Investors and developers have been able to significantly improve the economics of wind power projects by "monetizing" the federal production tax credit ("PTC"). There are a number of transaction structuring alternatives to achieve this, although the term "monetizing" is somewhat of a misnomer since these transactions do not involve sales of the PTC. These transactions constitute real investments in wind power projects by investors with sufficient income from other sources to fully utilize the PTC and other potentially significant tax benefits generated by those projects, with the potential of higher returns. Choosing the right structure will depend on the particular needs of the investor and the developer, including the investor’s return requirements. With the right structure, these transactions can have a tremendously positive impact by matching investors that can use tax benefits with developers looking for favorable funding alternatives.
The PTC
The PTC is a nonrefundable credit against federal income tax liability that is available for electricity produced from certain qualified renewable resources, including wind, and sold to unrelated parties. The amount of the PTC for 2004 was 1.8¢ per kWh ($18.00 per MWh) of electricity produced and sold during a taxable year. This amount is adjusted annually using an inflation adjustment factor published by the Internal Revenue Service each Spring. The PTC is available for each taxable year in the 10-year period that begins on the date a project is placed in service. Because the PTC is a relatively stable amount that is not directly affected by market conditions or the financial performance of the project, it can help to ensure a somewhat consistent return on investment regardless of the price of power, project expenses or other similar factors. Thus far, Congress has only authorized PTCs for limited periods of time. At this time, for a new project to qualify for the PTC, a project must be placed in service on or before the December 31, 2005. The hope and expectation is that Congress will continue to extend the expiration date.
Motivation
Many developers do not have sufficient federal income tax liability to fully utilize the PTC and other tax benefits (such as depreciation) generated by a wind power project. By bringing in an investor with sufficient federal income tax liability from other sources to use those benefits, a developer can fund the project while providing the realistic possibility of a high and relatively stable rate of return on the investor’s equity investment. Because of the relative certainty of the availability of PTCs, some equity investors are willing to provide certain limited credit support for project debt financing, which may increase the leverage available for a project (reducing the amount of equity needed to fund the project) and improve overall returns.
Structure
There are a variety of ways to structure an investment in a wind power project to take advantage of the PTC and other tax benefits. The specific structure of an investment must be highly customized to meet the investor’s, developer’s and project lender’s particular circumstances and requirements. One potentially useful structure involves an equity investment in a partnership (or a limited liability company taxed as a partnership) that owns the wind power project (the "Owner"). The basic project economics are premised on the sale of the electricity generated by the project and any associated "green tags" to utilities or other wholesale power marketers pursuant to one or more long-term power purchase agreements, generating a relatively stable stream of revenues. The equity interests in the Owner can be structured so that the investor initially receives a large percentage of all cash distributions and tax benefits from the project, including the PTC. Once the investor has received an agreed-upon after-tax return or some other objective standard has been met, the sharing ratios may "flip' so that the investor receives a smaller portion of cash distributions and tax benefits and the developer receives a larger portion. The developer also may retain an option to purchase the investor’s equity interest upon the occurrence of an agreed-upon event. The alternatives available for structuring the relationship between the investor and the developer are quite varied and these transactions frequently are highly complex. Thus, these transactions require careful structuring and drafting to meet each investor’s unique requirements.
Debt Financing And Credit Support
Wind projects often are partly financed with project debt, which can increase the returns offered to the equity investor. As discussed above, given the availability of the PTCs combined with the desire to increase the return on their investment, investors may be willing to provide credit support to cover certain circumstances that may occur, such as lack of wind, that could prevent the project from generating sufficient revenue to cover debt service. This credit support may take a variety of forms, such as an agreement by the investor to make additional capital contributions in the event of a cash shortfall, to be made up in later years from distributions when project production is at or above anticipated levels. In addition, products such as insurance and liquidity facilities may be available from third party financial institutions to cover some of these risks. If the investor is willing to provide credit support, or if insurance or liquidity support is available at a favorable price, the amount of debt may be increased or the overall cost of debt financing may be significantly reduced, or some combination of the two, which may improve the investor’s overall return.
Project Management
The developer typically manages the wind power project and is responsible for operation and maintenance, subject to customary rights of the investor to remove the developer from management and operation functions due to non-performance.