Distribution utilities are well positioned to provide tax equity for renewable projects, but some state laws prevent it. Tapping the potential will require progressive leadership by utility...
Green REITs, MLPs, and Up-Cs
Over the last several years, a confluence of political and market developments have made capital for renewable energy projects harder to come by, which has affected the ability of unregulated affiliates of public utilities (unregulated utilities) to finance or refinance new and existing renewable energy projects. As unregulated utilities search for capital, they are increasingly considering the use of tax-efficient public capital vehicles such as real estate investment trusts (REIT), master limited partnerships (MLP), and umbrella partnership C corporations (Up-Cs). These three vehicles have important similarities and differences, and they can play a helpful role in satisfying the current and future capital needs of unregulated utilities.
Current Political and Market Developments
In analyzing the sources of capital for renewable energy projects, it is difficult to evaluate political developments without also considering market conditions, and vice versa, because the two are so intertwined. Indeed, the political discussion around renewable energy starts with a simple market truth: Although most people would prefer to obtain their energy from renewable sources rather than burn fossil fuels, the upfront capital costs of renewable energy projects often make these projects unfeasible from an economic perspective. Put simply, consumers are eager to go green until it costs them too much green, at which point they are more than happy to burn fossil fuels. Thus, if the government wants to increase consumer reliance on renewable energy, it must find a way to subsidize that reliance.
Just as market conditions have driven political considerations on renewable energy programs, political considerations have affected the market for renewable energy capital. In order to subsidize the development of renewable energy projects without committing political suicide, American politicians have opted to rely on temporary renewable energy tax-reduction incentives, such as tax credits that reduce the tax liability of renewable energy investors, rather than direct cash payments to businesses that produce or rely on renewable energy or heavy taxes on fossil fuel users. But given the current political environment, the likelihood that these renewable energy tax breaks will be extended beyond their current expiration dates is uncertain.
As unregulated utilities have historically had significant federal tax liabilities, it shouldn’t be surprising that many of the largest portfolios of renewable energy projects are owned by unregulated utilities desiring tax breaks. Nor is it surprising that, in light of the pending expiration of the renewable energy tax incentives and the corresponding increase in economic costs associated with a renewable energy investment, many unregulated utilities are searching for new sources of low-cost capital. 1
In their search for new sources of capital, unregulated utilities are finding that the political decision to structure renewable energy subsidies as tax breaks has created a market dynamic that has encouraged historic renewable energy investors to leave the renewable energy space while financial market conditions simultaneously lay the groundwork for new investors to enter. For example, because the American system for subsidizing renewable energy investments depends on investors having positive income that can be shielded with tax breaks, the system starts to break down when, as happened in 2008 and 2009, those investors suffer