Monday, July 20, 2009

US Renewable Energy Grant Rules Exclude Private Equity

By Yuliya Chernova
July 20, 2009

A grant program introduced in the federal stimulus package passed earlier this year was intended to jump-start investment in renewable energy, but the rules of the program threaten to hobble it from the start by restricting private equity involvement in any projects the government backs.

The rules, published July 9, exclude from the program any projects with investors that have tax-exempt status. That was done because the grant program is intended to replace tax credits, which have become less widely used as taxable incomes have fallen. Tax-exempt investors wouldn't have been able to take advantage of tax credits so the intention is to bar them from the grant program too, according to industry participants.

However, most private equity firms receive backing from tax-exempt limited partners like endowments, pension funds and family trusts, excluding them from the program. Even if the tax-exempt entity holds just a 0.1% interest in the renewable energy project four tiers up the ownership structure, the entire project is disqualified, according to the rules published on the U.S. Treasury Department Web site and several attorneys and industry members. In a similar vein, if any of a project's ownership lands in the hands of a tax-exempt entity within five years of operation, the grant can be reclaimed by the government, according to the Treasury rules.

Projects backed by private equity can get around the ban by creating an extra layer of ownership, but this would force investors to pay more taxes.

The exclusion is "taking a huge piece of renewable energy off the table," said Greg Wetstone, vice president for government affairs at Terra-Gen Power LLC, a large solar, wind and geothermal project development company owned by private equity firm AcrLight Capital Partners.

Renewable energy industry groups estimate that this ban places more than $10 billion in new renewable energy development at risk, according to a letter seen by Clean Technology Insight that the groups sent to several members of the U.S. House of Representatives in June in response to their concerns about the program wording in the stimulus package. The groups sending the letter were the American Wind Energy Association, Geothermal Energy Association, Solar Energy Industries Association and Private Equity Council.

A Treasury official didn't respond to a request for comment.

When he announced the new guidelines, Energy Secretary Steven Chu said in a statement: "These payments will help spur major private sector investments in clean energy and create new jobs for America's workers. It is part of our broad effort to double our renewable energy capacity in the next few years and make sure that America leads the world in creating the new clean energy economy of the future."

But the letter from the industry groups counters that the ban included in the guidelines actually "has the effect of discouraging renewable energy investment by private equity funds."

The letter goes on to say: "it will be next to impossible to achieve the President's ambitious goal of doubling renewable energy production in the United States over the next three years. The participation of private equity is especially important in the current economic environment where renewable energy developers are having difficulty raising capital, development is being scaled back, it is difficult to borrow money, and there is a several billion dollar shortfall in the supply of tax equity."

Terra-Gen's Wetstone said that he and others in the industry are lobbying the government to change the rules before the Treasury starts taking applications Aug. 1. Wetstone declined to say whether Terra-Gen would apply for the grants if the rules don't change before the deadline.

The American Recovery and Reinvestment Act of 2009 authorized the Treasury to offer cash grants to renewable energy projects worth about 30% of their cost. The aim was to make up for the departure of tax-equity investors, a major source of capital for renewable energy in the past who backed projects and then used government tax credits to offset taxable income. At the same time, many in the industry looked to private equity as a new source of capital for projects that were being orphaned by banks.

As well as keeping the grants focused on tax-paying entities, the restriction in the program is also to ensure that entities eligible for another renewable energy incentive called Clean Renewable Energy Bonds don't also apply for the Treasury grants. Those issuing government-supported bonds are state, local and tribal governments, public power providers and electric cooperatives, according to the industry group letter.

Keith Martin, a partner at the law firm of Chadbourne & Parke LLP who works on renewable energy projects, described the restrictions on tax-exempt institutions as "like a nuclear bomb, when all that was needed was a fire cracker."

In order to circumvent the rules as they are, private equity firms would have to create "blocker" corporations that would be tax-paying entities. "Putting a blocker in the structure means the earnings from the project will be taxed at the blocker level at a 35% corporate tax rate," Martin said.

Some private equity firms intend to invest and apply for the Treasury grants even if the rules remain as they are.

"If there are transaction costs to be borne, so be it," said Neil Z. Auerbach, managing director at Hudson Clean Energy Partners, a clean technology focused private equity firm that holds controlling interests in two project-development companies, Recurrent Energy and Element Power. "I don't think there's any risk that the cost will outweigh the benefit. The benefit is huge," he said, adding "we are absolutely ready to operate within the system."

Even so, it's clear that projects that have private equity backers are at a disadvantage compared with those that don't. "Ironically, the stimulus [helped] the top tier of developers, but not the lower tiers that have had to turn to private equity funds to raise money," Martin said.

The issue hearkens to a broader discussion in the renewable energy world, according to Edwin Feo, partner at the law firm of Milbank Tweed Hadley & McCloy LLP, where he co-chairs the project finance and energy practice.

Feo said that all types of tax subsidies have unequal effect on industry members. So there's a school of thought, he said, that questions "why are we continuing to play the game of having subsidies through tax benefits that have these pernicious unequal effects versus direct pay subsidies that provide cash usable by anyone. That's the school of thought that's pushing feed in tariffs. And that's seeing traction at the state level."

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