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Before You Build It: Think Green

The complex financial analysis that has driven renewable energy investment has become the standard for assessing all potential electric generation investments.

Fortnightly Magazine - October 2007

every approach, however, is the need to analyze each factor and understand how the choices made with respect to one will impact another.

A critical concern for renewable-generation investments is qualification for, and the utilization of, the tax-based incentives that subsidize renewable (or other alternative) energy investments and operations in the United States, as these incentives typically are critical for ensuring viable project economics. From a financial analysis and modeling standpoint, an investor must be able to identify and quantify the benefits of the available federal, state, and local tax incentives, which range from technology-based, to production, investment and even to location-based incentives. 3 Tax incentives, and the utilization of those benefits, will depend upon several variables, including ownership structure, location, timing and source technology.

Additionally, many states have enacted some form of renewable portfolio standard (RPS), which requires that specific portions of power sold within a state be derived from renewable sources. These standards and the associated renewable-energy credits significantly can impact the value of electricity generation. While the impact of these standards currently has only a modest effect, if any, on the price of electricity in most states with renewable portfolio standards, the effect on pricing and the associated value of the power-purchase agreements that are used as financing devices for many projects can be quite significant in the markets like California, 4 where these standards have substantial near-term targets. In those markets, renewable portfolio standards also can be a critical factor in the analysis of potential generation investments.

Factoring in the value considerations associated with a renewable portfolio standard and renewable-energy credits can have an impact on ownership interests, location, power sales agreements, project timing, and many other aspects of the investment process, all or some of which may, in turn, affect the viability and value of the tax benefits. So, this process is not simply a determination of the aggregate value of the collective potential incentive. The economics of both tax and renewable portfolio standard programs must be balanced when analyzing issues like location or ownership structure because a decision may impact both financial considerations, but not necessarily in the same manner or direction.

While not yet as developed in the United States as the tax-incentive-based financing or even RPS-driven financing, the value and costs associated with carbon-limited electricity production are rapidly becoming relevant in California 5 and the several Northeast states that are in the process of implementing the Northeast Regional Greenhouse Gas Initiative (RGGI). 6 The value, therefore, associated with producing renewable electricity under a regional carbon cap-and-trade program, such as RGGI—or eventually under a national program—then must be built into the economic model. 7 As with tax incentives and renewable portfolio standards, integrating tax and carbon financing will be critical to successful investing in the U.S. markets. Carbon-offset valuation will add additional complexity to many of the same factors that could impact RPS efficiency or the viability and value of the tax benefits. 8

This economic-projection process is made exponentially more difficult by the uncertainty attached to each of these aspects of the financial analysis.