Tax equity options for renewable electricity projects are emerging for companies seeking impactful avenues to access renewable power, reduce their emissions, and generate financial returns. In the last decade, the corporate renewable electricity procurement market has grown and transformed in many exciting ways, giving businesses greater choice and autonomy over how and what kind of power they use in their operations. However, high competition and constriction of the markets for other renewable electricity procurement options, particularly in the U.S., are pushing corporate buyers to explore tax equity investment as an alternative. While the Inflation Reduction Act hopes to alleviate many of these headwinds, the impacts are still uncertain and corporate tax equity investment is expected to thrive under renewed tax credits for solar, wind, and other technologies.
Stay tuned for more details on the impact of the Inflation Reduction Act on corporate renewable and cleantech opportunities in an upcoming post.
Companies looking for the next evolution in their renewable electricity strategy should assess tax equity as another tool in the toolbox of renewable procurement mechanisms. For the opportunistic buyer, beginning to explore tax equity today is a great way to adapt to high competition among renewable electricity buyers, maintain or accelerate progress toward decarbonization goals, and take advantage of an attractive investment opportunity before the market potentially becomes saturated. Today, we explore some of the most common questions we get from our customers on renewable tax equity investment.
Dave Smith, Senior Client Development Manager, Schneider Electric
Dave helps global corporate clients explore and implement renewable energy solutions. He specializes in designing custom solutions for clients seeking to gain a competitive advantage through sustainability.
Hans Royal, Director of Renewables & Cleantech, Schneider Electric
Hans leads Schneider Electric’s Cleantech & Renewables client development team, specializing in renewable energy advisory, utility-scale PPAs, project development and finance, risk management, and corporate energy strategy.
How does tax equity work for renewable electricity projects?
While there are many forms of tax equity, in this blog we are specifically discussing investment in offsite solar and wind power projects in the U.S., where tax benefits and access to renewable energy certificates (RECs) in bulk make it an attractive option for some businesses. Historically, the market for tax equity investments has been dominated by banks and insurance companies. According to Norton Rose Fulbright’s investor panel, renewable energy tax equity in 2021 made up an estimated $19 - 20 billion market, about half of which was supplied by just a few large banks. As the dynamics of the U.S. renewables market shift, corporates are beginning to explore and invest in these projects to acquire RECs, reduce Scope 2 emissions, contribute additional renewable electricity to the grid, and generate financial returns.
When a company invests in a solar or wind project through tax equity, they agree to provide an upfront cash infusion to a new-build project. They will work with the developer from an early stage, providing an investment of typically $50 million or more to get the project off the ground. This one-time cash outflow is followed by average annual equity yields of 6-8% during the 5- to 10-year term of the agreement.
In exchange for financial support, the investing company may receive environmental benefits and financial benefits. From an environmental perspective, the company can claim Scope 2 emissions reductions, renewable electricity usage, and additionality if RECs are included. From an economic perspective, they gain the ability to monetize federal tax credits, accelerated depreciation benefits, and preferred cash distributions. Read more in our quick reference guide.
How is tax equity different from a power purchase agreement?
There are several key differences between tax equity projects and renewable power purchase agreements (PPAs). Perhaps most significantly is that, unlike a PPA, tax equity requires an upfront capital commitment from the company, typically of $50+ million, and a commensurate federal tax liability so that they can effectively monetize the tax benefits. These qualifiers drive scarcity in tax equity investment supply and help create the financial opportunity for those organizations that do meet the criteria. This is in contrast with mechanisms like offsite PPAs where the barriers to entry are relatively low and the market has become rich with corporate buyers.
The treatment of RECs is another difference between tax equity and an offsite PPA. Because tax equity has traditionally been a purely financial transaction, RECs are not included in a normal tax equity deal, as would be expected in a PPA. Prospective buyers who wish to make environmental claims via tax equity investment should work with a knowledgeable and experienced advisor to navigate this complexity and structure a deal that achieves their goals.
As PPAs become a mainstream decarbonization lever for businesses, the high competition from large electricity users means that the minimum viable threshold for electricity load has increased over time. In other words, to secure a PPA today, buyers must have a significant electricity load and be willing to offtake a substantial portion of a renewable project. As a result, we’re seeing a deterioration in the competitiveness of PPA bids for smaller companies with less consumption. However, tax equity is not subject to this load requirement. Some businesses targeting smaller volumes may have more success accessing utility-scale renewables to meet their needs via tax equity investment.
Finally, there are some differences in the additionality claims that come from tax equity projects compared to PPAs. By committing to offtake the renewable electricity from a new project via a PPA, companies give a level of certainty to the developer that helps the project move forward, enabling additionality claims. With tax equity, the corporate is a key financial supporter of the project and, by laying out cash, provides an even more direct link to the construction, or additionality, of a new renewable electricity facility.
Like PPAs, tax equity projects can be structured specifically to meet the needs of a corporate buyer looking to invest in renewables. However, because corporate participation in the tax equity market is nascent and many developers and companies do not yet have this institutional knowledge, it is important to make sure that the terms and conditions are favorable.
Who should consider tax equity investment for renewables?
Tax equity investment is not a strategy that will make sense for every company. There are several attributes that determine for whom tax equity will make the most sense:
- Businesses with U.S. federal tax liability and appetite for tax benefits. This implies that the company has a strong understanding of what its tax exposure looks like for the next 5 years or more to justify the investment.
- Companies with a sizeable electricity load, but may find themselves under-sized for today’s competitive PPA market
- Organizations seeking to meet 100% renewable electricity and/or emissions reduction goals
- Organizations seeking direct investment opportunities in impactful low-carbon technologies
Why tax equity? Why now?
Over the past 12 months, increasing corporate commitments to renewable electricity procurement and decarbonization have brought more demand into the marketplace. This has resulted in greater competition for the pool of available PPA projects that many companies rely on to reach their goals. This challenge, combined with the recent passing of the Inflation Reduction Act, which extends and restores the full value of renewable energy tax credits, makes now an opportune time to assess tax equity alongside other mechanisms for renewable electricity procurement.
Strong risk-adjusted returns and access to large tranches of RECs are key factors driving interest in this mechanism today. Tax equity should be treated as another tool that companies can use to reach their goals while securing a variety of other attractive environmental and financial benefits. It should be vetted against other strategies, such as PPAs and unbundled RECs, and could replace or complement any scalable REC procurement mechanism in a company’s portfolio.
Although tax equity investment in renewable electricity is new to many companies, the road has been well-paved. Tax equity investment is not an exotic or uncharted strategy – banks have been doing it for years with much success and have laid the groundwork for businesses to capitalize as early movers in the highly competitive corporate renewables market. Nestle and Starbucks are two examples of companies that have endeavored into tax equity to reach their goals.
We predict renewable tax equity will gain even more traction and popularity with eligible businesses due to the distinct advantages it offers. For the opportunistic buyer, beginning to explore tax equity today is a great way to adapt to high competition among corporate buyers, accelerate progress toward decarbonization goals, and join the early movers on an attractive investment opportunity that shows promise for years to come.
As the number one global advisor for corporate renewable electricity procurement, with a team of experts who have been charting new paths for corporate buyers for decades, Schneider Electric is an ideal partner for companies looking to investigate whether tax equity fits into their renewable power portfolio. We have the deep developer relationships and contract knowledge needed to secure the best deals and enable your company to achieve its clean energy ambition. Contact us today to learn more.
This blog is for informational purposes only and not for the purpose of providing legal, financial, or tax advice. Although we go to great lengths to make sure our information is accurate and useful, we recommend you consult a lawyer if you want legal advice, an accountant if you want accounting advice, and a registered investment advisor for investment advice. This is not an offer to buy or sell securities.