from Energy Realpolitik

A New Dawn for Wind Energy Infrastructure After the Production Tax Credit Sunset

Power-generating windmill turbines are pictured at sunset at a wind park in Cagnicourt near Cambrai, France, May 22, 2019. REUTERS/Pascal Rossignol

The wind industry is approaching the end of its federal financial support. Political leaders around the country are debating the best ways to continue supporting the wind industry.

July 15, 2019

Power-generating windmill turbines are pictured at sunset at a wind park in Cagnicourt near Cambrai, France, May 22, 2019. REUTERS/Pascal Rossignol
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This is a guest post by Benjamin Silliman, research associate for energy and U.S. foreign policy at the Council on Foreign Relations.

The wind industry is approaching the end of its federal financial support. The Production Tax Credit (PTC), which was designed to drive investment by providing reductions in tax liability for renewable energy producers, is set to expire for large wind facilities at the end of this year, meaning that no wind projects entering construction or procuring equipment after the next few months will be eligible for federal support. Political leaders around the country are debating the best ways to continue supporting the wind industry. Senator Lisa Murkowski (R-Alaska) asked recently whether the wind industry still needs help at all. There is little doubt that wind power is more competitive now than when the incentives were first introduced, but in a market saturated with incentives for coal, gas, and solar power, the wind industry will need new and innovative policies to continue propelling its growth. A new set of federal support mechanisms that expand transmission infrastructure, research and development, and energy storage while reducing investor risk through a loan guarantee program would create a more equitable market environment that will promote the wind energy buildout.

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Originally enacted in 1992, the PTC for wind began to phase out in 2017, with the credit set to drop to 0 percent of its original value at the end of 2019. In practice, however, the Internal Revenue Service (IRS) will allow facilities up to four years to come online, so the credit will be in effect for existing projects until 2023. The PTC offered a tax credit to eligible energy producers based on the amount of electricity produced. To take full advantage of this incentive, given that few energy producers have a high enough tax burden to make full use of the credits, wind energy producers typically form partnerships with larger firms that have greater tax liabilities, transferring the credits as a form of equity in the project. This gives wind producers two main financial benefits: an initial cash injection once the project connects to the grid that can be used to pay off construction loans, and an alternative source of income for the project untethered from electricity pricing risk. Once the project is operational, the tax equity investor is allocated a certain proportion of the project’s revenues, losses, and tax credits until it attains a target return on investment. At that point, the partnership structure “flips” and the project’s value begins accruing primarily to whomever owns the nontax “sponsor” equity.

While the PTC has worked as intended in generating revenue and catalyzing wind buildout, some drawbacks emerged as the industry matured. One issue was the limited pool of investors with both a tax liability high enough to reap the full value of the PTC and the necessary risk appetite and financial and legal understanding to enter into a complicated tax partnership. Therefore, most investors in the tax equity space are either heavyweight investment banks or the in-house financing shops of major equipment manufacturers like Siemens and General Electric. This has created a huge mismatch between the number of projects under development and the limited amount of capital available to finance those developments, which allows tax equity providers to exert a great deal of leverage over how many and which types of projects get built in a given year.

Additionally, tax equity is a more expensive form of capital than long-term debt in a low-interest rate environment, with target returns ranging as high as eight percent. One turbine manufacturer, Vestas, estimates that switching to other financing sources that have less complicated structures will still allow for profitability albeit at a lower margin than under the PTC. With the tax equity revenue stream unavailable, it is possible that investors, developers, suppliers, and construction firms will come to accept lower margins and premiums, as has already been the case for the more competitive solar market, where investors and participants throughout the entire value-chain do not expect as large returns. In the end, wind energy may become less lucrative, but ending the PTC does not change the record-low cost of wind energy itself, nor will it slow the deployment of high-efficiency turbines and performance-maximizing software, which will continue to push costs lower still. This means wind power will remain competitive against natural gas despite the loss of tax credits, especially in the central and western United States.

This resilience in the face of the tax equity cliff does not necessarily mean that the PTC has outlived its usefulness. The financiers of the wind industry will need to evaluate whether the amount of money and effort it takes to originate, develop, finance, construct, and operate a wind farm will still be an attractive use of capital. Wind energy will be uniquely disadvantaged in that evaluation, as it will be competing unsubsidized against other energy resources currently receiving government financial support. This evaluation could be even less favorable in more competitive and established energy markets like the Pennsylvania New Jersey Maryland Interconnection (PJM), where cheap existing sources of natural gas electricity and obtuse rules surrounding their Reliability Pricing Model, which requires suppliers to guarantee production into the future, can make it difficult for new wind plants to make an entry.

The U.S. federal government subsidized coal, oil, and gas production by nearly $14.7 billion annually in 2015 and 2016. The most valuable incentives included tax deductions for drilling and exploration, the ability to form tax-favored investment vehicles such as master-limited partnerships, and guaranteed below-market lease rates on federal land. Meanwhile, the rapidly maturing solar industry will continue to receive tax credits in perpetuity, as the investment tax credit for utility-scale projects is only stepping down from its current 30 percent to a floor of 10 percent in 2021. As an energy source with negligible marginal cost and a more varied production profile than solar, wind will remain competitive in its strongest markets, such as the Midwest and south-central United States. It may also continue to expand in the Rocky Mountains as regional utilities gradually sign on to the Western Energy Imbalance Market and implement decarbonized resource plans. However, in markets like PJM and New England, the loss of government tax credits could make it harder for wind to gain new market share.

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Policymakers looking to keep the wind industry thriving should consider addressing external factors that may be limiting wind development instead of access to tax incentives. Development and construction costs are not the only deciding factors for wind energy’s final price. Transmission costs for wind energy can be prohibitive due to geographic factors pushing wind supply farther from population centers where demand for electricity is highest. Also, combining wind power with energy storage options to reduce wind generation’s variability currently raises the cost of supplied generation.

What should ultimately replace the PTC is an incentive system that promotes not only wind generation itself, but the technology and infrastructure that is needed to support its continued development. A good successor would be an initiative to promote energy storage and high-voltage transmission. Federal storage capacity mandates, modeled after state-level storage targets, could help expedite the deployment of sufficient storage capacity. This could be accompanied by a tax incentive similar to the PTC for storage technologies. Including transmission in any larger-scale federal infrastructure package will be essential. Regulations requiring utilities to meet certain cybersecurity, demand response, and infrastructure access criteria will help put more emphasis on infrastructure quality and quantity. Transmission incentives in particular would benefit wind power more directly rather than offering tax assistance to major financial institutions. At this point in the maturity of wind technology, tax credits or direct federal spending is best spent lowering the financial barriers of long-distance transmission lines and to help balance variable production.

Another way to ensure continued spending on wind farms is to offer federal loan guarantees on wind projects to reduce financial risk. Alternatively, tax incentives might be useful for research on new technologies, such as materials and software for wind turbines and underground wiring and aluminum composite-core conductors for transmission lines.

As Columbia University economist Noah Kaufman and former CFR senior fellow Varun Sivaram recently proposed, a new tax incentive system for “critical applications,” a system that seeks to promote the benefits of a set of technologies instead of on the technologies themselves, could improve  not only wind capacity buildout, but also improve the competitive market selection process that guides Congress when it identifies technologies to subsidize. Instead of replacing the PTC with another technology-specific tax credit, the credit should be based on meeting certain hard-to-meet standards; for example, achieving zero-carbon emissions for under a certain price. This allows the government to subsidize breakthrough high-performing technologies, but not necessarily choose winners. This could also create competition among technologies and encourage more research and development since any technology capable of meeting the standards would receive the benefit.

Wind power remains a critical alternative to fossil fuel electricity generation, providing low-cost carbon-free power. Wind power in the central United States has lowered the national average cost of electricity. The federal government should not simply assume that because the wind industry can stand alone without support, it no longer needs any assistance. Creating ideal market environments for wind power will help expand the capacity buildout, lower fossil fuel dependence and carbon emissions, and continue to bring down electricity costs throughout the country.

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