our base case estimate of PPA prices under the House GOP plan, with the exception of wind coming online in 2018, when the impact would be about 16%. Similarly, the impact of including the border adjustment provision in the House tax plan would be to increase the PPA prices required for wind and solar by ~20% for both resources, compared to the PPA prices required under the current tax regime, and ~35% for wind coming online in 2018. (See Exhibit 12.)

Exhibit 12: Estimated Average Wind and Solar PPA Prices Under the House GOP Tax Plan with and without Border Adjustment (Expressed in Constant 2016 $)

Source: Lawrence Berkeley National Laboratory, Utility Scale Solar 2015 and Wind Technologies Market Report, 2011-2015; SSR estimates and analysis

While solar would still see declining PPA prices (in constant 2016 dollars) in 2020 and beyond compared to PPA pricing in 2016, this large an increase in PPA prices would likely slow the growth of solar and add a further headwind to the already unfavorable prospects for wind, putting company growth plans at risk.

The impact of the border adjustment provision could be offset by increased manufacturing of components in the U.S., which is the goal of this provision of the tax plan, but the adjustment would take several years and would likely result in increased costs.

What Will Be the Impact of Tax Reform on the Financing of Renewable Projects?

The most important feature of both the Trump and House GOP tax plans is a radical reduction in the corporate tax rate, from 35% currently to 20% under the House plan and 15% under the Trump plan. Firms that currently pay taxes at a rate near 35%, we anticipate, will enjoy a reduction in their tax bills commensurate with the cut in the tax rate. In particular, we expect this to be the case among the small group of large financial institutions that are the primary providers of tax equity to the renewable energy industry. While, we do not know how much excess tax equity capacity is currently in the market, if we are correct, the tax capacity of these key tax equity providers will be materially reduced, by ~55% under the Trump plan and ~40% under the House plan.

By contrast, unless the wind PTC and solar ITC are phased out more quickly under the Trump and House GOP tax plans, developers of new wind projects will continue to generate production tax credits on projects that commence construction through 2019, and developers of solar projects will generate the investment tax credit on projects that commence construction through 2021.

Moreover, as described in footnote 1 above and with additional detail in the footnote below, the IRS has provided guidance setting out safe harbor provisions for wind project developers wishing to claim the production tax credit that effectively allow developers to claim the PTC for projects that commence construction in 2019 but do not enter operation until 2023.[6] The IRS has not yet issued similar safe harbor provisions for the investment tax credit for solar (although we expect that the guidance should be similar.) Developers of both wind and solar projects will also be allowed to claim bonus depreciation through 2019.

If developer demand to monetize the wind PTC, the solar ITC and bonus depreciation continues unabated over the next several years, even as the tax appetite of tax equity providers is reduced by 40% to 55% due to the lower tax rates to be introduced by the Trump and House GOP tax plans, the supply of tax equity will likely be constrained relative to the demand. Absent a significant increase in taxable income for existing tax equity investors, or the entry of new tax equity investors, tax equity investors should be positioned to demand higher returns on their investments.

More importantly, for developers that cannot monetize the investment tax credit by applying it against their own tax liability, the inability to access tax equity would increase their required PPA price for solar by 35-40% and for wind by 70-80%. The renewable developers able to finance new projects most competitively, therefore, will be those with the best access to tax equity investors (either due to their size and pipeline of new projects, such as NextEra, or their strong relationships with investment banks, such as NextEra, Southern and Duke), and those with the ability to use the tax benefits internally on a current basis, such as AEP and Southern.

Finally, in an environment where the availability of tax equity is constrained, the developers of renewable energy projects are likely to look to the market for non-recourse debt (project financing) to offset any decline in the availability of tax equity. This result is similar to what can be expected when the PTC, ITC and bonus depreciation are fully phased out.

These trends may favor regulated utilities seeking to invest in renewable generation. We calculate that the levelized cost of energy (LCOE) from wind and solar projects developed by regulated utilities is lower than for competitive generators, under the current, Trump and House tax plans. This reflects regulated utilities’ longer capital recovery period (30 years vs. 20 under a PPA) and lower weighted average cost of capital over the project’s life. The difference in LCOE is equivalent to ~$0.10-0.15/W difference in cost for both wind and solar, comparable to what is achievable by the lower cost competitive developers.

Company Impacts

Within our universe, NRG and NextEra have planned the largest development of unregulated renewable generation capacity over the next few years. Through 2018, we estimate that the average annual cost of these companies’ planned wind and solar capacity additions is equivalent to 9.7% of current market capitalization for NRG and 5.4% for NextEra. Other utilities active in the development of unregulated renewable projects include Avangrid and Southern, whose planned annual investments in renewables average 3.8% and 3.1% of market cap, respectively. AEP, ConEd, and Duke plan to invest ~1.0-2.0% of their market capitalization in new renewable projects annually. (See Exhibit 13).

We note that most new unregulated renewables development, particularly for wind will likely be done by private renewable developers, private equity investors and others.

Regulated renewable projects are also being pursued by many utilities. Utilities planning to add renewable resources to rate base in the next few years, with varying degrees of specificity, including Allete, Alliant, CMS, Dominion, DTE, El Paso Electric, Great Plains, Hawaiian Electric, Pinnacle West, Portland General Electric, and Xcel.

Among publicly traded renewable companies, the module manufacturers, particularly those with development arms, such as Canadian Solar, First Solar and SunPower, have the greatest exposure to utility-scale solar development. TPI Composites and Vestas are among the most exposed to utility-scale wind development.

Should the final version of the tax reform include the border adjustment, disallowing the deduction of the cost of imports from taxable income, we expect many growth plans could be at risk, but First Solar and TPI Composites, with significant manufacturing capacity in the US, would be better positioned than other renewables equipment manufacturers.

Yieldcos, while investing in renewables, are not directly exposed to the impact of tax changes on the cost of developing new renewable resources; they acquire projects after they are brought online, leaving development risk on the developers. Among the yieldcos, we view NEP as having the largest, most stable and highest quality pipeline of potential acquisitions through its parent, NextEra.

Exhibit 13: Planned Development of New Unregulated Renewable Energy Projects over 2017-2021

(Estimated Annual Cost of New Projects Expressed as a % of Current Market Capitalization)

Source: Company reports and SSR estimates and analysis

©2017, SSR LLC, 225 High Ridge Road, Stamford, CT 06905. All rights reserved. The information contained in this report has been obtained from sources believed to be reliable, and its accuracy and completeness is not guaranteed. No representation or warranty, express or implied, is made as to the fairness, accuracy, completeness or correctness of the information and opinions contained herein.  The views and other information provided are subject to change without notice.  This report is issued without regard to the specific investment objectives, financial situation or particular needs of any specific recipient and is not construed as a solicitation or an offer to buy or sell any securities or related financial instruments. Past performance is not necessarily a guide to future results

  1. The production tax credit is available at rate of $23/MWh to all wind projects that began construction by the end of 2016. Under current law, the PTC falls by 20% in 2017, 40% in 2018 and 60% in 2019, before expiring in 2020. The IRS has stated that a wind project must complete construction within four years to qualify for the tax credit available in the year that construction began; thus a project that started construction in 2016 could be completed by the end of 2020 and still qualify for the $23/MWh PTC. We expect similar guidance will be given for solar. For purposes of modeling the economics of wind and solar projects in this note, we have assumed a construction period of two years for both wind and solar projects. In reality, however, many projects may take advantage of the full four year window for construction. Thus, there will likely be many wind projects coming online in 2020 that have similar economics to what we have modeled for 2018. Similarly, there could be solar projects coming online in later years that benefit from a higher level of ITC than we have modeled.
  2. We found that, while the difference was relatively small, the interest deduction resulted in ~$0.50/MWh reduction in the required PPA price with tax equity and ~$1-2/MWh without tax equity compared to 100% bonus depreciation.
  3. If the tax credits for wind and solar are eliminated immediately under tax reform, PPA pricing would rise dramatically for both types of projects, by more than 40% for solar and by more than 80% for wind. In this scenario, the continuing, rapid decline in the cost of solar projects should allow for continued development of solar projects after an initial reset. Wind would likely face much greater headwinds with only the lower cost developers and the repowering of older projects securing new PPAs, and much of the new wind capacity being developed on a regulated basis by utilities.
  4. The attractiveness of solar energy could of course be enhanced by higher or simply more volatile prices natural gas. Natural gas is the price-setting fuel in the power markets of the southwest, the region with the best solar resource in the United States and thus the lowest solar PPA prices. Higher natural gas prices would tend to close the gap between the wholesale price of energy and the PPA price of solar, rendering the decision to switch to solar more attractive to regulated utilities, even if state renewable mandates have been met. In markets where gas is the price setting fuel, the historical volatility of natural gas prices further enhances the attractiveness of a 20 year, fixed price contract for solar power to both utilities and their regulators.
  5. Lanz, Wiser & Hand, The Past and Future Cost of Wind Energy, The National Renewable Energy Laboratory, 2012, pg. iv.
  6. The IRS has provided guidance (Notice 2016-31) setting out safe harbor provisions for wind project developers wishing to claim the production tax credit. The IRS’ safe harbor provisions allow a developer to claim the PTC available in a particular year if (i) the developer commences construction of the project in that year, and (ii) the developer makes continuous progress towards completion of the project once construction has begun. A wind project developer may establish the beginning of construction in any year by starting “physical work of a significant nature” or by incurring 5% of project expenditures in that year (e.g., by placing a down payment on a wind turbine.) The second prong of the test, the “continuity requirement,” is satisfied if the developer put the project into service within four calendar years of the year during which construction was began. Thus to claim the wind PTC before it expires in 2020, a project developer must commence construction of the project, or incur 5% of project expenditures, in 2019, and complete the project by 2023.
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