The NY Times has an important editorial up today, arguing for the extension of the Treasury Cash Grants for renewable energy.
Some background: last year, in response to the most significant economic downturn in several decades, the Treasury Grant Program was enacted in the Recovery Act (ARRA) to help support our growing renewable energy industry. Essentially, as we’ve written about here and here, tax credits were previously a vital deployment mechanism for renewables that were rendered ineffective as an incentive to development by the drying up of tax equity investment market. In response, a short-term fix was included in ARRA that allowed renewable energy companies to take an upfront cash grant based on project capital costs in lieu of tax credits.
The cash grant was welcomed by the renewable industry (and investors), and for good reason. It provides a fiscally efficient, timely and transparent cash incentive than is easily monetizable to help fund project capital needs. In 2009, in the face of a brutal recession, the wind industry (the primary recipient of cash grants on an aggregate dollar basis) actually grew, impressively installing over 10GW of capacity. Early numbers on solar in certain states (New Jersey, California) have been extremely bullish as well. More detail is found in this early analysis of the program from LBNL. Privately, we’ve heard from developers, bankers and attorneys that the vast majority of renewables projects being funded are using the cash grant. (while the tax credit has been an effective deployment mechanism, it is less lucrative for most projects, and more difficult to utilize).
Unfortunately for developers, the cash grant expires at the end of 2010. This expiration is problematic for a few reasons:
1) It could stifle a growing industry in a still weak economy. Due to a recession-induced fall-off in electricity consumption, constrained capital markets, and a decrease in natural gas prices, demand for renewables projects is currently limited in most states (those with strong renewable portfolio standards being the exception). Several renewable technologies (especially wind and solar) are at key inflexion points in terms of their ability to compete with conventional energy technologies, and need to continue expanding to ensure manufacturing facilities, supply chains and labor resources remain viable and accessible. Once electricity demand recovers, capital markets improve, and natural gas prices potentially revert back to historically higher, more volatile levels, renewables will be in a much stronger position. Until then, the elimination of the cash grant could severely hamper renewables growth in the short term and have negative longer term repercussions.
2) Policy uncertainty leads to investment uncertainty which leads to an earlier halt to growth. The longer the cash grant extension remains in limbo, the less likely investors are to provide capital to projects. Given this, any project unable to guarantee construction completion [see update below] by December 31 of this year (and thus access to the cash grant) will face considerable challenges raising funds. This will likely mean that fairly soon, we will begin to see and immediate and dramatic slowdown in project development, which will take 12-18 months to clear out, even with a last minute cash grant extension in December.
3) The rush to complete projects could lead to bad projects. Given the above, we’re now seeing a rush of additional projects from developers seeking to take advantage of the cash grant before its expiration. This is stressing the range of regulatory agencies in charge of permitting new projects and could lead to bad decisions and bad projects. Extending the cash grant would give understaffed regulators more time to review projects and ensure renewable facilities are environmentally sound.
There are certainly challenges with the cash grant approach, which we’ve raised in previous blogs, among them that it could lead to inflation of project costs and lower capacity factor projects. It’s also pretty expensive (almost $4 billion in a recent Joint Committee on Taxation analysis). However, given the current headwinds facing the renewables industry, we believe it to be an important short-term policy to maintain growth in this new industry (with commensurate job and local tax revenues) and ensure a successful U.S. renewables industry in the long-term.
[UPDATE 8/4/10 - small but important correction re point #2 above - developers don't need to guarantee construction completion but rather the start of construction (i.e. 5% safe harbor, via several options). The point itself still holds.]