New Production Tax Credit language in the last-minute tax compromise passed by Congress on January 1st is helpful to bioenergy projects, including anaerobic digesters.
BioCycle January 2013, Vol. 54, No. 1, p. 49
The last minute tax compromise passed by the U.S. Congress on New Year’s Day contains some important incremental benefits for bioenergy projects, but the industry should not expect big changes from Washington, D.C. in 2013. The basic allocation of power that caused the last two years of paralysis in the federal government remains fundamentally unchanged.
The main objective of the January 1st law, the American Taxpayer Relief Act of 2012, was to prevent what was commonly referred to as the “fiscal cliff.” It achieved this by making permanent almost all of the reduced tax rates originally passed in 2001 and 2003, and postponing something called the “sequester,” which is the somewhat bizarre name Congress uses for massive, across the board spending cuts.
Also in the bill, but not in the headlines, are extensions of over 50 smaller tax provisions, including some applicable to bioenergy projects. They include multiple credits for alternative vehicles, energy efficiency, biofuels and the extension of the New Markets Tax Credit, which encourages development in economically disadvantaged areas.
While all of these provisions help renewable energy, one of particular interest is a very important change to the Production Tax Credit (“PTC” or “Section 45”). The PTC is a tax credit for production of renewable electricity, awarding a tiny credit for every kilowatt produced over the first ten years of the operation of a facility.
With the understanding that “a history of tax law” does not invite the reader’s full attention, a brief recap is needed.
As part of the Recovery Act of 2009, also known as the “Stimulus,” two major changes were made affecting bioenergy electricity projects. First, any future facility that qualified for the PTC was granted the ability to elect the Investment Tax Credit (ITC) instead. The ITC had previously been available almost exclusively to solar projects, and differed significantly from the PTC in that the tax credit equaled 30 percent of the capital cost of the facility, available at the time of commissioning. It is important to note that the ITC Section 48 did not substantively change either in 2009 or this most recent legislation and a bioenergy project’s ability to take the ITC still arises from its qualifying for the PTC. Because it is set up this way, the January 1 legislative changes to the PTC language affect either credit; bioenergy projects that qualify for the PTC continue to also qualify for the ITC.
The second change in 2009, now of historical interest only, was the introduction of a program known as “1603.” This program created a cash grant which projects could take instead of the ITC, making the 30 percent ITC essentially a refundable tax credit. The 1603 option has expired, was not renewed, and no serious observer of renewable energy policy expects to see it return. It was meant to cover the international financial crises of 2008-2010, when tax credits were not worth much since large financial institutions had massively lower tax liability.
During the 1603 period, developers obviously chose to elect the ITC based on their qualifying for the PTC and then try to qualify for the 1603 grant to get the ITC credit paid to them at commissioning. In the post-1603 environment, most developers still elect to take the ITC based on their qualification for the PTC. The decision to stay with the PTC or elect the ITC is a combination of math (10 years of PTC revenue compared to 30 percent of capital cost up front) and transactional complexity.
One major challenge to projects trying to qualify for the PTC has been the milestone criteria. To meet the deadline for eligibility, the facility must be “placed in service” by the deadline, which means completely finished, operating and selling power to the grid. For example, when the PTC was last renewed in 2009, the law required that in order to qualify for the PTC (and therefore the ITC), a facility must be “placed in service” by December 2013. In order to legitimately assume the PTC (or ITC) as part of its economic model (that is, to be economically incentivized by the credit), a project must have a high degree of certainty that it would be fully constructed and selling electricity to the grid by December 2013.
Even assuming normal economic conditions, a two to three year development and construction cycle for a renewable electricity project meant that December 2013 was right around the corner by 2010. Risk analysis made this time window even shorter, placing all the delay risk on the developer. Any delay throughout the development or construction process risked missing the deadline, and losing the credit entirely, with devastating effect to the project economics. Over the course of 2010 and into 2011 the number of parties willing to take that risk fell steeply.
The PTC had been severely disrupted by short renewal periods since it was created in 1999, never getting renewed for more than a few years at any one time. These short renewal periods, along with how the deadline to qualify for the credit is drafted, have limited how effectively it incentivizes renewable energy development.
The law just passed makes a major fix to the deadline problem, by changing the criteria for making the deadline to “under construction” from “placed in service.” Therefore, any project that can show it has “commenced construction” by the end of 2013 will qualify for the credit. The Treasury Department has not released guidance yet on what that means, but since there was a similar standard for 1603 it should be somewhat similar.
The simple effect of this is that projects with no chance of being in operation by the end of the year might be under construction and therefore qualify. The more nuanced impact is that the risk calculus has changed. While projects must still take their development risk (that they will obtain permits, etc. and begin construction) the tax credit will now share some of the construction risk. It is likely the forthcoming Treasury Department criteria will not allow construction to stop altogether, but a modest delay in the completion date while some work continues — which would have blown the placed in service deadline — will presumably not affect eligibility. This should be a significant benefit to the number of projects incentivized by the credit.
Renewable Energy Issues To Watch In 2013
The renewable energy industry, including the American Biogas Council (which represents anaerobic digestion and biogas project developers and facilities), will undoubtedly push for an actual extension of the PTC/ITC deadline beyond December 31, 2013. There is talk on Capitol Hill of major tax overhaul being on the agenda this year, which would offer an opportunity for an extension, but there is always talk of major tax overhaul, and the smart bet is that the 113th Congress will be almost as ineffectual as the 112th.
The sequester postponement is only for two months, so many difficult choices await the new Congress. The House and Senate must, before March 1, 2013, address the sequester spending cuts as well as the “debt ceiling,” which is a recurring crisis relating to U.S. government borrowing. Many hold out hope that there will be some sort of “grand bargain” that will allow major reform of entitlement programs, the tax code and who knows what else.
Unfortunately, if the new Congress is like the old Congress, it will neither be “grand” nor will it “bargain.” The most likely outcome of the March 1 deadline is a compromise to cut some spending from the entitlement programs in exchange for cancelation of certain parts of the sequester, most notably the defense portion, and a raising of the debt ceiling. Work may begin on a tax overhaul in the form of discussions and hearings, but progress will be slow.
The one legislative event that probably will occur is the large agricultural and nutrition bill known as the “Farm Bill.” It was set to expire before the January 1 law basically put it on life support for a nine month, bare minimum extension. The Farm Bill was very thoughtfully considered last year, and the nearly final bills from both houses are done. Absent other drama, dusting them off and reconciling them should be possible, but nothing is certain anymore. The Senate version of the Farm Bill contained the energy provisions helpful to bioenergy, such as the popular REAP program, and more importantly contained mandatory funding for them. The House version did not, and trying to push the Senate version of the energy title through to the final law will be a major focus of bioenergy groups this year.
Publicly the Obama Administration has stated that climate change is a major priority for its second term, but the unfortunate reality is that no meaningful carbon controls will pass the 113th Congress. And presented with a recalcitrant House of Representatives and a timid Senate, the Obama administration will probably focus its efforts to support renewable energy on the executive branch agencies it can direct without additional legislation.
Several policies are being played out at the Environmental Protection Agency (EPA), most notably the expansion and strengthening of the Renewable Fuels Standard (which is sometimes confusingly abbreviated as “RFS2” because there were two major laws and we are obviously under the second). The current news at EPA is that Lisa Jackson is stepping down as Administrator. Jackson’s tenure as an advocate of increased protection for the environment has been a lightning rod for Republican opponents of increased or tighter regulation of industrial activity. As such, the confirmation process for any replacement is likely to be a release valve for this anger, subjecting even a moderate nominee to intense scrutiny.
While the administration will put forward a nominee, the process will be long and contentious, and so the EPA will be administered for the foreseeable future by deputy administrator Robert Perciasepe. Perciasepe is well regarded and expected to continue current policies, albeit with perhaps a slightly more diplomatic tone. Under the terms of an incredibly boring and complicated law known as the Vacancies Reform Act, he could serve indefinitely should confirmation proceedings bog down.
In addition to the EPA, the Department of Energy may take a larger role in bioenergy, having spent the first term of the Obama administration in the admirable if somewhat myopic pursuit of cheap solar power. Also in the agencies, but not driven by any political agenda, the Department of Defense (DOD) continues to implement renewable energy targets set for it in 2005, and still views alternative fuel and power as a common sense goal. If the sequester spending cuts go into effect for the DOD, however, all discretionary activity in this regard will be halted.
In short, the bioenergy industry should keep its expectations low for legislative gains in 2013, and focus its attentions on the executive branch agencies, which will hopefully have instructions from the White House to be helpful where they can.
Ted Niblock is General Counsel for Turning Earth, LLC, and is co-chair of the American Biogas Council’s Federal Legislative and Regulatory Affairs Committee.