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Phase-Out of the Federal Wind Tax Credit a Good Thing?

| Written by John Farrell | 4 Comments | Updated on Jun 14, 2012 The content that follows was originally published on the Institute for Local Self-Reliance website at http://www.ilsr.org/phase-out-federal-wind-tax-credit-good-thing/
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Energy and Environment News has a very long story on a new angle for the federal wind tax credit debate: a phaseout. This article raises several issues, apart from that policy strategy, that are worth a quick discussion.

1. Why Would Wind Compete with Natural Gas?

The article waxes long about the trials of the wind industry in the face of low natural gas prices, implying that utilities choose new natural gas power plants over wind power on the basis of price. I’m a bit skeptical.

Wind power is inflexible, meaning utilities have to take the power whenever the wind blows. Natural gas power plants have typically been flexible, used to provide peaking power to meet rapid changes in electricity demand. From the perspective of adding new power supply, the two aren’t competitors.

Or am I mistaken? Are there are a lot of utilities choosing to add new natural gas power plants as baseload/inflexible power that would otherwise have chosen wind power?

2. Are We Really Basing 20- to 40-year Electricity Prices from Natural Gas on Today’s Gas Price?

The article notes that natural gas power plants have a current levelized cost of $45-55 per Megawatt-hour, compared to $60-90 for wind projects that do not receive the federal tax credit (based on the quality of the wind resource). Since this is much less than estimates made last year, when gas prices were higher, one can only assume that the estimators believe that gas prices will remain forever low.

I’ll take that bet.

3. Why Would the Tax Credit Matter?

Most wind power in the U.S. has been either installed in states or the environmental attributes (renewable energy credits) sold to states with renewable energy mandates. Thus, the wind tax credit isn’t really the market-driver, but instead is transfer payment from federal taxpayers to electricity ratepayers in those states. Utilities in Minnesota, with a mandate for 25% renewable energy by 2025, for example, will have to meet that goal whether or not the contract for wind power costs 11 cents (without any federal subsidies) or 7 cents (with the credit and accelerated depreciation). Utilities in Iowa get to buy wind power very cheap, because the low-cost wind projects in that state use the federal tax incentives and then sell their renewable credits in neighboring states (e.g. Illinois).

I can think of a few reasons that the tax credit still matters:

  • Utilities are buying more wind power than they are required to, because it is so cheap.
  • Developers have projects that are financed based on the tax credit, and they fall apart without it.
  • Merchant wind power projects (selling into a competitive wholesale market) are relying on it.

If it’s the first, then the tax credit is going to slow the wind industry. If it’s the second, it’s largely a short-term problem. If it’s the third, it won’t really affect new projects so much as it will punish developers who chose to gamble on the longevity of the credit.

4. Could an Expiring/Phasing Out Credit Be a Good Thing?

In the short term, it will be bad for the industry, as illustrated by history in the adjacent chart from AWEA. But in the long run wind power will get cheaper and natural gas – a finite resource – will not. And one of the big logjams for renewable energy projects right now is an inability to actually use the federal tax incentive.

That’s because a lot of developers don’t carry the tax liability necessary to offset their power generation, and the list of big corporations that do is relatively short, giving them a lot of market power. In fact, in exchange for partnerships with wind projects to access the federal tax credits, these companies routinely get rates of return from 10% up to 49%. (I discuss this issue in more detail here).

The short supply of tax equity partners lets them charge high prices, increasing the cost to wind power developers of using the tax credits and perversely increasing the cost of electricity from wind power.

The tax credit has also created an environment where community-based wind power, with its multiplier to jobs and economic benefits (and political benefits), has an uphill struggle to compete. (There’s a great counter-example of a wind farm in South Dakota with 600 local owners made possible by the cash grant in lieu of the tax credit. I’ve also discussed how low-cost financing could allow solar developers to opt out of the federal tax credit and still lower the cost of solar energy by 25%).

If there’s no tax credit, however, there’s no high-priced tax equity market or artificial barrier to local ownership. And both of these changes may benefit the industry in the long run.

 

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About John Farrell

John Farrell directs the Energy Self-Reliant States and Communities program at the Institute for Local Self-Reliance and he focuses on energy policy developments that best expand the benefits of local ownership and dispersed generation of renewable energy. More

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  • http://www.striebecklaw.com Chris Striebeck

    John,

    Some very interesting points ….as usual!

    Have you or anyone else ever analyzed a scenario for the removal of all governmental subsidies for every form of energy, which would include marking to market the “hidden” expenses often associated with energy production such as the military expense of protecting foreign supply chains and latent enviromental or health problems?

    With respect to the later expenses, a return to common law environmentalism would also allow greater tort recovery from harm in terms of injury or nuisance as a result of coal and gas-fired emissions, nuclear waste etc.

    I think in such a context renewables would compete quite well. My problem with subsidies in general is that they are somebody’s arbitrary assessment of distorting market to favor a particular group or goal.

    I think it is easier to make a philisophical argument for equity and fairness that virtually anyone can understand rather than play the complicated game of calculating and comparing the ever-changing landscape of subsidies in all their varied forms. Granted that’s a pretty large undertaking, but I think its time is coming.

    What do you think?

  • http://www.ilsr.org/about-the-institute-for-local-self-reliance/staff-and-board/john-farrell/ John Farrell

    Part of the problem with eliminating all subsidies is that fossil fuels received much larger subsidies early in their development (late 19th and early 20th century). To zero out all subsidies now doesn’t actually level the playing field.

    Interesting concept with common law. I’m unfamiliar with how that works, but like the idea of more legal accountability for pollution!

  • Sean Casten

    You write that “the estimators believe that gas prices will remain forever low”. I think that’s quite right, but misses a key point – “the estimators” and “the investors” are two very different classes of people – EIA and others do make lots of long-term price forecasts that assume stable, predictable energy prices, but damned few investors will put $ into a new-build gas plant that is unhedged against gas price volatility, because they – unlike the estimators – do not believe that gas prices will remain forever low.

  • Sean Casten

    John:

    One other issue that strikes me is that your analysis implicitly assumes that the supply/demand for project capital is a fixed value, unaffected by regulatory incentives. I don’t think this is true, in large part because capital for clean tech has swung so dramatically between different technologies in response to changing federal policies (see chart here for particularly graphic example: http://grist.org/article/2011-12-16-us-electricity-20-years-prediction/).

    Somewhat more generally, the capital providers who put money behind tax equity deals are pretty different than the ones who provide capital for projects without significant monetizeable tax attributes. The former are dominated by large banks that have big taxable income and a fairly low risk tolerance (the nature of tax equity deal structuring is that much of the cash flow that accrues to the tax equity investor is nearly riskless, associated as it is with depreciation and interest shields. There is of course risk in the PTC tied to kWh production, but the deals are generally conservative enough to accomodate pretty severe downturns before the ‘first loss’ position doesn’t accrue to the developer rather than tax equity sponsor.) With bank profitability high, there’s a big pool of capital available for those low risk investments.

    By contrast, the capital providers for non-tax advantaged deals are dominated by fairly high risk equity that is willing to take construction risk (a small sliver of the total PE market, or strategics with a balance sheet to front the equity on their own) and project finance debt. As bank regulation is forcing banks to increase liquidity, those PF debt markets are getting much tighter.

    Upshot is that the dial back in the PTC almost certainly causes lasting damage to wind, because it forces wind to compete for capital with other technologies on a more level playing field. (e.g., CHP, biomass, geothermal, efficiency that have comparable/better fundamentals, but don’t have the same size tax subsidy). That may not be a net negative for clean tech generally, but the fact that so much capital has preferentially flowed to wind over the last 10 years does suggest that capital providers have a strong bias for tax structured deals, and in their absence could potentially find that they prefer to invest outside of energy entirely.