7 minute read 19 May 2020
Engineer inspects turbines at Colorado Wind farm

Why US renewables are looking beyond subsidies

By Brian Murphy

Partner, Power & Utilities Tax, Ernst & Young LLP

Seasoned Power & Utilities Sector tax executive. Renewable energy thought leader. Passionate about transforming tax functions.

7 minute read 19 May 2020

COVID-19 is disrupting the sector, but declining costs, technological advances and financial innovation will drive long-term growth.

This article is part of the 55th edition of the Renewable Energy Country Attractiveness Index (RECAI).

In January, the US Government’s Energy Information Administration (EIA) was forecasting a record year for wind and solar in the US in 2020, with 18.5GW of wind and 13.5GW of utility-scale solar expected to begin commercial operations. COVID-19 will inevitably complicate or even delay some of these installations. However, the pandemic is likely to present a temporary – albeit significant – disruption to the trend of ever-growing penetration of renewable energy across US power markets, while the renewable energy ownership and investment landscape is set to be transformed.

Last year was the third-strongest for wind energy capacity additions in the US, at 9.1GW, according to the American Wind Energy Association (AWEA), bringing the total to 105.6GW. The Solar Energy Industry Association (SEIA) recorded 13.3GW of solar entering operation, the second-highest total after 2016, bringing total solar capacity to 77.7GW. Together, the two sources accounted for two-thirds of new US power-generating capacity in 2019, according to the SEIA, with natural gas making up most of the remainder.

The forecast surge in 2020 installations, particularly wind, is largely a result of projects that began construction in 2016 and need to be operational by year end to qualify for the full Production Tax Credit (PTC) under safe harbor rules. This key federal tax incentive is worth around $24/MWh for 10 years.

For solar, the Investment Tax Credit (ITC) began tapering for projects starting construction as of this year. A similar surge in solar installations is likely to occur in 2023, the last year in which projects must be placed in service to claim the credit’s full value (worth 30% of the project’s qualified costs) under similar safe harbor guidelines.

Near-term disruption, longer-term optimism

The shutdown of the economy in response to COVID-19 may not have a material impact on the long-term outlook for renewables in the US, but it is certainly causing disruption in the near term. In April, the EIA revised its 2020 forecasts for wind and utility-scale solar capacity additions downward by 5% and 10%, respectively.

As noted above, many wind projects are operating to tight timetables to qualify for the PTC. Difficulties caused by the pandemic, such as sourcing or moving equipment through battered supply chains and crew working issues, could hold up projects, potentially affecting their ability to qualify for PTC or ITC credits. The risks presented by a delayed installation that might put a project outside of these safe harbor rules are driving the sector to seek guidance from the Government on whether COVID-related delays could be an exception to the rule.

Looking ahead, some in the industry are concerned that an economic downturn triggered by the pandemic will reduce the appetite of tax equity investors for tax credits. These buyers – typically investment banks – are likely to have lower tax receipts in the near term against which to offset these credits. However, signals so far from investors are that they will remain in the market.

While the COVID-19 pandemic presents near-term headwinds to renewables, the longer-term prognosis remains favorable. One powerful driver for the sector is the clean or renewable energy targets set by a growing number of states. Thirteen states, including California, New York and New Jersey, have set 100% goals or mandates, typically to be reached between 2040 and 2050. In addition, the improved performance and falling costs of renewables, allied with growing sustainability concerns among ratepayers and corporate buyers, have encouraged utilities to favor renewables for new capacity.

While the COVID-19 pandemic presents near-term headwinds to renewables, the longer-term prognosis remains favorable. One powerful driver for the sector is the clean or renewable energy targets set by a growing number of states.

Here, persistent low natural gas prices resulting from any economic slowdown have the potential to change some utilities’ investment decisions in favor of natural gas generation over renewables, although the likely extent is currently unclear. The EIA is continuing to forecast that renewables will grow to 38% of power supply by 2050, from 19% today, with natural gas declining slightly – to 36% from 37% at present – and coal losing out, dropping from 24% to 13%. 

Broader market realignment

A longer-term transformation is also taking place, with regulated utilities set to increase their ownership of renewables and showing a reduced appetite for signing power purchase agreements (PPAs) with independent power producers (IPPs).

Historically, many utilities have relied on IPPs as their primary source of renewable energy, entering into long-term PPAs to meet state mandates and customer demand for clean power. As these mandates and demands continue to grow, utilities are rethinking those relationships.

A critical enabler of the IPP renewable model has been the inability of utilities to take advantage of renewable energy tax credits in the same way as IPPs. Put simply, because of tax normalization rules and traditional utility ratemaking, utilities are required to spread the benefits of the credits across the entire useful life of the project. While IPPs can realize their benefits upfront, often through the use of tax equity partnerships. This has made renewable power from IPPs cheaper than if the utilities owned the assets themselves.

However, utilities are exploring how they might access the same tax equity markets that IPPs use – and, so far, seem to be making progress on addressing the critical issues. While complexities exist, and each utility is in a different position, there appears to be a clear opportunity to close the renewable energy price gap with IPPs.

This is likely to change the US renewable landscape again, by enabling more utilities to develop renewables projects on their own balance sheets. IPPs will probably evolve as well, pursuing develop, build and operate models on behalf of utility clients – in which case, they would no longer own the renewable assets.

While utilities may encroach on the existing IPP business model, they face their own mounting pressures as well. One to watch is from Community Choice Aggregation (CCA) programs. These allow municipalities to procure power on behalf of their residents and businesses, and for their own needs, from alternative energy suppliers.

However, utilities are exploring how they might access the same tax equity markets that IPPs use – and, so far, seem to be making progress on addressing the critical issues. While complexities exist, and each utility is in a different position, there appears to be a clear opportunity to close the renewable energy price gap with IPPs.

These CCAs – which typically involve municipalities tapping power from renewable sources (often provided by IPPs) – are permitted in California, Illinois, Ohio, Massachusetts, New Jersey, New York and Rhode Island. In California, roughly 15% of the state’s load has moved from incumbent utilities to CCAs. The growth and increasing cost-competitiveness of energy storage is likely to accelerate this trend.

Looking ahead

The industry is lobbying hard for support from Congress as part of broader stimulus funding. Here, concerns about job losses from COVID-19 impacts will be central to any support; the SEIA has warned that 50% of the 250,000 jobs in the solar sector could be affected, while AWEA estimates that 35,000 wind-energy jobs are under threat.

Such support from Congress could take a number of forms, ranging from a further extension of PTC and ITC deadlines, to making these tax credits refundable in some form or another.

One area with a potentially unique claim for support is offshore wind. As the technology is less mature than its onshore equivalent, while also offering significant promise in terms of capacity addition and job creation, there is some momentum on Capitol Hill behind special treatment for the offshore sector. AWEA forecasts the market to grow from almost zero at present to 20-30GW by 2030.

Energy storage is also set for strong growth. The sector achieved record deployment in the last quarter of 2019, with 186MW/364MWh of new capacity added, according to figures from the Energy Storage Association. They and Wood Mackenzie forecast that the market will grow from annual deployment of 523MW in 2019 to 7.3GW in 2025, with growth largely driven by utility procurement.

While COVID-19 undoubtedly poses challenges and headwinds in the near term, declining costs, technological advances and financial innovation will generate tailwinds for a sector already benefitting from strong user demand and a clear environmental imperative.

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Summary

The COVID-19 pandemic is having a significant impact on the US renewables sector, complicating or delaying some wind and solar installations. In the long term, however, penetration of renewable energy across US power markets will continue to grow, and its ownership and investment landscape will be transformed. 

About this article

By Brian Murphy

Partner, Power & Utilities Tax, Ernst & Young LLP

Seasoned Power & Utilities Sector tax executive. Renewable energy thought leader. Passionate about transforming tax functions.