Energy Law Alert: Energy Policy Act of 2005

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The Energy Policy Act of 2005 was signed into law by President Bush on August 8, 2005, in a ceremony in New Mexico. The U.S. House of Representatives and the Senate passed the Act by votes of 275-156 and 71-29, respectively, prior to adjourning for the August recess. Several controversial issues are notably absent, such as drilling in the Alaska National Wildlife Refuge and liability protection for MTBE producers. At least the former is expected to resurface in a budget resolution. The comprehensive 1,724-page bill provides over $12 billion in tax breaks and other production and conservation incentives for both industry and consumers. It also includes significant government regulatory reforms ranging from federal reliability standards for the nation's electricity grid to simplifying licensing procedures. Following are some of the many highlights of the bill;

TAX INCENTIVES

Renewable Energy

  • Extension and Equalization of the Production Tax Credit (§ 1301). The Act extends the production tax credit sunset date for certain types of facilities that are placed in service on or before December 31, 2007. This extension applies only to wind, closed-loop biomass, open-loop biomass, geothermal, small irrigation power, landfill gas, and trash combustion facilities. It does not apply to solar facilities, which still must be placed in service on or before December 31, 2005 to qualify for the PTC, or to refined coal facilities, which continue to qualify for the PTC if placed in service on or before December 31, 2008. The Act also extends the credit period for all qualifying facilities to 10 years (including biomass facilities, for which the credit period previously was five years). In addition, the Act adds two new energy resources to the list of "qualifying facilities"—certain incremental hydropower production and Indian coal (coal produced from reserves owned by Indian tribes). The PTC also is modified to allow passthrough of the credit to owners of certain agricultural cooperative associations. These provisions are estimated to provide over $2.7 billion in relief to the renewable energy sector, allowing for partial offsets of the costs associated with facility construction and power generation, as well as providing an avenue for innovative financing.
  • Clean Renewable Energy Bonds (CREBs) (§ 1303). The Act creates a new tax credit associated with ownership of bonds. A project may be financed with CREBs if 95% of the proceeds are used to finance capital expenditures incurred for facilities qualifying for the Production Tax Credit under 26 U.S.C. § 45. Instead of tax-free interest characterizing traditional private activity bonds issued by governments, bondholders receive a tax credit to offset their other income on a quarterly basis. Qualified issuers include governmental bodies and mutual or cooperative electric companies. The Secretary of Treasury can allow CREBs up to an aggregate of $800 million nationally. CREBs will encourage individual private investment in renewable energy projects, providing a benefit to both the taxpayer in the form of a tax credit and the renewable energy sector in the form of additional private financing.
  • Extension of Biodiesel Income and Excise Tax Credits (§ 1344; § 1346). The Act extends the biodiesel income and excise tax credits and payment provisions, which were set to expire on December 31, 2006, through December 31, 2008.
  • New Small Producer Biodiesel Credit (§ 1345). Prior to the Act, there was no specific incentive for small biodiesel producers. The Act alters this regime by adding to the biodiesel fuels tax credit a small agri-biodiesel producer tax credit of 10-cents-per-gallon for up to 15 million gallons of agri-biodiesel produced. The credit sunsets on December 31, 2008.
  • Modifications to the Small Ethanol Producer Credit (§ 1347). The Act increases the limit on production capacity for small ethanol producers from 30 million gallons to 60 million gallons per year, allowing more ethanol producers to qualify.
  • Alternative Fuel Refueling Property (§ 1342). Permits taxpayers to claim a 30% credit for the cost of installing clean-fuel vehicle refueling property to be used in a trade or business of the taxpayer or installed at the principal residence of the taxpayer. 85% of the volume must consist of ethanol, natural gas, compressed natural gas, liquefied natural gas, liquefied petroleum gas, and hydrogen. Any mixture of diesel fuel and biodiesel must contain at least 20% biodiesel.
Other Incentives for Producers of Electricity
  • Nuclear Power Tax Incentives (§ 1306). The Act establishes a production tax credit for advanced nuclear power facilities. Credit is 1.8 cents per kWh for electricity produced over an eight-year period beginning after the date of enactment.
  • Nuclear Decommissioning Costs (§ 1310). The Act expands the rules allowing current deductions for amounts deposited into qualified funds to pay nuclear decommissioning costs.
  • Transmission Property Depreciation (§ 1308). The Act shortens the previous 20-year recovery period for assets used in the transmission and distribution of electricity for sale to 15 years. This shortened recovery period applies generally to transmission and distribution property that is placed in service after April 11, 2005.
  • Treatment of Electric Cooperative Income under 85/15 Test (§ 1304). The Act extends the changes made to the 85/15 test in the Jobs Bill that were set to expire. Under the 85/15 test used to determine tax exemption, an electric cooperative is required to use 85% of its income from amounts collected from members of the cooperative to meet losses and expenses. The Jobs Bill modified this test by excluding certain income related to electricity restructuring.
  • 5-Year Net Operating Loss Carryback (§ 1311). The Act allows an elective five-year carryback of net operating losses for certain electric companies of up to 20% of the cost of electric transmission capital and pollution control expenses paid or incurred in 2003-2005. To qualify, transmission property must be used by the taxpayer in transmission at 69 or more kilovolts of electricity for sale.
  • Carryback and Carryforward of Section 29 Credits (§§ 1321-22). The Act allows a one-year carryback and 20-year carryforward of unused Section 29 credits for producing fuel from nonconventional sources. In addition, the Act expands the Section 29 credit to apply to coke and coke gas produced in certain facilities placed in service before January 1, 2010. The credit amount for coke or coke gas is $3.00, indexed for inflation using 2004 as the base year. The amount of credit-eligible coke produced may not exceed an average barrel-of-oil equivalent of 4,000 barrels per day.
  • Clean Coal Tax Credit (§ 1307). The Act establishes investment tax credits for clean coal facilities producing electricity. This amounts to a 20-percent investment tax credit for industrial gasification or integrated gasification combined cycle projects and a 15-percent investment tax credit on other advanced coal-based projects that produce electricity.
  • Accelerated Depreciation for Pollution Control Equipment (§ 1309). The Act expands the amortization allowance for certain certified air pollution control facilities used in connection with an electric generation plant that is primarily coal fired and that was placed in service after 1975.
  • Arbitrage Rule Safe Harbor for Prepayments for Natural Gas (§ 1327). The Act provides a safe harbor from arbitrage restrictions under Section 148 of the Internal Revenue Code for prepayments for natural gas that are part of a qualified natural gas supply contract. The Act also provides that such prepayments are not treated as private loans for purposes of the private business tests. This eliminates the risk that such loans are treated as tax-exempt private activity loans, which are limited by volume caps of either $80 per resident or $239 million.
Oil and Gas Incentives
  • Deduction for Capacity-Increasing Refinery Investments (§ 1312). The Act allows an election to currently deduct 50% of the cost of certain capacity-increasing refinery investments, generally effective for property the original use of which commences with the taxpayer and that is placed in service after the date of enactment and before 2012. The remaining 50% is recovered over a 10-year period using MACRS.
  • Determination of the Small Refiner Exception to the Oil Depletion Deduction (§ 1328). Oil and gas producers are classified under present law as either independent producers or integrated companies. Independent producers may claim a percentage depletion deduction rather than deducting the cost of their asset, a producing well, based on actual production from the well (or its depletion). Prior to the Act, independent producers could not have refining operations that receiving inputs of crude oil exceeding 50,000 barrels on any day in the taxable year. The Act increases this current barrel-per-day limitation to 75,000 barrels, thereby allowing more refiners to take advantage of the more advantageous deductibility rules.
  • Amortization of Geological and Geophysical Expenditures (§ 1329). The Act allows for two-year amortization of amounts paid or incurred after the date of enactment in connection with oil and gas exploration in the United States.
Natural Gas Incentives for Production, Transmission, Storage
  • Natural Gas Gathering Lines (§ 1325). Prior to the Act, it was unclear whether natural gas gathering lines had a 15-year or a seven-year recovery period under MACRS. The ambiguity has been litigated on three different occasions, with appellate courts reversing lower court holdings that expenses associated with gathering lines should be recovered over 15 years. The Act resolves this ambiguity by treating natural gas gathering lines as seven-year property. The provision is effective for property subject to an acquisition contract after April 11, 2005.
  • Natural Gas Distribution Line Depreciation (§ 1326). The Act shortens the recovery period for depreciation deductions on natural gas distribution lines from 20 to 15 years. The provision is generally effective for property placed in service after April 11, 2005 and before January 1, 2011.
Energy Efficiency and Conservation Incentives
  • Alternative Powered Vehicles (§ 1341 and § 1348). The Act provides a credit for fuel cell vehicles based on both the vehicle's gross weight and fuel efficiency. The Act also provides a credit equivalent to 50% of the incremental cost of such vehicle, plus an additional 30% if the vehicle meets certain emissions standards. These credits are capped at certain levels depending on the weight of the vehicle. A vehicle weighing less than 8,500 lbs. is entitled to a maximum credit of $5,000. Vehicles weight more than 26,000 lbs. are eligible for a $40,000 maximum credit. For hybrid vehicles, the credit is the sum of two components: (1) a fuel economy credit that varies as compared to 2002 model year standard; and (2) a conservation credit based on estimated lifetime fuel savings. The credit ranges from a minimum of $650 to $3,400. The credit for advanced lean-burn technology vehicles is determined the same way. Both hybrid and advanced lean-burn technology vehicles must be placed in service before January 1, 2011.
  • Residential Fuel Cell Equipment (§ 1335). The Act provides a new 30% tax credit for the purchase of qualifying residential solar water heating, photovoltaic equipment, and fuel cell property. The maximum credit is $2,000 for solar equipment and $500 for each 0.5 kilowatt of fuel cell capacity. The property must be placed in service after 2005 and before 2008.
  • Business Tax Credit for Purchase of Fuel Cell Power Plants (§ 1336). The Act increases the tax credit for investments in solar or geothermal property that is used to produce electricity to 30 percent and expands the eligible property to any fuel cell that converts fuel into electricity using electrochemical means and generates at least 0.5 kilowatts of electricity. The credit may not exceed $500 for each 0.5 kilowatts of capacity. Additionally, the Act provides for a new 10-percent credit for the purchase of qualifying stationary microturbine power plants. To qualify, property must be placed in service after December 31, 2005 and before January 1, 2008.
  • Personal Credit for Energy Efficient Home Improvements (§ 1333). The Act provides a new 10-percent personal tax credit for energy efficient improvements to existing homes up to a lifetime maximum of $500 per taxpayer. The provision is generally applicable to property placed in service after December 31, 2005 and before January 1, 2008.
  • Business Tax Credit for Developer Constructing Fuel Efficient Homes (§ 1332). The Act provides a new business tax credit for contractors for the construction of new energy efficient homes up to a maximum of $2,000 if homes meet a 50-percent reduction standard or $1,000 if the home meets a 30-percent reduction standard.
  • Credit for Commercial Building Energy Reductions (§ 1331). The Act provides a new $1.80-per-square-foot deduction for energy efficient commercial buildings meeting a 50-percent energy reduction standard. A partial credit of $0.60 is available if a taxpayer fails to meet the overall 50-percent standard, but certain building subsystems achieve certain benchmarks.
  • Manufacturers' Tax Credit for Efficient Appliances (§ 1334). The Act adds a new manufacturer's tax credit for the production of certain energy-efficient dishwashers, clothes washers and refrigerators.
The bill contains a host of additional tax credits and incentives for energy efficiency and conservation matters in addition to the production incentives listed above. For a more detailed description of each tax incentive provision in the conference report, click here.

FINANCING INCENTIVES
  • Incentive Payments for Grants and Renewables (§ 202). The Act extends renewable energy production incentive payments for electric energy generated by qualified biomass energy facilities owned by a not-for-profit electric cooperative, a public utility described in section 115 of the Internal Revenue Code of 1986, a State, Commonwealth, territory, or possession of the United States, or the District of Columbia, or a political subdivision thereof, an Indian tribal government, or a Native Corporation. Additionally, the Secretaries of Agriculture and Interior may make grants to those owning/operating a facility using forest biomass as raw material to produce electric energy, transportation fuels, or other petroleum-based substitutes. Grants may not exceed $20 per green ton of biomass and may not exceed $500,000 total. The Act authorizes $50 million to be appropriated each year through FY 2016. The Act also authorizes grants to merchant producers of cellulosic biomass ethanol, waste-derived ethanol, and approved renewable fuels in the U.S. to assist them in building eligible production facilities for the production of ethanol or approved renewable fuels. The Act authorizes appropriations for 2005-2007 ranging from $100 million to $400 million.
  • Grants for Facilities using Forest Biomass to Produce Energy (§ 210). The Act authorizes the Secretaries of Agriculture and Interior to make grants to those owning/operating a facility using forest biomass as raw material to produce electric energy, transportation fuels, or other petroleum-based substitutes. Grants may not exceed $20 per green ton of biomass. Grants may not exceed $500,000. $50 million is authorized to be appropriated each year through FY 2016.
  • Loan Guarantees (§§ 1702-03). Loan guarantees are authorized for up to 80% of the project cost of an eligible project. Eligible projects include projects that both reduce greenhouse gas emissions and employ significantly improved technologies. Additionally, projects must fall into one of 10 broad categories.
  • Grants to Producers of Certain Ethanol (§ 1512). The Act authorizes grants to merchant producers of cellulosic biomass ethanol, waste-derived ethanol, and approved renewable fuels in the U.S. to assist them in building eligible production facilities for the production of ethanol or approved renewable fuels. The Act authorizes appropriations for 2005-2007 ranging from $100 million to $400 million.
REGULATORY/GOVERNMENTAL REFORMS
  • Changes to Hydropower Relicensing Requirements (§ 241). Section 241 requires an expedited review and public comment process for hydropower license applications. Allows license applicants or any other party to propose alternatives to a federal resource agency's Federal Power Act sections 4(e) (reservation lands) or 18 (fishway) prescriptions. The Act requires the relevant federal resource agency to accept the alternative if it is no less protective than the fishway initially prescribed (for section 18 prescriptions) or provides adequate protection and utilization of the reservation (for section 4(e) prescriptions), and either costs significantly less than the original prescription or results in improved operation of the project works for electricity production. The Act provides for a trial-type hearing and a determination on the record on any disputed issues of material fact with respect to sections 4(e) and 18 prescriptions. The Act establishes non-binding dispute resolution for final prescriptions that the Commission finds inconsistent with the Federal Power Act.
  • PUHCA Repeal and FERC Jurisdiction (§ 1263). The Act repeals the Public Utility Holding Company Act of 1935 effective 6 months after the date of enactment. FERC is given approval authority over mergers of public utility companies, acquisitions, sales or other dispositions of more than $10 million in assets or stock of a public utility company and over the leasing of more than $10 million in public utility assets. Repeal of PUCHA will open opportunities for utility acquisitions and mergers that have been prohibited since 1935.
  • Amendments to PURPA (§§ 1251-1254). The Public Utility Regulatory Policies Act of 1978 required utilities to buy capacity when needed, as well as all energy made available to it by Qualifying Facilities. The Act eliminates the mandatory purchase obligation if the Qualifying Facility has non-discriminatory access to competitive wholesale markets for capacity and energy. The Act also eliminates restrictions on public utility ownership of Qualifying Facilities.
  • Exclusive FERC Jurisdiction over LNG Siting (§ 311). The Act clarifies that the Federal Energy Regulatory Commission has authority over siting, licensing and operation of LNG import terminals and acknowledges that states have permitting authority with respect to the Clean Water Act, Clean Air Act and Coastal Zone Management Act.
  • Renewable Fuels Standard (§ 1501). The Act establishes a Renewable Fuels Standard ("RFS"), requiring refiners to use four billion gallons of renewable fuel in 2006, ratcheting up to 7.5 billion gallons per year by 2012. Every gallon of cellulosic or waste derived ethanol counts as 2.5 gallons toward the RFS requirement. After 2013, levels will be as determined by the EPA Administrator in coordination with the Secretaries of Agriculture and Energy. Additionally, cellulosic biomas must compose a minimum of 250 million gallons of the applicable volume of renewable fuels. The provision also establishes a credit-trading regime to provide refiners with flexibility. Excess credits can be transferred to another person for purposes of complying with the RFS mandate. The RFS requirement does not apply to small refineries until 2011, but small refineries may opt-in to the program. "Small refinery" is defined as a refinery for which the average aggregate daily crude oil throughput per calendar year does not exceed 75,000 gallons.
  • Federal Government Renewable Purchase Requirement (§ 203). Requires, to the extent economically feasible and technically practicable, that the total quantity of electric energy the Federal Government consumes during any fiscal year must be renewable energy as defined in the section: 1) At least 3% in 2007-2006; 2) At least 5% in 2010-2012; and 3) At least 7.5% in 2013 and after.
  • Geothermal Lease Program Revisions (§§ 222-25). The Act requires significant revision of the competitive lease program administered by the Department of Interior.
  • Reduction in Federal Geothermal Royalties and Increase in Acreage Limits (§ 224, § 235). The Act amends the Geothermal Steam Act of 1970 to reduce lease royalty percentages to between 1 and 2.5 percent of the gross proceeds from the sale of electricity during the first 10 years of production under the lease. After that period, royalty payments cannot exceed 5 percent. The Act authorizes a credit to a lessee against royalties owed to state and county governments. As an additional incentive to current leaseholders, a 50 percent reduction in the royalty payments is available if production occurs on the lease within six years. This also applies to existing facilities that undertake a "qualified expansion." An expansion qualifies if it increases production by 10 percent within six years of the Act's enactment and if such production increase is greater than 10 percent of the average production by the facility during the prior five-year period. The Act also increases the acreage limitations on geothermal leaseholds from the current 2,560 acres per lease limitation to 5,120 acres. Additionally, the Act increases the total limit on control and ownership of leases to 51,200 acres.
  • Reauthorization of Price-Anderson Act (Title VI, Subtitle A). The Act reauthorizes Price-Anderson for 20 years to encourage expansion of existing or construction of new nuclear power plants.
MISCELLANEOUS PROVISIONS
  • Authorization for Construction of Nuclear Reactor in Idaho (§ 642). The Act authorizes the construction of a prototype nuclear reactor at the DOE Idaho National Laboratory, which will generate both electricity and hydrogen.
  • Outer Continental Shelf Inventory (§ 357). The Act requires an inventory and analysis of oil and natural gas resources beneath all waters of the United States Outer Continental Shelf.
  • Extensive R&D Provisions (Title IX - §§ 931-34). The Act directs the Secretary to conduct programs of renewable energy research, development, demonstration, and commercial application in the following areas: (1) solar energy and photovoltaics; (2) cellulosic biomass; (3) biofuels and biobased products; (4) biomass integrated refinery; (5) wind energy (low speed, offshore, distributed wind energy generation); (6) geothermal energy (improving resource detection, decreasing drilling and maintenance costs); and (7) hydropower.

Key Contributors

Gary R. Barnum
Jennifer H. Martin
Kevin T. Pearson
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