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									       TRENDS IN FINANCING AND
     INVESTMENT IN RENEWABLES

James F. Duffy, Esquire   RENEWABLE ENERGY IN NEW
Nixon Peabody LLP         ENGLAND
100 Summer Street
                          Law Seminars International
Boston, MA 02110-2131
(617) 345-1129            Boston, Massachusetts
jduffy@nixonpeabody.com   September 8-9, 2008
              PROJECT FINANCE

• This panel will focus on project finance, as opposed
  to company finance
• Both project finance and company finance are, as
  the seminar brochure suggests, “booming” but
  project finance for renewables is different than from
  other project finance, so it deserves special attention
  and special discussion


                                                            2
              PROJECT FINANCE

• Project finance for most renewable facilities is
  heavily tax driven
• The tax considerations are the primary drivers in
  financing these transactions
• Tax equity investors are a somewhat special type of
  investor, and their motivations and goals have to be
  understood

                                                         3
          TAX EQUITY INVESTORS

• Tax equity investors are generally (but not always)
  institutional investors -- banks, investment banking
  firms, insurance companies, and “companies that
  advertise on the Super Bowl”
• The investments addressed here are not traditional
  investments in companies or in projects, but
  investments in the tax attributes of renewable energy
  facilities


                                                          4
         INVESTOR MOTIVATIONS

• Tax equity investors in renewable energy are
  generally motivated by a combination of policy and
  economic reasons
• Investing tax equity in renewable energy is both
  “good” AND economically advantageous




                                                       5
    RENEWABLE ENERGY IS “GOOD”

• This is self-evident to some, including most or all of
  us here in this room, but increasingly corporate
  America is looking to be “green”, whether or not the
  corporation’s leaders believe in global warming
• Depending on the corporation’s situation and
  markets, the incentives can differ somewhat, but the
  policy motivations for tax equity investors generally
  have many common themes


                                                           6
         POLICY CONSIDERATIONS
• Green investments are viewed favorably by
  customers/suppliers/the public at large
• Green investments generate good press for
  companies beyond the investments themselves
• Government policies favor investments in renewable
  energy -- today this applies particularly to utility
  companies, but will spread (i.e., the recent federal
  real estate statute)

                                                         7
         POLICY CONSIDERATIONS

• Stockholders of public companies clamor for “green”
• Company leaders may be “true believers” in green
  OR in the nation’s need for energy independence
• Employees like to work for environmentally
  responsible companies
• Investments in green energy can be publicized to
  offset other not-so-green corporate activities

                                                        8
          ECONOMIC MOTIVATIONS
• Tax equity investors generally have an internal rate of
  return to achieve in making investments in renewable
  energy
• There are 3 components to this rate of return:
   – Tax Credits;
   – Losses to offset the investor’s income from other
     sources; and
   – Cash returns

                                                            9
            ENERGY TAX CREDITS
• There are two basic types of tax credits for renewable
  energy:
   • Production Tax Credits (“PTCs”) for renewable
     electricity production, under Section 45 of the
     Internal Revenue Code
   • Investment Energy Tax Credits (“ITCs”), under
     Section 48 of the Internal Revenue Code
   • Each of the PTC and the ITC is a dollar-for-dollar
     reduction in Federal income tax liability
                                                           10
           PRODUCTION TAX CREDITS
• Available with respect to electricity produced from
  “qualified energy resources”:
   –   Wind;
   –   Closed-loop biomass;
   –   Open-loop biomass;
   –   Geothermal
   –   Solar (but only if placed in service prior to 1/1/06);
   –   Small irrigation power;
   –   Municipal solid waste; and
   –   Qualified hydropower production.
                                                                11
         PRODUCTION TAX CREDITS

• The Production Tax Credit is currently (for 2008) 2.1
  cents per kilowatt hour of electricity produced by the
  taxpayer and sold to an unrelated person, for a 10-
  year period beginning on the date the facility was
  originally placed in service

• So, the amount of tax credits depends upon the
  amount of electricity generated

                                                           12
       PRODUCTION TAX CREDITS

• The 2.1 cents per kilowatt hour is reduced to by
  50%, to 1.05 cents per kilowatt hour, for the
  following facilities: open-loop biomass, small
  irrigation power, landfill gas, trash combustion and
  qualified hydropower



                                                         13
      PRODUCTION TAX CREDITS
• The “Produced by the Taxpayer” requirement
  means that the owner of the energy facility
  receives the PTCs
  – subject to an exception for lessees of certain open-
    loop biomass facilities to receive the PTCs
• So, the PTCs are generally syndicated to a tax
  equity investor who becomes a partner or
  member of the entity owning the energy facility

                                                           14
           SYNDICATING THE PTCs
• You can’t just sell PTCs to a tax equity investor; you
  have to make the “purchaser” of the PTCs an owner
  of the wind project

• Most developers of renewable energy projects either:
  (i) do not anticipate having Federal income tax
  liability for the next 10 years such that they will be
  able to take advantage of the PTCs themselves, or
  (ii) need to monetize the PTCs up front in order to
  help pay for the costs of developing the project
                                                           15
      SALE OF THE ENTIRE PROJECT

• One option is that at or just before the date when a
  wind project is placed in service, the developer will
  sell the entire wind project to a purchaser who will
  then own the project and receive the PTCs

• Under this scenario, the value of the PTCs is one
  component of the total purchase price paid for the
  project


                                                          16
      SALE OF THE ENTIRE PROJECT

• Also, under this structure, the original developer
  generally gives up control of the project

• Particularly in a community-oriented project, the
  original developer may not want to give up control of
  the project, as the original developer is generally a
  part of the local community



                                                          17
   BACK TO SYNDICATING THE PTCs

• Section 45(e)(3) of the Internal Revenue Code
  anticipates that the owner of a project may have
  more than one owner

• Section 45(e)(3) provides that if a project has more
  than one owner, the PTCs will generally be shared
  by the owners in proportion to their respective
  ownership interests in the “gross sales” from the
  facility

                                                         18
           SYNDICATING THE PTCs
• One way to structure a transaction so that there is
  more than one owner for tax purposes is to utilize, as
  the owner of the renewable energy project, a limited
  partnership or a limited liability company

• For tax purposes, a partnership (which includes a
  limited liability company) is not recognized as a tax-
  paying entity, so that the partners are treated as
  owners according to their allocable interests in the
  partnership
                                                           19
           SYNDICATING THE PTCs

• The original project developer can structure the legal
  owner of the project as a limited partnership or an
  LLC, and the tax equity investor who is interested in
  the PTCs can be a limited partner or member thereof
  and thus an owner of the project for tax purposes

• The owner can then allocate almost all (up to 99%)
  of the PTCs to the tax equity investor

                                                           20
           SYNDICATING THE PTCs

• The original developer can remain in control of the
  project by being the general partner of the
  partnership (or the managing member of an LLC)

• But, remember that the PTCs are shared between
  the owners in proportion to their shares of “gross
  sales”

• So, in my example the investor would generally have
  to receive a 99% interest in the gross sales of the
  project
                                                        21
           SYNDICATING THE PTCs
• However, the developer, as the general partner of the
  limited partnership, can receive a reasonable fee for
  managing the project

• The original developer could also receive a
  reasonable development fee for developing the
  project, and to the extent that there were insufficient
  sources of funds to pay that fee up front, some of it
  could be deferred and paid out of operating revenues

                                                            22
           SYNDICATING THE PTCs

• Debt on the project could be paid prior to reaching
  the 99-to-1 sharing ratio

• Where the developer has contributed capital to the
  limited partnership to fund the gap between the total
  development costs and the amount of the investor’s
  capital contribution, under Rev. Proc. 2007-65 (more
  on that later) the developer’s capital contribution can
  be returned as a priority cash flow item prior to the
  99-to-1 sharing ratio
                                                            23
           SYNDICATING THE PTCs

• The developer could borrow outside the partnership
  to obtain this capital, possibly pledging its interest in
  the partnership as collateral

• The investor’s payments can be characterized
  entirely as capital contributions to the owner limited
  partnership or they can be characterized partially or
  entirely as a purchase price for the investor’s interest
  in the owner limited partnership

                                                              24
      99%                1%
Limited Partner     General Partner
   (Investor)        (Developer)



             Limited
           Partnership
            (Owner)




              Project



                                      25
           SYNDICATING THE PTCs
• At some point after the end of the 10-year PTC
  period, there could be a ”flip” to give the general
  partner (the developer) a greater percentage interest
  (up to 95%) in the project’s cash flow (or gross sales)

• And at some point after the 10-year PTC period (or
  after the investor has achieved a targeted IRR yield),
  the general partner/developer could have an option
  to buy out the limited partner/investor’s interest at the
  fair market value of that interest (generally post-flip)
                                                          26
          SYNDICATING THE PTCs

• The tax equity investor’s payment can be made up-
  front, so that it can be used as owner’s equity in the
  development process, or (more likely) upon
  completion to pay off development period financing

• The investor could pay most (up to 80%) of its funds
  on a pay-in schedule of up to 10 years, as PTCs are
  delivered (a “pay-as-you-go” plan), but at least 75%
  of the investor’s reasonably expected investment
  must be fixed and determinable and not contingent
                                                           27
         SYNDICATING THE PTCs

• These are just general concepts. The terms of
  the syndication of the Production Tax Credits
  from each project will vary, based in part upon
  the economics of the particular transaction




                                                    28
            SYNDICATING THE PTCs
• Because of the sophisticated tax structuring involved,
  there will be not insignificant legal and accounting costs in
  each of these transactions, so it may not be as cost-
  efficient to syndicate the PTCs in this manner for smaller
  projects, unless (i) the investor is a community-oriented
  company willing to make a relatively small investment, (ii)
  a smaller project can be pooled with other similar projects
  to provide a larger investment to cover the transaction
  costs, or (iii) a smaller project can take advantage of
  favorable financing not generally available to larger
  projects

                                                                  29
        AGGREGATING PROJECTS

• In the model shown on the chart on the
  following slide, each relatively small project can
  be structured based upon its own economics
  and can negotiate its own business deal with
  the investment fund




                                                       30
                          1%                            99%
                     General Partner                  Limited
                      (Syndicator)                   Partner(s)
                                                   (Investor(s))
                           99%
                    Limited Partner(s)
                    (Investment Fund)

    1%            1%                   1%                   1%
  General       General              General              General
  Partner       Partner              Partner              Partner
     A             B                    C                    D
(Developer)   (Developer)          (Developer)          (Developer)

  Limited       Limited              Limited              Limited
Partnership   Partnership          Partnership          Partnership
     A             B                    C                    D
 (Owner)       (Owner)              (Owner)              (Owner)


  Project       Project                  Project          Project
    A             B                        C                D


                                                                      31
         AGGREGATING PROJECTS
• With aggregation, the investor benefits from
  diversification of sponsor and energy regime, and
  perhaps off-taker, compared to an investment in one
  large project

• To keep down transaction costs, the same base
  documentation can be used as the starting point for
  each project

                                                        32
          AGGREGATING PROJECTS

• Facilitating these structures is an area where the
  states and public advocacy groups could be very
  helpful

• States and institutional non-profits have done this in
  the housing tax credit area to facilitate the
  syndication of those tax credits


                                                           33
                 PTC POINTERS

• The PTC is reduced by up to 50% to the extent that
  project costs are funded by (i) federal, state or local
  government grants for use in connection with the
  project, (ii) the proceeds of state or local tax-exempt
  obligations, (iii) subsidized energy financing provided
  directly or indirectly by federal, state or local
  programs or (iv) other credits allowable with respect
  to any property which is part of the project

                                                            34
                 PTC POINTERS

• For the first 4 years of the 10-year PTC tax credit
  period, PTCs can be applied to reduce the investor’s
  Alternative Minimum Tax

• The amount of the PTC, currently 2.1 cents per
  kilowatt hour of electricity generated, is re-calculated
  by the IRS for each year of the PTC period of a
  facility (it was 1.9 cents per kilowatt hour for 2006
  and 2.0 cents per kilowatt hour for 2007)


                                                             35
                 PTC POINTERS

• PTCs are received by the taxpayer as they are
  earned, so there is no recapture risk to a tax equity
  investor if the investor sells its PTC investment
  during the 10-year PTC period (this is an advantage
  over many other tax credits where there is a tax
  credit recapture risk if the investment is disposed of
  during the tax credit period)


                                                           36
      REVENUE PROCEDURE 2007-65

• Revenue Procedure 2007-65 (effective November 5,
  2007) gives guidance in structuring wind energy
  transactions (although it is also taken into
  consideration in PTC transactions which do not
  involve wind projects)

• This is a “safe harbor”, but be very wary of not
  following it

                                                     37
      REVENUE PROCEDURE 2007-65

• In order to comply with Rev. Proc. 2007-65, the
  developer must have a minimum 1% interest in each
  item of partnership income, gain, loss, deduction,
  and credit throughout the term of the partnership

• Also, an tax equity investor’s interest cannot “flip”
  down to less than 5% of its initial interest



                                                          38
      REVENUE PROCEDURE 2007-65

• Under Rev. Proc. 2007-65, there are no calls
  (developer’s rights to buy out the tax equity investor’s
  interest) in the first 5 years, and no puts (tax equity
  investor’s rights to require the developer to buy out
  the tax equity investor’s interest) at all

• Any calls must be for not less than the fair market
  value of the interest involved

                                                             39
      REVENUE PROCEDURE 2007-65

• In order to comply with the Rev. Proc., as of the later
  of the project’s placed in service date or the investor
  admission date, the investor must have at least 20%
  of its total anticipated capital invested in the
  partnership

• Also, at least 75% of the investor’s capital must be
  not subject to adjusters

                                                            40
         INVESTMENT TAX CREDITS
• ITCs are available, generally, for energy property
  using solar energy to generate electricity, to heat or
  cool (or provide hot water for use in) a structure, or to
  provide solar process heat (except for swimming
  pools), or to produce, distribute or use solar energy to
  illuminate using fiber-optic distributed sunlight, or
  qualified fuel cell property, or qualified microturbine
  property
• So this is a generally described as a solar energy tax
  credit -- Photovoltaic “PV” and Concentrated Solar
  Power (“CSP”), but also includes fuel cells
                                                              41
          INVESTMENT TAX CREDITS

• As an investment tax credit, the credit is based on the
  cost of the facility, not on how much electricity is
  produced
• There is no requirement that electricity be sold, just
  that the facility generate electricity, heating, cooling or
  lighting



                                                                42
          INVESTMENT TAX CREDITS

• The credit is generally 30% of the cost of the “facility”
  (which does not include ancillary aspects like
  transmission lines and substations)
• The credit is claimed in the year the facility is placed
  in service in daily operation (although in certain
  circumstances it could be claimed based on
  “progress expenditures” over more than one year)
• Recapture possible for 5 years (credit vests 20% per
  year)
                                                              43
          INVESTMENT TAX CREDITS

• ITCs are generally claimed by the owner of the solar
  facility, so the tax equity investor generally becomes a
  part owner of the facility and the ITCs are syndicated
  in a manner similar to the syndication of PTCs
• Unlike the situation with wind and most PTCs, a lease
  can be used so that the tenant claims the ITCs



                                                             44
         TAX-EXEMPT OWNERSHIP
            CONSIDERATIONS
• One complication for installations on property owned
  by governmental or tax-exempt entities is the
  existence of the so-called “tax-exempt use” rules
• Essentially, the tax credits are not available to the
  extent that the energy property is used by a tax-
  exempt entity (such as a government or a non-profit
  school, hospital, etc.)
• So, the government or other tax-exempt entity
  cannot own, or to protect 100% of the tax credits,
  have an ownership interest in, the energy facility
                                                          45
           TAX-EXEMPT OWNERSHIP
              CONSIDERATIONS
• The tax-exempt entity can purchase the electricity
  from the owner of the energy facility
• So, at least for the duration of the tax credits, the tax-
  exempt entity cannot be an owner of the facility
• And the transaction cannot be structured so that the
  tax-exempt entity would be considered an equity
  owner from the beginning (for example, no right to
  buy the facility for $1 down the road)

                                                               46
        DEPRECIATION DEDUCTIONS

• Facilities are generally depreciated over 5 years (5-
  year MACRS), so losses accumulate quickly
• For facilities placed in service in 2008, under the
  economic stimulus act, 50% of the facility can be
  depreciated in 2008



                                                          47
                  CASH FLOW
• Project Cash Flow generally comes from two
  sources:
   •   Payments for electricity, generally through a
       power purchase agreement or by merchant
       sales
   •   Monetization of renewable energy certificates
       (RECs)
• In some states there are also state incentives or
  grants which subsidize construction or operations

                                                       48
                    CASH FLOW
• The cash returns to a tax equity investor can vary
  greatly, as some properties produce significant cash
  flow while others do not
• The tax equity investor generally only wants to
  remain in the transaction for the duration of the tax
  benefits, 10 years for PTCs and 5 years for ITCs
• After the tax benefit period, it is generally intended
  that the tax equity investor exit the transaction

                                                           49
                   CASH FLOW
• One common exit strategy is for the tax equity
  investor’s interest to flip down from 99% during the
  tax benefit period to, 5-10% after it has received
  aggregate benefits (tax credits, depreciation losses
  and cash flow) equal to the investor’s negotiated
  internal rate of return hurdle
• The project developer can often then have a call to
  buy out the tax equity investor’s remaining 5-10%
  interest at its then fair market value, generating
  additional cash on exit for the tax equity investor
                                                         50
   RETURN TO TAX EQUITY INVESTOR

• The return to the tax equity investor is a combination
  of the PTCs or ITCs, the depreciation losses, and the
  cash flow
• As a result the financial models for the facility are
  closely scrutinized for each transaction
• The equity contributed by the tax equity investor
  constitutes a significant portion of the facility’s
  funding sources
                                                           51
 EXTENSIONS OF THE PTC AND THE ITC
• Under current law, a facility must be placed in service
  and be in daily operation prior to January 1, 2009 or
  PTCs go away and ITCs reduced from 30% to 10%
   – Credit extension legislation is under consideration
     now in the Congress
   – Many financings will close in 2008, but
     developments scheduled for 2009 are being
     delayed due to uncertainties as to the status of the
     tax credits in 2009
                                                            52
      NEW MARKETS TAX CREDITS

• One federal incentive which can be used by
  renewable energy projects located in certain census
  tracts is New Market Tax Credits

• New Market Tax Credits are designed to promote
  investment in communities in need of economic
  revitalization



                                                        53
        NEW MARKETS TAX CREDITS
• New Markets investors receive a federal income tax
  credit (39% over 7 years) for making qualified equity
  investments in designated Community Development
  Entities (CDEs)

• The CDEs could then invest in or lend to renewable
  energy projects

• The net result of utilizing New Markets Tax Credits is
  often a lower interest rate on project debt and a
  partial forgiveness of the debt after the 7-year New
  Markets period
                                                           54
        NEW MARKETS TAX CREDITS

• New Market Tax Credits are somewhat complicated,
  but taking advantage of them can help fund project
  costs

• Large scale renewable energy projects generally do
  not utilize New Markets Tax Credits because New
  Markets Tax Credits do not generally work well with
  larger projects due to the size of the typical award of
  New Markets Tax Credits
                                                            55
                       CREBs

• In certain situations, an alternative to PTCs or ITCs
  can be Clean Renewable Energy Bonds (“CREBs”)

• CREBs come under Section 54 of the Internal
  Revenue Code, which was added in 2005

• CREBs were designed to provide an incentive for
  governmental bodies (including Indian tribes) and
  cooperative electric companies to produce
  renewable energy
                                                          56
                      CREBs
• CREBs are “tax credit bonds”

• The borrower gets a 0% loan, as the Federal
  Government pays interest on the bonds in the form
  of a tax credit to the bond holder




                                                      57
                       CREBs
• A total of $1.2 billion of CREBs was authorized to be
  allocated in 2 rounds, in 2006 and 2007 (See IRS
  Notice 2007-26)

• These CREBs have now been allocated and, under
  current law, all of these CREBs must be issued by
  December 31, 2008



                                                          58
                      CREBs
• CREBs were allocated to qualifying and approved
  applicants beginning with the project with the
  smallest dollar amount of volume cap requested and
  then the next-smallest dollar volume cap, until the
  volume cap was exhausted (after allowing for
  minimums to be allocated to munis and coops)

• An extension of, with modifications to, the CREBs
  program is now before the Congress and is expected
  to be enacted later this year or early next year

                                                        59

								
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